Walmart (NYSE:WMT) was sure to have a blowout first quarter this year, as it's kept its doors open throughout the coronavirus pandemic. Sales jumped 8.6% year over year due to consumers stocking up on groceries and everything else available at its stores. Shoppers flocked online as well; digital sales improved 74% last quarter.
But that was expected.
What was surprising was Walmart's operating expenses as a percentage of revenue fell significantly. Operating expenses accounted for just 20.3% of Walmart's revenue last quarter, versus 20.9% a year ago. That's despite hiring over 235,000 new employees, increasing wages and bonuses, and various efforts to reduce the spread of COVID-19 for both employees and customers.
Both Target (NYSE:TGT) and Amazon (NASDAQ:AMZN) have seen similar spikes in hiring and operating expenses related to the pandemic, but it's had a much more noticeable impact on their operating margin. Target's operating leverage improved only slightly, with selling, general, and administrative (SG&A) expenses as a percentage of revenue falling nearly 10 basis points despite sales growing even faster than they did at Walmart. Amazon's operating expenses climbed to 36% of revenue from 35.8% last year, and it expects profits to fall to $0 next quarter as it invests heavily in COVID-19-related areas.
So, how is Walmart able to produce such strong operating leverage while its peers aren't exactly translating higher sales into higher profits?
Reducing the drag of e-commerce
E-commerce was one of the biggest factors driving sales for Walmart. Digital sales increased 74% for the company, led by grocery pickup and delivery.
Importantly, Walmart noted "lower losses in Walmart U.S. eCommerce compared to Q1 FY20" in its press release. Walmart's e-commerce operations have been dragging down profits for years as the company has rapidly expanded its marketplace and online grocery operations. The company reportedly lost $1 billion on the operation last year.
Those investments are starting to pay off. Walmart has been the biggest beneficiary in the shift to online grocery purchasing. It's also driving more traffic to Walmart.com, positioning its higher-margin marketplace business to become a bigger source of revenue.
Reducing the losses in the online business likely had a significant impact on Walmart's overall operating margin. And there's still lots of room for improvement given coronavirus is accelerating trends that benefit Walmart.
Watch for the trend to continue
As more shopping moves to Walmart.com, particularly grocery shopping, several underlying trends ought to continue, helping to maximize Walmart's operating efficiency.
First, fully scheduled store pickup times means employees can be more efficient at Walmart's grocery pickup locations. Second, online ordering may encourage larger average basket sizes due to the minimum order threshold. Walmart saw its average ticket size increase 16.5% last quarter versus just 12.5% for Target. Larger baskets and lower traffic means more efficient operations.
Additionally, the growth of its e-commerce business could enable it to increase the efficiency of its warehouses. That could reduce fulfillment expenses or enable Walmart to expand its NextDay product selection to drive incremental sales and better compete with Amazon Prime.
Walmart has also become more vigilant in cutting its losses. It's shuttering Jet.com after shifting most of its staff to Walmart.com. That follows efforts to divest ancillary e-commerce brands.
The coronavirus pandemic is accelerating retail trends that should help Walmart improve its profitability as it scales its e-commerce operations. While improving e-commerce operations certainly isn't the only factor that helped boost Walmart's operating efficiency last quarter, it's the most likely to see a continued positive trend for the business as in-store shopping habits and facilities eventually go back to normal.