Investors have started to show some sympathy for Walmart (NYSE:WMT). This comes after months spent punishing the world’s largest retailer for not doing enough to counter the existential threat coming from the consumer shift to e-commerce.
Walmart shares surged more than 10% on August 16 after its Q2 2018 earnings report beat analyst consensus on the stock. On the news, the stock broke out of its six-month sluggish spell, a result of investors mostly having moved to the sidelines on concerns that this brick-and-mortar retailer was losing ground in its battle with the online giant, Amazon (NASDAQ:AMZN).
That perception has shifted a bit since the second-quarter earnings report which crushed expectations. Walmart’s U.S. comparable sales jumped 4.5% in the second quarter, the retail giant's biggest expansion in more than a decade and more than double the consensus forecast.
The gains were fueled by more store visits in the U.S. along with customer willingness to spend more on each trip. Grocery sales rose the most in nine years thanks to improved fresh-food offerings. Walmart also boosted its full-year forecasts for comparable sales and adjusted profit.
On top of the sales gains, there was clear evidence that the company’s massive investments to improve its digital platform were paying off. U.S. online sales continued their upward momentum, surging 40% from the same period a year ago, putting Walmart's full-year guidance for its online sales growth within reach.
Going forward, however, the biggest concern lurking in the minds of potential investors is whether Walmart's Q2 win is enough to keep its stock moving higher.
For perspective, the Bentonville, Arkansas-based big-box behemoth is still lagging, even after a 23% jump in its stock price in the past year. Other top retailers, such as Target (NYSE:TGT), Costco (NASDAQ:COST) and Home Depot (NYSE:HD), have massively outperformed Walmart, delivering gains in the range of 40% to 90% during that same period.
Strong Economy Vs. Margin Squeeze
Walmart’s impressive financial performance in the second-quarter shows that the retailer is successfully executing on its strategy to get its store traffic growing again. As well, its “click and collect” push to ramp up online sales has begun to show results.
That said, the strengthening U.S. economy has also played a big role in improving the sales outlook as consumer sentiment has been buoyed by tax cuts which left more money for spending in American pockets. That makes some investors skeptical about the pace of future growth since it’s tough to figure out how much of Walmart’s blockbuster performance is the result of a strong economy as opposed to the retailer having fixed its core problems.
For long-term investors, it’s also important to be aware that Walmart's profit margins continue to take a hit as the company invests heavily to take on its e-commerce rival Amazon. Gross margins fell for the fifth consecutive quarter during Q2, slipping 17 basis points. In the previous quarter that measure was down 23 basis points.
These cost pressures aren’t letting up anytime soon either. According to Walmart.com CEO Marc Lore, online profits will continue to be squeezed, while rising commodity and transportation costs pose another threat to bottom-line profitability. Walmart said its second quarter operating income fell 3.7%.
Bottom Line
There is no doubt that Walmart is succeeding in changing investor perceptions of the long-term viability of its business amid the growing threat of online competition. The success of its hybrid retail model—in which its massive store network and online presence come together to create a superior shopping experience for customers—shows that the retailer has a future.
Still, we don’t see a huge upside potential for Walmart stock in the medium-term, given the hit on its operating margins and cost pressures. We continue to see its shares underperforming in the near- to medium-term as it struggles to catch up to online juggernaut Amazon, which already has over 49% of the U.S. online retail market.