Inflation Dents Walmart's Results

Our $152 per share valuation of wide-moat Walmart WMT should slide by nearly 10%, not far from the market's reaction to first-quarter earnings that saw greater-than-anticipated margin pressure caused by pandemic-related factors and inflation. Still, we believe Walmart's value proposition should become increasingly valuable to strained consumers and expect low-single-digit annual percentage sales growth and mid-single-digit adjusted operating margins over the next decade. Prospective investors should await a more attractive entry point. Sales were strong, with inflation and consumers' focus on value driving Walmart's global top line (up 2.4% to $141.6 billion, near our estimate). However, its operating margin lagged our 4.8% estimate at 3.8%. Management attributed the softness to three factors, mostly affecting its domestic operations: overstaffing on account of shorter-than-anticipated absences by employees that caught COVID-19, a mix shift from general merchandise toward less-lucrative grocery as consumers redirected dollars considering inflation (which was exacerbated by high transport costs), and fuel and supply chain expenses that rose faster than Walmart's ability to lift prices. While the first factor appears controlled and price hikes should gradually help rebalance Walmart's cost profile, we are likely to take our full-year adjusted EPS target down from its current $6.87, up 6.5% from a year ago, toward management's new expectation of a 1% decline (previously a mid-single-digit increase). Management gave a mixed read of consumers' reaction to higher prices, with strong sales of big-ticket items but a shift toward private label grocery items, smaller pack sizes, and food and beverage at the expense of general merchandise. We believe the unsettled environment favors Walmart's value orientation and assortment rife with trade-down opportunities, though the rapidity of the price shift strains even its ability to dynamically adjust pricing and cut costs.