The Daily Dose: On Wal-Mart's Earnings

 | Aug 13, 2014 | 11:00 AM EDT
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It was late in 2011 when I sat down in a dark, cold room as a mid-20-something-year-old stock analyst, stared into the CNBC camera, and with ferocity rifled off reasons for investors to dump Wal-Mart (WMT) shares. New rating: downgrade to sell from hold. Although I had been on-air numerous times before, there was still a nervous tingle in my hands (I held a pen as is common industry practice to relieve tension) and feet, along with the feeling of a shirt collar tightening around the 15 ½ inch neck. Not making matters any better: I had a 100-degree temperature.

But, damnit, I refused to miss that appearance, as I deemed it career-defining. It sort of was, although work I have done on Sears (SHLD) since has been the real career definer. In fact, I even hauled my sick self to the mall the night before to buy a new blue shirt and tie because as the late, great Mark Haines once remarked to me off camera: "it's a privilege to be in front of the camera, kid." Most certainly it is. There is no college training course for financial media, and every opportunity must be approached as if it could be the last call from a producer. That means intense research, sharp views based on that research, and a whole bunch of behind-the-scenes planning to drive interest in what you are saying to the world.

Now, a wee bit over 30 years old, I am reminded of that moment in the airwaves ahead of Wal-Mart's second quarter earnings release. Since that stock call, the powerful Wal-Mart machine (you have no idea of the company's reach/influence) has sought to discredit my insightful research and limit access to the information that is normally shared between analyst and company not during earnings periods and presentations. In most cases, I let my eyes and perception take the lead in the analytical process, though obviously in the end the PDF document published includes years of careful study of Wal-Mart's financials.

Creepily, as I re-watched that 2011 appearance, I realized that Wal-Mart has been on a fundamental tailspin since. The stock has underperformed both the S&P 500 and the Dow from December 12, 2012 to today, reflecting weakening ROIC, sales and gross margin metrics in spite of the company's massive investments in square footage, lower prices, and omni-channel retailing capabilities. I believe that Wal-Mart is in a state of operational chaos and will experience its next step down in operating performance looking out over a two-three year horizon, should drastic actions not be taken by 2015 by the increasingly new management team. Such drastic actions include a significant number of international and U.S. supercenter closures, a capital reallocation to smaller store openings and technology from the opening of supercenters, and the spinoff of Sam's Club so that it could merge with Costco (COST) or BJ's Wholesale.

If you are obsessed with short-term stock calls not rooted in bigger-picture thinking, then Wal-Mart appears set to disappoint investors across the board on Thursday with a soft second quarter, below consensus third-quarter earnings guidance, and a slashing of the top end of its full-year earnings outlook. Here are a couple of things I will be analyzing:

Comparable store sales: U.S. business has run negative comps for three straight quarters. Wal-Mart must reverse this trend, backed up by favorable earnings call commentary, for investors to return to the stock.

Inventory: continues to outpace sales growth in the U.S., which I think is preventing life to be seen in countless segment operating metrics. Wal-Mart has to show serious deceleration in U.S. inventory growth to pique my curiosity.

International: execs sounded a little more upbeat on the international operation's turnaround in the first quarter, so now the market has to see it begin to swing further to positive.  Wal-Mart's operating margin internationally has been on an ugly four-year downtrend.

Special Note

Thank you to all those who congratulated me on the Kate Spade (KATE) warning last week after the stock plunged 20% yesterday post earnings. In case you missed it, here is that article I did for TheStreet.

Guidance now: do not buy the stock; it's still valued as a growth retailer that is having trouble demonstrating outsized gross margin expansion and high-quality quarters.



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