Walmart (WMT.US)'s performance fell sharply after a severe setback and hit the biggest decline in four years! Wall Street collectively lowered the target price but no one downgraded. Little Mo said “the sell-off is basically in place”

The Zhitong Finance App learned that Walmart (WMT.US)'s latest quarterly earnings report was mixed: although revenue and profit continued to grow and annual performance guidelines were raised, the US same-store sales growth rate slowed markedly. Coupled with headwinds brought about by pharmacy regulations, the stock price fell sharply by 9.2% in a single day after the earnings report was announced, setting the biggest one-day decline since May 2022.

Since then, many investment banks, such as J.P. Morgan Chase, BMO Capital, and TD Cowen, have lowered their target prices, but most have maintained a “buy” or “increase in holdings” rating. The focus of the market debate is whether the drag on the pharmacy business is only a temporary factor, and whether Walmart's high valuation can be supported by high-growth businesses such as advertising, marketing platforms, and membership.

Looking at total data, Walmart's latest fiscal quarter (ending July 31) achieved revenue of US$187.9 billion, up 5.9% year on year; non-GAAP adjusted earnings per share were US$0.81; operating profit increased 28.8% year over year, and increased 17.4% at the adjusted fixed exchange rate. The profit data was boosted by tariff refunds, partly offset by the company's active price cuts.

Based on the above performance, management also raised its full-year guidance: fixed exchange rate sales are expected to increase by 4% to 5% for the full fiscal year, compared to 3.5% to 4.5% previously; adjusted earnings per share are expected to be $2.80 to $2.87.

Motivation behind the sharp decline

However, what the market really focuses on is comparable sales at the same store in the US. Walmart's same-store sales in the US increased by only 2.6% in the current quarter, not only lower than 4.6% in the same period last year, but also lower than 4.1% in the previous fiscal quarter. The volume of transactions increased by 1.5%, and the average customer unit price rose by only 1.1%, indicating that consumers are still spending but are becoming more cautious.

Although Walmart CFO John David Rainey said in an interview, consumers are still spending and real wage growth keeps pace, so they are very resilient in this environment. However, the company's sales growth guideline for the next fiscal quarter is 3% to 3.75%, which means that growth may slow further.

In addition to this, management attributed the slowdown in same-store sales in part to the pharmacy business. Rainey said during the earnings call that pharmacy price pressure related to the highest fair pricing regulation of drugs dragged down comparable sales in the US by about 125 basis points during the season, higher than the 100 basis points expected by the company at the beginning of the year. Without considering the health and wellness business, Walmart's US same-store sales growth rate during the quarter was close to 3% to 4%, in line with the range that the company has continued to maintain over the past two and a half years.

In addition, the company also expects fuel costs to increase by more than 2 billion US dollars this year, which will put some cost pressure on them.

CEO John Furner said that overall, it was a good quarter. Sales growth was at the upper end of the guidance range, and adjusted revenue grew 17.4% at a fixed exchange rate. He stressed that the headwinds in the pharmacy business overshadowed the strong performance of other businesses such as groceries, general commodities, and e-commerce. But investors are clearly more concerned about the reality of slowing growth rather than management's explanation.

Investment banks have collectively lowered their target prices, but most are still bullish

After the financial report was announced, J.P. Morgan Chase lowered Walmart's target price from $137 to $125, maintaining an “overweight” rating. In fact, the bank lowered its expectations for Walmart same-store sales in the first three weeks of the earnings report, but the actual data is still lower than the forecast after the cut.

Analysts at J.P. Morgan described the situation before the earnings report as “a mess,” that is, various factors are intertwined, making it difficult to determine the trend of stock prices. However, the bank believes that the sell-off is basically in place, and Walmart's trend is expected to improve as advertising, marketing platforms, and membership businesses continue to expand.

Other investment banks have taken similar actions. BMO Capital lowered its target price to $126 because of the same slowdown in same-store sales and weakness in the health and wellness business; TD Cowen lowered the target price to $125, citing 2.6% same-store sales growth; and Bernstein maintained a “outperforming market” rating, pointing out that Walmart's strong profit margin was a reason to maintain confidence.

According to statistics, out of 32 analysts covering Walmart, 29 recommended “buy,” 3 recommended “hold,” and there was no “sell” rating. The average target price is around $130, implying about 25% upside compared to the current stock price of around $104. This means that Wall Street as a whole remains optimistic, but short-term expectations have been lowered.

New businesses become engines of growth

Despite the headwinds posed by the pharmacy business, Walmart is hedging the pressure through diversified revenue streams. Global advertising revenue increased 38% year over year during the quarter; platform sales in the US market increased 52%; global membership fee revenue increased nearly 17%; the number of new members added to the Walmart Plus membership program in the first half of the fiscal year was the highest in history.

CFO Rainey said that nearly half of the quarter's profit growth came from businesses such as membership, advertising, and marketing platforms rather than traditional core retail businesses. He also pointed out that e-commerce advertising is growing faster than overall e-commerce sales, driving up incremental profit margins.

On the e-commerce side, global e-commerce sales increased 23% year over year. In the international business, e-commerce accounts for 30%, and the Chinese, Indian and Canadian markets are growing strongly; e-commerce sales at Sam's Club stores in the US have increased 26%. Since the launch of the 1-hour delivery service in April, club delivery volume has increased by three digits.

CEO Furner also stressed that the company carried out more than 11,000 “Rollbacks” price reduction activities during the quarter, up from 7,200 at the end of the first quarter. He believes that price cuts will first increase sales volume, and then increase market share over the next few quarters. The food market share data showed strong performance during the quarter and seemed to support management's judgment.

Analysts at J.P. Morgan Chase said that Walmart's profit channels are more diverse today than in the past, and these emerging businesses are growing rapidly, enough to hedge against the drag caused by the pharmacy business.

The bank further added that the bearish argument for Walmart assumes that price cuts will not bring lagging returns, that is, they believe that these promotions will only erode profits without boosting traffic or share. However, management statements and food share data show that the company has different views on the effects of price cuts.

Implications after major historical declines: Moderate rebound and overvaluation pressure

Walmart fell 9.2% in a single day last Thursday, the biggest drop since May 2022 and the fourth largest single-day decline in the past 15 years. As of writing, Walmart's market capitalization is around $825 billion. Over the past decade, after adjusting for dividend reinvestment, Walmart has generated returns of more than 400% for shareholders.

Looking back at history, Walmart's performance after the previous three larger one-day declines was not bad, but it wasn't amazing:

On October 14, 2015, the stock price fell 10% as management warned that profits would fall the following year. A year later, the stock price was up about 14% from the closing day;

On February 20, 2018, the stock price fell 10.2% due to a slowdown in e-commerce growth and a compression in profit margins during the holiday season. A year later, the stock price was up about 6% from the closing of the day, but it was still below the level before the decline;

On May 17, 2022, the stock price plummeted 11.4%, seriously hampering profits due to soaring costs. A year later, the stock price was up about 14% from the closing day of the day, and had just returned to the level of the day before the decline.

Overall, investors who bought in the above three sharp declines all received positive returns after a year, but the increase was moderate; if measured from the day before the sharp fall, the stock price only made up for the gap, and was even lower than the previous level. Meanwhile, on May 21 of this year, Walmart fell 7.3% due to the financial report for the first fiscal quarter. After three months, the stock price was still about 14% lower than the closing price of the same day, and it has not recovered its lost ground.

The important difference between this time and the past three is that the previous sharp decline was mostly accompanied by bad news at the profit level: 2015 was a profit warning, 2018 was a profit squeeze, and 2022 was a sharp rise in costs. However, Walmart raised its full-year guidance this time, and profit performance was strong, but sales guidance for the third fiscal quarter increased by 3% to 3.75%, indicating that revenue growth continues to slow. Investors are not reacting to profit shocks, but are lowering revenue growth expectations.

At the valuation level, based on the median value of the updated full-year adjusted earnings per share guide, Walmart's current stock price corresponds to about 37 times the expected profit, which is significantly higher than its ten-year average price-earnings ratio of about 25 times. Profit is expected to grow at a CAGR of 8.7% over the next five years, and the current valuation is still not cheap. Even after the sharp drop, the stock price was still about 9% higher than the 52-week low and about 23% lower than the 52-week high. This is still a highly valued stock, but “not that expensive anymore.”