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Wal-Mart Reports Strong Earnings:
Is It Creating A Pricing Umbrella For Aldi?

We’ve written a lot about Wal-Mart, and recently, the series we’ve been running on procurement changes have made some think we were hostile to Wal-Mart.

Among the pieces we’ve run recently:

SPECIAL EDITION: Wal-Mart’s Global Food Sourcing Initiative Closes The Peterson Era And Threatens Sustainability Of Agricultural Base

Flaws In Wal-Mart’s Produce-Procurement Thinking

Wal-Mart’s Blind And Costly Focus On FOBs

Wal-Mart Produce Procurement ‘Set-Up For Devastating End’

The End Of The Sam Walton Era At Wal-Mart: Navigating A New Business Model

The truth, however, is that we have always thought and have often written that Wal-Mart is a great national resource. There is simply no question that the ability to offer excellent prices on good quality goods frees up the purchasing power of countless millions of Americans.

It is not just Wal-Mart customers who have gotten this benefit; Kroger, Safeway, Supervalu… virtually all retailers are more efficient companies than they would have been and offer better values to consumers than they would have had Wal-Mart not existed.

So our critique is not an attack on the Wal-Mart concept. It is a claim that some of things Wal-Mart is doing either A) will not, in the long run, help it achieve its own goals, and B) offers an assessment that there are contradictions between Wal-Mart’s professed values, particularly around sustainability, and its actions in agriculture.

Which brings us to the latest news. Wal-Mart just announced strong earnings:

Earnings Exceed Guidance and First Call Consensus Estimate Highlights — Walmart reports fourth quarter earnings per share of $1.23 and adjusted earnings per share(1) of $1.17, five cents above the company’s latest guidance and five cents above the First Call consensus estimate. — The company’s full year EPS was $3.72 and adjusted EPS was $3.66. — Net sales for the full year topped $405 billion, with International net sales exceeding $100 billion for the first time. Walmart U.S. comparable store sales for the fourth quarter were below guidance. — Consolidated operating income for the fourth quarter was $7.3 billion, up 13.8 percent from last year. — The company leveraged operating expenses for the fourth quarter and expects to leverage expenses for fiscal year 2011. — Walmart ended the year with strong free cash flow(1) of $14.1 billion, an increase over last year of almost 21 percent. — The company has returned $11.5 billion to shareholders through dividends and share repurchase this fiscal year, a level of return that is 58 percent higher than last year. — Walmart posted a pre-tax return on investment(1) (ROI) of 19.3 percent for fiscal year 2010, equal to last fiscal year’s ROI.

It is all very strong, but we see long term problems growing out of the short term success. Of course, business is all about making money, but making too much money can create opportunities for competitors, because a market leader, such as Wal-Mart, provides an umbrella for pricing that others can undercut.

We look at Wal-Mart’s sales chart…

Net Sales

Net sales were as follows (dollars in billions):

Three Months Ended
January 31,
Years Ended
January 31,
Net Sales 2010 2009 Percent
2010 2009 Percent
Walmart U.S. $70.969 $71.293 -0.5% $258.229 $255.348 1.1%
International 29.572 24.751 19.5% 100.107 98.840 1.3%
Sam’s Club 12.285 11.836 3.8% 46.710 46.899 -0.4%
$112.826 $107.880 4.6% $405.046 $401.0 1.0%

…and then we look at Wal-Mart’s Profit Chart…

Segment Operating Income
Segment operating income was as follows
(dollars in billions):

Three Months Ended
January 31,
Years Ended
January 31,
Segment Operating Income: 2010 2009 Percent
2010 2009 Percent
Walmart U.S. $5.632 $5.343 5.4% $19.522 $18.562 5.2%
International 1.891 1.490 26.9% 5.033 4.940 1.9%
Sam’s Club 0.305 0.438 -30.4% 1.512 1.646 -8.1%

…and we see something creating an opportunity for ALDI and deep discounters.

Wal-Mart’s US stores had a sales increase of 1.1% over the previous year. Yet Wal-Mart’s US store-related operating income went up by 5.2%.

Now Wal-Mart claims its sales growth was slowed by deflation, especially in food, and the company credits tight cost control with the increased profits.

This may all be true, but begs the question: What should Wal-Mart do with the additional margin it earns when it finds ways to reduce costs?

If you follow Sam Walton’s notions of Wal-Mart as a ”buying agent” for the consumer, the answer is obvious. Agents pass on cost reductions to their principals.

From a standpoint of fealty to consumer interests, the constant cutting of prices as Wal-Mart achieves greater efficiencies allows consumers to vest in the Wal-Mart brand an assumption that Wal-Mart always has the best prices. How can it not? Wall-Mart is super efficient, and as it gets more efficient it passes on the benefits of that greater efficiency to the consumer.

We would think that reputation, that brand equity, borders on priceless.

From a competitive business point of view, if Wal-Mart passes on any efficiencies it can gain, there won’t be enough margin in the markets to encourage competitors to invest.

Ideally we would like to see sales rise sufficiently that even if Wal-Mart passes on all efficiencies gained and works on closer margins, dollar profits are still up. But if need be, we would think it wiser to work closer and snuff out competitive opportunities while winning customer loyalty than it would be to maximize this year’s profits.

Wal-Mart is so big, so powerful, has so many smart executives and great consultants, it may sound ridiculous to think this Pundit focusing on perishables can discern anything from these financial statements that such important people haven’t already seen and rejected.

Perhaps, but remember that there were times when Sears, A&P and General Motors also seemed invincible. It may take a very long time, all the current managers may long be retired, but we see seeds being planted that will one day threaten the behemoth of Bentonville.

Discussing these issues is not hostility to Wal-Mart; it is called free consulting.

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