Analysis: WMT AMZN

Walmart (WMT) , before the opening bell on Thursday, reported a mixed result with its fourth-quarter earnings results. On the top line, total revenues of $152.1 billion (+7.3% YoY) outpaced the $148.5 billion consensus. On the bottom line, adjusted diluted earnings of $1.39 per share (+0.7% YoY), or $1.46 ex-tax related items, missed expectations of $1.51 per share.

"We completed a strong year and a strong Q4 thanks to our amazing associates. They stepped up to serve our customers and members exceptionally well during a busy holiday period in the midst of a pandemic," said Walmart President and CEO, Doug McMillon. "Change in retail accelerated in 2020. The capabilities we've built in previous years put us ahead, and we're going to stay ahead. Our business is strong, and we're making it even stronger with targeted investments to accelerate growth, including raises for 425,000 associates in frontline roles driving the customer experience."

Before digging in, a quick look at the consolidated numbers. Net sales of $151.0 billion were compounded by membership and other income of $1.1 billion (+2.9% YoY). The gross profit rate was 23.7%, an increase of 29 basis points (bps) YoY while operating expenses as a percent of sales increased 41 bps to 20.8%, resulting in adjusted operating income of $5.7 billion (-3.2% YoY), a miss versus the $6.4 billion consensus.

Operating Segments

Digging into the various operating segments, Walmart U.S. delivered solid results with net sales of $99.6 billion (+7.9% YoY), exceeding estimates of $97.56 billion. This represents a reacceleration from the 6.2% segment revenue growth seen in the prior quarter. Overall comparable sales were very strong, increasing 8.6% in the quarter versus a 5.8% consensus. On the release management noted that sales were strong throughout the quarter, holiday sales were "robust," and the company saw an acceleration in January because of stimulus-related spending. Food comps also accelerated throughout the quarter.

Looking at comparable sales growth in key categories, the company saw high single-digit growth in grocery, mid single-digit growth in health and wellness, and low double-digit growth in general merchandise.

Making up the comparable sales number was a 10.9% decline in comparable transactions that was more than offset by a 21.9% jump in comparable average ticket as, similar to prior quarters, "customers consolidated store shopping trips with significantly larger average baskets."

Despite a slight sequential deceleration, consumers continued to flock to as e-commerce net sales increased 69% YoY (versus 79% in the third quarter) and contributed ~620 bps to comparable sales (versus in ~570 bps in the third quarter) with marketplace and pickup and delivery sales once again up triple-digit percentages.

U.S. operating income was $5.2 billion (+17.4% YoY), short versus the $5.5 billion consensus and representing a margin of 5.2% as the gross profit rate expanded 20 bps thanks to strategic sourcing initiatives and fewer mark downs and improvements to e-commerce margin rates (key to the long-term story). The operating expense rate, declined 22 bps, benefitting from reduced travel and professional services and the lapping of a $450 million business restructuring charge from last year, though this was offset by ~$900 million of incremental Covid costs (over 90% of which was related to associate bonuses and benefits).

Walmart International net sales were $34.9 billion (+5.5% YoY) and beat out expectations of about $33.72 billion. On a constant currency basis, net sales were $35.1 billion (+6.3% YoY), with growth being led by Flipkart (India), Mexico, Canada, and eCommerce in general accounting for 18% of the total.

Adjusted operating income was $1.0 billion (-19.7% YoY; -18.3% on a constant currency basis), a miss versus expectations closer to $1.3 billion. The gross profit rate expanded 39 bps as the segment lapped unrest in Chile and reduced fuel sales in the UK, though this was offset by a mix shift to lower margin formats. Operating expense rate increased 78 bps with 66 of those bps coming from a decision to repay tax relief in the U.K and Covid-related costs of ~$100 million also taking a toll.

Sam's Club net sales were $16.5 billion (+8.1% YoY) with fuel and were better than estimates of $16.3 billion. Aiding segment revenues was strong eCommerce sales, which grew 42% YoY thanks to "strong curbside performance and solid direct-to-home contribution."

Without fuel, comparable sales increased 10.8% YoY and with fuel comps grew 8.5% YoY and were "driven by an increase in both transactions and average ticket." Looking under the hood at the drivers of the strong comparable sales, fresh/freezer/cooler saw high teens growth, grocery and beverage saw high teens growth, consumables comp growth was in the low 20% range, home and apparel growth was in the high single-digit region, and health and wellness saw mid teens comp growth. On the other hand, technology, office and entertainment comps contracted at a low double digit rate.

Membership income increased at the highest quarterly rate in over six years and 12.9% YoY due to Improvement in total number of members, overall renewal rates, Plus renewal rates and Plus penetration rate. New member count was up ~28% from the year ago period.

Adjusted operating income with fuel was $0.4 billion (+1.3% YoY), in line with estimates, as the gross profit rate expanded 53 bps, thanks to a "favorable sales mix, including lower tobacco and fuel sales, partially offset by higher eCommerce fulfillment expense." E-commerce net sales increased 42% YoY. Meanwhile, the operating expense rate increased 73 bps as "Wage & club investments, incremental Covid-19 costs and lower tobacco & fuel sales weighted on operating expense leverage."

FY2022 Expectations

Though management did not provide guidance for the current quarter, we did get FY2022 expectations. While consolidated net sales are expected to decline on a constant currency basis, they are expected to be up "low single-digits" after accounting for divestitures (the company completed the sale of Walmart Argentina in November 2020, the U.K. in February 2021, and expects to complete the sale of operations in Japan in FY1Q22). International sales are expected to decline in constant currency terms, however, grow at a faster rate than the U.S. when excluding the impact of divestitures.

Walmart U.S. comp sales growth is expected to be up low single digits, ex-fuel, while Sam's Club comps are expected to be up low single digits, ex-fuel and tobacco.

Capital Expenditures are going up to ~$14 billion (from $10.3 billion in FY21) as the team invests in the supply chain, automation, customer-facing initiatives and technology. Management also announced an investment in their people and will be raising the average wage to a level over $15 per hour. These are all areas where we fully support the added expenditures as we believe the investments crucial to longer-term top line growth.

Similar to the top line, consolidated operating income is expected to be down slightly in constant currency, however, flat to up slightly, excluding divestitures, as consolidated expense leverage is expected to be flat, or see slight deleveraging. U.S. operating income is expected to "increase slightly." Throw in expectations for a 24.5% to 25.5% tax rate and we get earnings per share expectations of down slightly, or "flat to up slightly, excluding divestitures."

Lastly, the company announced a new $20 billion share repurchase program, which will take place "over the next three years or so" and increased the dividend, for the 48th consecutive year, by ~2% to $2.20 per year from $2.16.

Long-Term Growth Objectives

Touching again on the investments and ongoing transformation, CFO Brett Biggs commented during the call "as we accelerate investment, capex is expected to be around $14 billion this year, with most of the increase versus last year in the U.S. over the next few years, we expect capex to be around two and a half to 3% of sales. While this is higher than the past few years, it is far below the capex peak of 4% to 5% of sales during the period of heavy supercenter growth. This spin will allow us to fully optimize our strategy and in turn, accelerate the company's top line and profit growth rates in the mid to long term. After a year or so of transition, these investments should put us in position for 4 plus percent sales growth and operating income growth rates higher than sales. 4% top line growth would basically be the equivalent of adding a fortune 100 company every year."

Biggs went on to discuss some of the ways Walmart plans to achieve these longer-term growth objectives, including investments in Walmart+, advertising and a slew of other revenue streams as well as what it means for margins in the mid- to- long-term: "We expect continued strong growth in the U.S. businesses and expect even higher international growth rates as we focus on key markets and making money in new ways. We'll continue improving margin mix through an enhanced general merchandise offering, new brands, and marketplace growth, with a greater push towards expanding fulfillment and other services for sellers. We'll drive existing and new customer growth through initiatives like Walmart+. We'll grow sales and profit increasingly with growing higher margin businesses and advertising, financial services, marketplace, healthcare services, and the like. Our operating discipline will continue to sharpen. After a pause in FY '22 primarily because of additional wage investments, I expect expense leverage to continue at or above 20 basis points a year."

Overall, while profitability in the quarter was clearly disappointing and is weighing on shares, we believe that the company is focusing investments exactly where it needs to. The top line was strong, and the comparable sales growth was incredible, two factors that we believe more important at the moment as the company invests in greater customer engagement, operating efficiency, the omnichannel experience, and new revenue streams such advertising and annual memberships.

A term that was constantly mentioned during the conference (37 times by our count) was "flywheel" and that is exactly what management is building, a "mutually reinforcing set of assets" that constantly reinforce each other - not unlike what the "Death Star" Amazon (AMZN) has built.

The transformation we invested in when we initiated our position remains intact. While it may hit the bottom line in the near-term, the moves management is making are exactly what is required and will allow Walmart the ability maintain its leadership position in commerce as consumer habits change. Investments in areas such as the supply chain, automation and technology will allow Walmart to differentiate itself as the one retailer that started as a brick-and-mortar operation has transformed in such a way that it can compete head-to-head with the likes of Amazon. If short-term traders want to knock shares down because management is focused on the long-term, we will take the other side of that trade all day, as we did earlier this morning, here. It's a strategy that has rewarded us handsomely in shares of Amazon over time and one believe will do the same with shares of Walmart.

Lastly, for those interested, a replay of the call (which lasted around 3.5 hours as it was followed by the company's 2021 Investment Community Meeting) can be found here.