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Walmart's Low-Cost Approach Wins Again

By Lawrence Rothman, CFA – May 30, 2020 at 8:34AM

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Walmart's costs rose due to COVID-19, but you don't have to worry about a troubling trend.

Walmart's (WMT -0.75%) fiscal first-quarter 2021 (ended April 30, 2020) results were strong, faring better than many other retailers that had to shut down their physical stores. Sure, management admitted that the coronavirus pandemic drove increased demand as people ran out to buy the company's goods. The Walmart U.S. business had a same-store sales (comps) increase of 10% and Sam's Club's comps rose 12%.

The pandemic didn't leave the company completely unscathed, however. Walmart temporarily raised hourly wages at U.S. fulfillment centers and paid special bonuses to all hourly associates.

Certainly, no one likes to see higher expenses, particularly at Walmart where costs are so important to the business' success. However, this shouldn't concern investors.

A post-it with the words How Much Can You Save written on it.

Image source: Getty images.

Looking closer

Examining its quarterly results, Walmart's gross margin contracted to 23.7% compared to 24.3% in the year-ago period. Management blamed lower prices enacted last year, customers buying lower-margin merchandise, and some markdowns.

Even in a quarter with higher operating costs, Walmart's operating income rose 6.6% to $5.3 billion when excluding foreign exchange translations. Its margin was 3.9%, essentially flat compared to last year's 4% operating margin.

In an extraordinary period, this is more than acceptable. Better still, this should prove fleeting.

Management's laser focus

What gives us this confidence that Walmart can hold the line on expenses? Management's long-standing focus on keeping costs low will allow the company to offset the temporary expense increase. It's this ethos that has long allowed Walmart to keep prices low for its customers.

This philosophy has its roots nearly six decades ago when the company opened its first discount store. A core part of management's strategy is to offer everyday low prices and avoid promotional activity. Its pricing strategy is predicated on monitoring and controlling costs.

While the company may feel increased cost pressure in its second quarter due to higher COVID-19 expenses, there is no doubt that Walmart will continue to focus on cost savings, including using its size to leverage savings from suppliers and other areas where it can squeeze costs.

A stable force

The uncertainty created by COVID-19 caused management to withdrew fiscal 2021 guidance.

But, offering customers low prices is always in style, and never more so than during a weak economy. With the unemployment rate at nearly 15% and continuing unemployment claims at 21 million, Walmart's large store base, e-commerce platform, and low prices will appeal to many people.

As an added bonus, while other companies are cutting their dividend, Walmart can easily manage to keep making its payout. Its first-quarter free cash flow was $5.3 billion, handily covering the $1.5 million dividend payment. Historically, that has been the case, too. Its payout ratio stands at 51%.

Walmart's commitment to its dividend is so strong that the company has raised it every year since its initial payout back in 1974.

The company's philosophy is simple but hard to replicate. It's hard to undercut Walmart on price and it is not shy about using its size to extract cost savings. This model will continue serving its customers and Walmart's bottom line very nicely for a long time.

The stock, trading at a price-to-earnings multiple of 24 times, is not cheap. But, quality companies, unlike Walmart's goods, sometimes require paying a higher price.

Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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