Markdowns may reduce Walmart’s second quarter net income by 10%

All eyes will be watching Tuesday (Aug. 16) as Walmart reports fiscal second-quarter earnings. With more than 230 million shoppers visiting stores each week, the retail giant is seen as a barometer for the overall economy and consumer spending patterns.

The Bentonville-based global retailer is expected to earn a net income of $4.398 billion or $1.60 per share for the second quarter ending July 31. This would be a 10% decline from the $1.78 per share earned in the year-ago period. Revenue is expected to top $155 billion for the quarter, which would be an increase of 7% from a year ago.

The lower income and higher revenue will not surprise Wall Street because the retail behemoth recently lowered its own guidance for the remainder of the year, citing heavy markdowns and tighter operating margins amid changing consumer behaviors. The yellow “clearance” balloons have been seen flying around Walmart stores in recent weeks, a further indication the company is trying to move excess inventory ahead of the holiday season.

Walmart CEO Doug McMillon recently said runaway inflation is causing shoppers to spend more on necessities such as food and fuel, leaving them less money to purchase items such as clothing and electronics. He said heavy markdowns are necessary because Walmart found itself with too much inventory ordered last year when spending levels were high.

Store traffic is expected to be steady, and higher overall pricing is forecast, lifting same-store sale growth an expected 6% in the quarter. McMillon recently said back-to-school sales have been strong, but he anticipates people will pull back on buying general merchandise in the second half of the year.

Ben Bienvenu, a retail analyst with Stephens Inc., said the excess inventory has been a double whammy for Walmart as storage costs were higher and now heavy markdowns are reducing profit margins. He maintained his overweight or “buy” rating on Walmart following the recent lower earning guidance announcement and dropped his quarterly earnings forecast to $1.64 per share, the high estimate on the street. (Stephens Inc. conducts investment banking services for Walmart and is compensated accordingly.)

Bienvenu and a majority of retail analysts rank Walmart to outperform the overall market in the next year, despite the recent challenges. They say Walmart has the opportunity to grow market share during times of economic downturn because of the company’s ability to hold the line on price increases longer than smaller competitors.

“While there are certainly limits to this, and we don’t expect the company to irrationally price, we believe Walmart’s relative pricing gap will be an attractive draw for consumers feeling inflationary pains in their wallets,” Bienvenu said. “Walmart’s growth in high-value businesses like advertising and healthcare also underpin the terminal value for the company that has been in place for the last several years.”

Analysts with Zack’s Market Research said against a persistently elevated inflationary backdrop, they continue to view Walmart shares as attractively valued, given the company’s position as the largest low-price retailer. But challenges regarding margins continue to linger for the unforeseeable future, and that has Zack’s backing off of the Walmart bandwagon. Zack’s has a “sell” rating on Walmart shares following the recent downward guidance announced by the retailer. Zack’s prefers Dollar General and Ulta Beauty, who are each in a better position to deliver higher than expected earnings in the quarter.

“Walmart is grappling with supply-chain bottlenecks. The company’s consolidated gross profit margin contracted by .87% in the last reported quarter, primarily due to Sam’s Club, wherein the gross margin fell by 2.19 %. This was due to supply-chain costs, a fuel mix, inflation and markdowns stemming from the delayed inventory. On its first-quarter earnings call, management stated that it expects the gross margin to remain under pressure in the second quarter, though it is likely to improve sequentially,” Zacks noted.

The market research firm said while margins are compressed, the retailer is also grappling with rising costs which escalated by 0.39% in the first quarter due to higher U.S. wages. Zack’s believes some of the higher costs likely persisted in the second quarter. While margin compression is a real threat to profits, analysts remain bullish about the top-line growth opportunities.

“Walmart has been benefiting from its efforts to strengthen store and online operations. It has been undertaking several efforts to enhance merchandise assortments. Also, the company has been focused on store remodeling to upgrade them with advanced in-store and digital innovations. The company’s compelling pricing strategy has been helping it draw customers,” Zack’s noted.

Walmart shares (NYSE: WMT) closed Thursday at $129.82, up $1.24. Over the past 52 weeks, the stock has traded between $117.27 and $160.77. The share price is down 10.3% year to date.