2/18/2010
By Brian Sozzi, Research Analyst

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Today, Wal-Mart Stores Inc. (WMT) announced its highly anticipated holiday quarter financial results.  Having not heard much from the company since late November's 3Q10 earnings release other than to announce price rollbacks on holiday merchandise or new expense saving measures, suffice it to say uncertainty was in the air.  However, when the book is officially closed (after all the analyst notes are published) on Wal-Mart's 2009 fourth quarter, despite a few negatives to call out, we believe it will support a bullish thesis on the retail giant's stock (especially considering trough valuation).

Wal-Mart reported diluted EPS adjusted of $1.17 (consensus: $1.12), $0.04 above our consensus high estimate of $1.13.  On the most favorable gross margin comparison of the fiscal year, Wal-Mart posted a gross margin of 24.38%, +34 bps y/y, arising from things we have come to expect from the company (increased productivity, inventory reductions at all divisions, utilization of unmatched sourcing model).  Adjusted operating margin was a strong 6.61%, +41 bps y/y (using an adjusted 4Q09 rate of 6.21%, which takes into account a wage settlement charge).  Wal-Mart division comps were below guidance at -2.0% as success came in deflationary merchandise categories such as electronics (entertainment is 13% of annual sales) and consumables (grocery 49% of annual sales).  Sam's Club had a +0.7% ex. fuel comp, weaker than monthly trends from Costco (COST) at the core level, but reasonable in light of the expense reduction announcements lately.  However, profit metrics were the real takeaways; operating income adjusted advanced faster than sales at all divisions.  We will delve more into business segment trends in our final note.

In concluding 4Q10, Wal-Mart not only expanded net earnings above the pace of sales in each quarter of FY10, but there was a sequential ramp in the percentage rate.

The stock's reaction to the results (negative) depicts, in our view, concerns pertaining to the following:
* 1Q11 comp/EPS guidance was soft (traffic and lingering deflation)
* Sales in non-essential categories in 4Q10 were less than robust; it's important for Wal-Mart's margin to gain that trade up from opening price-point items
* Full year EPS guidance was short of some sell-side estimates ($3.90-$4.00 per share guidance; we were seeing estimates as high as $4.05 per share heading into announcement)

Now, having said these things it's our stance that Wal-Mart deserves more credit for a strong quarter that arose as consumers remained tepid on discretionary spending, pricing was fierce, and deflation was so prominent.  The way we think about Wal-Mart for FY11 is that productivity initiatives throughout the organizational structure will continue to be an important driver of earnings on a sales base that should gain ground (inflation returns somewhat in 2Q, consumers transition to a slightly better economic frame of mind, international continues to gain share).  As we have communicated to clients, we believe Wal-Mart is entering the next phase of its transformation, one that will help bring gross margin and operating margin to previously unforeseen levels, as further costs are wrung from an already efficient operating model and international growth ramps.  It's very probable, that barring any cataclysmic economic occurrence (or black swan event), we will be sitting here one year from now discussing how FY11 earnings surpassed the guidance set forth on February 18, 2010.

Brian Sozzi
Wall Street Strategies