Walmart's Earnings Are Up, and It's Disappointed

You can sense the frustration emanating from Walmart's (WMT) Bentonville, Ark., headquarters. Something is not right, and that something is comparable store sales, or "comps."

Earnings aren't the problem. The company knows how to make the eagle on every nickle scream. Walmart has emphasized the "productivity loop," which meant slashing costs, and that helped drive earnings to $1.21 per diluted share in the quarter ended Jan. 31, well ahead of the 96 cents per diluted share for the same time last year, and above the consensus analyst estimate of $1.12 per share.

However, comps are another matter. In fact, they've declined for the past three quarters at Walmart stores and came in slightly negative for the year. (Sam's Club has done better, reporting positive comps for the quarter and year.)

Comps are indicative of productivity across the established stores in a retail chain, demonstrating the appeal of the product assortment as well as display and marketing initiatives that get customers to shop more at stores. A retailer with healthy comps generates free cash flow that can be used to lower prices, build more stores and/or improve earnings. When higher comps can be achieved in conjunction with earnings growth -- meaning sales at existing stores are gaining without deep discounts -- they are a sign of retail health.

Walmart blames deflation for its comps problem. It's true that commodity price declines in the recession have undermined the price of milk and grain and other basics that Walmart sells in abundance. The recession has driven deflation in electronics, too. But it's not like Walmart didn't know what was happening. Costco, for example, took a $30 million hit in December on commodity price-related markdowns, the company revealed in a recent conference call, but posted positive comps in December and January.

And Walmart clearly expected better comparable store sales. The retailer admitted that it had missed its own comps guidance.

Walmart is in a transition. It continues to press Project Impact, an effort to provide a better shopping experience and to make stores more productive, and related initiatives that are designed to drive sales and other wise improve its business. In fact, its initiative to clean up Action Alleys in its stores â€" the main aisles once crowded with merchandise on pallets â€" has been successful enough that the retailer plans to finish it by the end of this quarter. Also, Walmart has seen mid-single digit growth in its Great Value private label, which was upgraded and expanded in the first half of last year. To some extent, though, the Great Value expansion may contribute to softer comparable store sales, as private labels generally have lower prices than national brands, even if they typically produce greater profits.

So, Walmart's recent initiatives seem to be driving earnings effectively, but Mike Duke, Walmart's CEO, said in a conference call that he was "disappointed" in the negative comps. He noted that market basket, the price of all goods purchased in a trip, was down. That was the deflation part of the problem. But so was traffic, the measure of customers shopping at U.S. stores.

Walmart now says it is accelerating the next phase of Project Impact, one designed to cut costs and allow it to lower prices. Consumers will likely respond to lower prices with more store visits, but they must purchase enough to make up for the lower costs if Walmart is to enjoy higher comps. But if it takes price cuts to gain additional sales, comps could still not improve. Walmart could find itself in a two steps forward, one step back scenario.

If Walmart can't get comps going positive, it could be back to 2006-08 again, when Target (TGT) comps sometimes exceeded those at Walmart. Target became a Wall Street darling and Walmart's share price languished. Walmart executives certainly don't want to relive that. The world's top retailer certainly doesn't relish again becoming second fiddle to investors.