Dollar damages Walmart profits
Walmart’s latest results are disappointing overall, with the flat growth of last quarter turning into a 1.3 per cent decline in sales over the latest period.
This deterioration has filtered through to the bottom line where net income was down by 11 per cent over last year.
As poor as the numbers are it is important to recognise the negative impact of international on the performance. Walmart, like many other US retailers, is feeling the heat of the strong dollar which is having a deleterious impact on the contribution from overseas divisions. The scale of this can be measured by the fact that the 11.4 per cent slip recorded for international sales translates into 3.2 per cent growth when the vagaries of foreign exchange are removed. This, in turn, adds an extra $5 billion of sales to the total number which would equal net sales growth of around 2.8 per cent over last year.
That exchange rates have punished Walmart should not be taken to mean that all is well in the international division. Across many geographies the business continues to be challenged with, for example, sales at its Asda format in the UK falling by 4.5 per cent on a same store basis. Such declines in productivity demonstrate that there is much work to be done to improve resonance with customers and rebuild loyalty against the backdrop of markets which are becoming ever more competitive.
In essence, Walmart’s international dominance and scale no longer affords it easy protection against other global retailers like Aldi.
This same argument also applies closer to home in the US market, although in our view Walmart’s scale and reach arguably still gives it more of an edge in a country as vast and geographically dispersed as the US. That said, the days of Walmart prospering simply because it offered the lowest prices in the most convenient location are on the wane – even in locations where it remains the predominant player.
There are several reasons for this undercutting. The first of these is an obvious one in that the internet in general, and the rise of Amazon in particular, continues to threaten Walmart on both price and convenience. While not as comprehensive in terms of offer, the rapid growth of dollar stores over recent years poses similar risks albeit in the physical arena. Overlaid on top of this is growing trend of shopping at smaller, local stores. All of these things are a challenge to a legacy player such as Walmart.
That said, against such a backdrop Walmart’s domestic figures are far from shoddy. Certainly total US sales growth slowed to 3.8per cent from last quarter’s 4.8 per cent, but this is in line with the general sluggishness across the consumer economy over the period and does not necessarily signal that the growth trend at Walmart is now inevitably downward. Pleasingly, part of the growth was down to an increase in customer traffic across the period although, store traffic remains down on the levels seen back in 2013, mostly because of the evolution in shopping habits and the rise of competition.
Less favorably, while gross profits in the US edged up thanks to more discipline around promotions and discounting, operating profit fell by 8.6 per cent. Much of this is down to higher costs around online fulfilment, an increase in the complexity of the operation, and some of the investments made in areas like customer service.
On top of this, significant investments in areas like eCommerce will, as Walmart has previously noted, have a drag on near term earnings growth.
In our view, it is this deterioration in profitability, and not the pressure on the sales line, that represents the biggest forward challenge to this behemoth of a retailer. Arguably, if Walmart is to retain and grow its market share in the US it has to flex and align its business model with new ways of shopping and consuming. Those ways are more complex and more costly, and they require investment in systems, logistics, and propositions. The price of continued dominance, at least over the short term, is reduced profit.
In our opinion, that Walmart has elected to take the long term view and sacrifice short term earnings for continued relevance over the longer term is correct. Walmart may be judged harshly by some investors, but there is a certain irony in the fact that many of those same investors applauded Amazon – which for many years was hopelessly unprofitable – for pursuing the self same strategy. The difference, of course, is that Walmart will remain profitable throughout its transition period.
Arguably Walmart has only really started its transformation, especially in eCommerce. Here we believe its advancement – and the fact it is able to leverage its sizable store base as part of the distribution and fulfillment operation – poses some threat to Amazon and to other online players. Walmart may have been relatively late in coming to the eCommerce party, but now it has arrived it brings with it a very considerable set of party tricks, including massive economies of scale, superior technology, and an advanced and extensive logistics operation. It also has the financial firepower to invest in and enhance these things over time.
Despite its size, and some of its international headaches, back at home Walmart remains highly entrepreneurial and open to change — both virtues that will serve it well in a rapidly changing retail market.
- Neil Saunders is CEO of retail analyst Conlumino.