Even in the face of weakening economies in the U.S and globally, each of Wal-Mart Stores Inc’s (NYSE: WMT) segments: Wal-Mart U.S., Wal-Mart International and Sam’s, posted higher same store sales and profits. Q2 EPS of $1.18 was at the high end of the $1.13-$1.18 guidance.Overall, Wal-Mart demonstrated a combination of defensive and growth characteristics, which is what investors seek in this environment. We expect Wal-Mart to continue to pursue a balanced approach toward increasing shareholder value through its sustainable long term growth in its proven business model.We continue to be impressed with disciplined expense management and strategies in place to maintain positive same store sales. The following are the key reasons that make us optimistic about the company.
Rising International profitability
Wal-Mart’s international business continues to perform well with sales up 6.4% (up 7.2% in constant currency) and operating income up 11.9% on a constant currency basis. All of the company’s markets had positive constant currency growth in the quarter, with the larger markets, U.K., Mexico, and Canada posting solid growth and margins.
Energy is one of the major operating costs. In markets like Mexico and Japan where energy costs continue to elevate, the company with its own wind farms has been able mitigate cost fluctuations. Overall, energy costs are now $3 million less than last year. Thus, we are encouraged that operating expenses grew slower than sales and the majority of the geographic regions were able to leverage operating expenses in 2Q.
Momentum at Sam’s Club
Sam’s Club strong momentum continued in 2QFY13 posting a SSS growth of 4.2% (Traffic was up 1.8% and ticket was up 2.4%) with both Business and Advantage members positive. We believe the quality and innovation behind merchandising and services are contributing to strong SSS. The momentum is expected to continue in Q3 with 4%-5% SSS gain.
Better than expected U.S. SSS
Wal-Mart’s U.S. SSS increased 2.2% (above mid-point of 1%-3% guidance range), led by strength in grocery and general merchandise. Traffic and ticket were again both positive. Though the company posted a better SSS growth in Q1 (2.6%), we are not concerned as Q1 was benefited from early sales of spring goods. Wal-Mart overcame slower consumer spending in 2Q with better assortments, better values and successful results on holidays. Sales strength was broad-based, with all three geographic regions and all store formats showing positive SSS. Most Importantly, July was the strongest month, so underlying momentum looks good.
Cash flow machine
Wal-Mart is a cash flow generating machine. During Q2 the company generated $3.0 billion in free cash flow and returned around $3.1 billion to shareholders through share repurchases and dividends. The company generated a free cash flow of $6.1 billion in 1H12, showing a 50% improvement with respect to 1H11. The change was driven by the improvement in net inventory investment and changes in 401(k) plan, which affected the timing of accrued liabilities and improved operating results.
The big-box retail model is proving to be costly for many retailers. For example, Best Buy (NYSE:BBY) is struggling with large and inefficient stores that have precipitated the collapse of several big box retailers in the past. However, Wal-Mart and Target (NYSE: TGT) are going strong. It is worth noting that both these companies generate a substantial proportion of revenues through groceries, with Wal-Mart generating over 50% and Target generating around 44% of its total revenues through groceries. While the online grocery shopping experience is growing, the internet won’t do for groceries what it did for books as consumers still prefer stores over internet when it comes to groceries. Even in a slowdown scenario, grocery business is relatively stable; a low beta of 0.41 further strengthens the fact that Wal-Mart’s stock price fluctuates less dramatically than the market itself. Thus, a good overall performance, strong cash flow, vast exposure to groceries and favourable business economics makes it a good long term defensive investment.
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