As Walmart (WMT, Financial) reported 2Q16 results, the stock trended lower by 3.4% and there were some concerns in the company’s results. This article discusses these concerns with an overall view of still holding the stock from a dividend gains perspective.
The first negative factor that impacted Walmart’s results was currency fluctuation and this factor is beyond the company’s control. With China devaluing the yuan recently, it seems to me that we are in a global currency war environment and currency headwinds are likely to continue for Walmart as well as other companies. Therefore, I am not focused on this point and I will rather look at company specific factors that have impacted growth and margins.
Coming to company specific factors that impacted margins and the factors that can offset the negatives:
Walmart had higher wage investment during the quarter with the company increasing minimum starting wages in stores to $9 per hour. This has resulted in 500,000 associates receiving a raise and was bound to impact margins. In my view, the factor that can offset decline in margin due to higher wages is an increase in productivity. The company is investing in overhaul of inventory management systems and I believe that similar operational improvements can offset the margin decline.
One of the major reasons for quarterly decline in gross margin primarily related to lower than expected pharmacy reimbursements. Reduced reimbursement rates from Pharmacy Benefit Managers is negatively impacting gross margin. In addition, there is lower mix of higher-margin cash transactions as customers are now benefiting from greater drug insurance coverage. Walmart expects the negative impact of the pharmacy segment to continue through FY15. Recently Target (TGT, Financial) signed an agreement with CVS Health Corporation (CVS, Financial) where CVS Health will acquire Target's pharmacy and clinic businesses for approximately $1.9 billion. I believe this is one of the strategies for Walmart going forward. The cash inflow from pharmacy sale can be used to increase dividends, share repurchase and make further ecommerce investments. It remains to be seen if Walmart follows Target.
In terms of positives, the company’s ecommerce sales globally increased by approximately 16% on a constant currency basis and the GMV increased by 18% on a constant currency basis. I believe that global ecommerce sales growth will continue to be robust. While this forms a small portion of the company’s revenue, ecommerce is integral part of the company’s long-term growth plans and survival in a competitive marketplace. Once major investments in the ecommerce space are completed, I expect improvement in overall margins.
It is important to note here that Walmart updated full-year EPS guidance to a range of $4.40 to $4.70, from a previous range of $4.70 to $5.05. The revised downward guidance due to factors discussed is likely to have an impact on the company stock. However, Walmart continues to generate strong cash flows to pay robust dividends and continue with share repurchase. For the first six months of 2015, Walmart reported free cash flow of $5.1 billion.
I therefore see the correction as an opportunity to consider additional exposure to the stock. In the second quarter of 2016, the company’s comparable sales at U.S. stores increased by 1.5%, and this shows that the overall trend is not negative. Higher wages, currency headwinds and the pharmacy business have been the primary negatives.
In conclusion, I remain positive on Walmart and I believe that the company can address near-term challenges and continue creating shareholder value. In the U.S., consumption is the economic growth driving sector and will remain the GDP growth driver in the years to come. Walmart is well positioned to derive benefit from this continued consumption trend.
