Walmart Warning Shows Significantly More Profit Pressures From Inflation, But Long-Term View Intact

We do not believe wide-moat Walmart’s long-term standing has changed despite revised guidance that suggests significantly more near-term profitability pressure than we had expected. Our $138 per share valuation should slide by a high-single-digit percentage in the wake of the news, similar to the after-hours trading reaction, and we suggest prospective investors await a greater margin of safety.

Although we are not surprised by Walmart’s indication that sales mix (in favor of less lucrative food and consumables at the expense of more discretionary items) and markdowns to clear excess inventory are weighing on profitability, the magnitude of the strain is greater than expected. For the full year, leadership now expects an 11%-13% plunge in adjusted earnings per share, well below its earlier calls for a low-single-digit percentage dip (which was near our forecast, and we expect to revise our estimates toward the lower end of management’s range). Management indicated double-digit food inflation rates are higher than they were at the end of the first quarter, leading consumers to shift more spending away from categories like apparel. We suspect longer-than-usual lead times for certain orders are magnifying the effects of rapidly shifting demand, leading to Walmart’s need to discount excess merchandise to keep inventories clean.

Reassuringly, management cited continued market share growth in grocery, which we believe suggests Walmart’s value-oriented market positioning is paying off as consumers cut expenses. With unparalleled purchasing power and vendor relationships, strong cost leverage, and a reputation for aggressive pricing, we believe Walmart should benefit from trade-down traffic as the effects of inflation are felt by more middle-income households. Consequently, we expect Walmart to endure the current situation better than most retailers, with an opportunity to retain customers attracted by low prices with an increasingly convenient omnichannel offering.