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First Amazon Missed. Now Walmart. What’s Going on in Retail?

Walmart’s softer than expected earnings for the first quarter demonstrate that no retailer is immune from the higher cost pressures reverberating throughout the retail sector,” Moody’s retail analyst Mickey Chadha said Tuesday after the retail giant lowered its full-year profit guidance while raising top line sales estimates after a surprise profit miss.

In the wake of Amazon’s disappointing earnings and now the nation’s biggest brick-and-mortar chain showing signs of mortality, the sector will be watching closely when Target and Kohl’s report their respective numbers on Wednesday and Thursday. Credit analysts at Moody’s investors Service covering the U.S. and European retail and apparel sectors see inflation hampering retail worldwide, and project little if any growth for the sector in the next 12 to 18 months.

In a Nutshell: Walmart said last year’s stimulus-enhanced quarter made for a tough comparison, though sales in non-essential categories were starting to slow and “unseasonably cool weather” didn’t compel shoppers to spend like they usually would on apparel. Rising supply chain expenses also dragged on the bottom line for the quarter ended April 30.

Walmart president and CEO Doug McMillon said sales “were ahead of what we expected” and pointed to good “momentum” in the second quarter to date. 

The bottom line was below our expectations due primarily to three areas that negatively affected operating income and our U.S. businesses, both in Walmart and Sam’s Club,” McMillon told Wall Street analysts on a conference call Tuesday, referring to higher wage spend, inventory levels and storage costs, and fuel and supply chain expenses.

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Gross margin was a lower percentage of Q1 total sales in the first quarter. Food saw double-digit inflation and may continue to increase, he said, and higher costs pulled dollars away from general merchandise sales. However, the company could use promotions to turn products like apparel more quickly.

We like the fact that our inventory is upbut a 32 percent increase is higher than we want. We’ll work through most or all of the excess inventory over the next couple of quarters. We started being aggressive with rollbacks, in apparel for example, during Q1. Even with reduced prices, the apparel margin can still be helpful to our overall mix,” McMillon said.

With higher inventory levels, the company reduced 10,000 prices, concentrating on seasonal merchandise categories. Customers are responding “very well” to the lower clothing prices, McMillion said.

Walmart aims to “control what we can control, reduce our inventory level, and keep prices as low as we can, especially on opening price points,” he added.

Despite the lower earnings guidance, “Walmart is one of the best suited retailers to weather the challenging period for the sector with its scale, strong balance sheet,  merchandise mix, lower price points and stellar execution,” Moody’s Chadha said.

Along with Walmart, Moody’s pegged Target and Costco as some of the value retailers that should perform well because of their diversified merchandise assortment. Off-price could see operating margins shrink due to increased costs, while department stores and online shopping will also come under pressure.

Chadha and his U.S. colleagues cut the outlook for the U.S. retail and apparel sector to “negative” from “stable” as they expect consumers will eventually balk at retail’s higher prices. They’re also uncertain whether retailers can pivot their inventory to meet changing demand.

Shipping capacity isn’t expected to improve anytime before 2023, and that could mean retailers will take on inventory risks through aggressive buying well before the timing of consumer purchases to avoid future stock-outs—a factor in why Walmart’s inventory levels were so high in the first quarter. And if retailers continue to ramp up buying without matching consumer need, they could be forced to send out a flurry of promotions to entice people to spend.

Moody’s European credit analysts covering retail and apparel also lowered their retail and apparel sector rating to “negative” from “stable.” They cited supply chain disruption that’s expected to continue through the end of the year, and ongoing challenges sourcing from Asian countries battling Covid. They expect Europe’s economic growth will slow down through 2023. And the longer the Russia-Ukraine war continues, the more severe the business disruption will be for retailers.

Net Sales: Walmart’s revenue for the quarter rose 2.4 percent to $141.6 billion from a year ago.

Walmart U.S. net sales rose 4 percent to $96.9 billion, while comp sales rose 3 percent. E-commerce grew 1 percent. Walmart International net sales fell by $3.5 billion, or 13 percent, to $23.8 billion on $5.0 billion in divestitures and $400 million from currency fluctuations. Walmart said the business posted “positive comps across all markets.” At Sam’s Club, sales rose 10.2 percent, while membership income was up 10.5 percent.

Earnings: The company said earnings per share (EPS) was 74 cents for the quarter, with adjusted EPS at $1.30.

Wall Street expected adjusted diluted earnings per share of $1.48 on revenue of $138.88 billion. Investors sent shares of Walmart down 11.4 percent to close at $131.35.

Walmart guided full year net sales growth in the range of 4.5 to 5 percent, above original guidance of 3 percent in February. Walmart U.S. comp sales growth is forecasted at 3.5 percent, slightly above the original guidance of 3 percent. Chief financial officer Brett Biggs said because of higher-than-anticipated first-quarter costs, the company expects operating income and EPS to be “relatively flat” year-on-year.

For the second quarter, net sales growth is forecasted at over 5 percent, including comp sales up 4 to 5 percent for Walmart U.S. Operating income and EPS are expected to be “flat to slightly up,” Biggs said.

CEO’s Take: McMillon said the company remains “committed to our 4 percent top line growth and greater than 4 percent profit growth algorithm.”