Why Walmart’s earnings disappointment is an indicator of pain to come

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When one of the world’s largest retailers loses more than 10 per cent of its value in a matter of hours, investors should stop and ask themselves what that slide implies for the broader stock market.

At the very least, the very bad day for Walmart Inc. WMT-N offers a vivid demonstration of why people may want to be wary about the outlook for the North American economy.

The giant discounter is usually a great defensive investment during times of stress because its core business of selling bargain-priced groceries and other must-have items has a history of sailing through downturns. During the depths of the financial crisis in 2008 and 2009, while other stocks were crashing, Walmart’s share price actually edged upward.

It is not enjoying such a smooth ride this time around. And that raises a question: If a huge, well-managed flagship such as Walmart is having trouble navigating this economic storm, how successful will other companies be?

The retailer’s sin on Tuesday was to confess in its quarterly earnings report that higher food prices and wage costs are eating into its profit margins. Its net income for the three months that ended on April 30 was down 25 per cent from a year earlier despite a modest increase in revenue.

The dismal earnings report fell short of analysts’ expectations and sent the stock skidding. By early afternoon it had lost more than 10 per cent of its value.

The abrupt slide offered proof that no business is invulnerable to the current malaise. Up until the earnings report, Walmart had been outperforming the battered U.S. stock market by a wide margin. Its shares had gained about 2 per cent this year, compared with a 16-per-cent decline for the S&P 500.

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From all accounts, Walmart remains a tightly managed, no-nonsense company with a laser focus on the bottom line. Its major problems appear to be economy-wide issues: inflation, supply-chain snarls and a tight labour market.

Consumers are still spending, but rising food costs are prompting them to shift away from buying general merchandise, Walmart executives said. This penny-pinching is also being reflected in rising sales of store-brand goods rather than brand-name products.

Meanwhile, supply chains remain an issue. Costs for many goods came in higher than expected during the quarter because of delays caused by the war in Ukraine and outbreaks of COVID-19, the company said.

On top of all that, Walmart’s labour costs bubbled higher during the quarter. The company blames much of the added expense on workers coming back from COVID-19 leave faster than expected, resulting in temporary overstaffing at some stores.

However, labour costs don’t appear likely to plunge even when staffing numbers come back into line. One of the tightest job markets on record is prompting the company to raise wages, especially in hard-to-fill jobs. A month ago, it told the Wall Street Journal that it was raising starting pay for in-house truck drivers to as much as US$110,000 a year, up from an average of US$87,000 previously.

For Walmart specifically, these issues aren’t likely to leave a lasting scar. Its huge size – it had more than US$572-billion in revenue last year – means it has more flexibility than most companies to deal with any temporary blips in the economy.

The retailer said Tuesday that it expects net sales for its 2023 fiscal year to increase 4 per cent, slightly higher than its previous forecast. However, full-year earnings per share would likely be down 1 per cent, it said, a notable cut from the mid-single-digit increase it had previously expected.

Its disappointing earnings outlook underlines the stresses affecting businesses across North America. In the U.S. especially, companies are being hammered from a couple of directions.

Consumer price inflation is running at 8.3 per cent a year, one of the highest levels since the 1970s. Meanwhile, wages are galloping ahead by 6 per cent a year, the hottest reading in more than two decades, according to April data from the wage growth tracker compiled by the Federal Reserve Bank of Atlanta.

This combination of soaring prices and surging wages means the outlook for corporate earnings is exceptionally murky. Mike Wilson, chief equity strategist at Morgan Stanley, warned in a note Monday that “earnings growth is likely to decelerate, driven by margin compression and slowing top-line growth.”

Similarly, Kieran Tompkins, assistant economist at Capital Economist, cautioned in a note last week that profit margins are facing pressure. So long as the job market remains drum tight and wage growth stays high, profits are likely to flow more to labour than companies’ bottom lines, he wrote.

To be sure, any earnings slowdown will affect some companies more than others. Home Depot Inc., for instance, also reported earnings on Tuesday and was generally upbeat, raising profits and revenue forecasts for the year.

Canadian businesses, too, seem in a somewhat better position than their U.S. counterparts. Inflation is lower here and wage increases have not been as dramatic.

Still, investors may want to look at Walmart for an example of how quickly earnings expectations can change.

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