Coming off a bloody week for the markets, we have seen an increasing number of investors taking a defensive stance, making large cap companies like Wal-Mart (NYSE: WMT) in vogue again. WMT came out with a strong Q1 performance, and while we like the stock along with Warren Buffett, Mark Hart, Boykin Curry, and John Horseman, we feel that there is a better value retailer stock out there.
After two consecutive earnings misses, Q1 EPS beat consensus estimates by $0.05. Top line and operating profits were up 1.5% and 5%, respectively. Note that the Leap Day helped. US sales growth of 5.9% was quite strong with productivity growth of 1.7% (square footage) and US comps excluding the Leap Day effect, up 2.6%. That 2.6% is a big positive for WMT and is the best quarterly growth rate since the company has seen since early 2009. Both increased traffic and ticket prices drove the better-than-expected earnings. We did not expect to see gross margin compression, however, slight, but cost controls offset that, helping the bottom line. We were impressed Sam’s Club performed well with 5.3% comps growth supported by inflation. WMT expanded operating margins by 4 bps, which isn’t much but is worth noting as it is the first margin increase since Q4 2011. WMT also announced that it is ahead of expectations in meeting its estimated cost savings.
Every category minus entertainment e.g., grocery, health & wellness, entertainment, hardlines (sports), apparel, and home showed positive comps for the quarter. Consumer electronics are still struggling hence the negative entertainments comps. The early spring and accompanying nice weather helped out apparel and outdoor living in particular. Internationally, traffic comps were up and EBIT margins also showed improvement. However, we were concerned by negative traffic comps for Brazil and China, two of the company’s most important markets. Overall Brazil comps were up 2.5% but traffic was down 4.6% and ticket price was up 7.4% and overall China comps were 1.8% but traffic was down 8.2% and ticket price was up 10.0%. This is not an encouraging trend and some data points that we will be closely monitoring moving into Q2.
We were surprised that management did not add color to the FCPA allegations surrounding Mexican bribery incidents. The company merely noted that “the investigation is ongoing” and that WMT remains committed to strengthening global anti-corruption programs. It doesn’t seem like investors have been too concerned over this case, especially after such a definitive Q1 earnings beat. However, we are not certain that WMT will be able to replicate this kind of outperformance in next few quarters and caution investors on too much optimism surrounding a repeat of this quarter.
Even given the promising WMT results, we like Target (NYSE: TGT) more among domestic value retailers as it is more compelling from a valuation standpoint. TGT beat Q1 consensus estimates and provided guidance inline with consensus whereas many other value retailers revised downward. WMT trades at 12.4x NTM P/E and 7.2x forward EV/EBITDA, Costco (NASDAQ: COST) trades at 20.3x NTM P/E and 8.2x forward EV/EBITDA, Dollar Tree (NYSE: DR) trades at 18.6x NTM P/E and 9.8x forward EV/EBITDA, Ross Stores (NASDAQ: ROST) trades at 17.0x NTM P/E and 9.0x forward EV/EBITDA, and TGT trades at 11.2x NTM P/E and 7.1x forward EV/EBITDA for its US operations. This translates to TGT trading at a discount to both WMT and the broader value peer universe.