Inflation: A Tale of 2 Retailers (Walmart and Home Depot)

In this podcast, Motley Fool senior analyst Asit Sharma discusses:

• Walmart's (WMT 0.19%) unusually large stock drop in the wake of disappointing first-quarter results.
• Being a blacksmith, not a goldsmith.
• Home Depot (HD -1.06%) raising guidance after strong first-quarter profits.
• The role higher mortgage rates play for home improvement retailers.

Motley Fool host Alison Southwick and Motley Fool personal finance expert Robert Brokamp continue their conversation with Insider's Mark Reeth about unusual economic indicators.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on May 17, 2022.

Chris Hill: We've got a tale of two retailers. It was the best of times, it was the blurst of times. Motley Fool Money starts now. I'm Chris Hill joined by Motley Fool Senior Analyst, Asit Sharma. Thanks for being here.

Asit Sharma: Chris, thanks for having me.

Chris Hill: Two of the biggest retailers in the US. Two pretty different stories. We'll start with the bigger one. We'll start with Walmart, bigger company and bigger story. First quarter profits for Walmart were much lower-than-expected. Shares are down 10 percent. I know we don't really care about stock movement for any one given day. I will point out, however, we don't really see that type of movement up or down with this company. I get the impression, I'm sure this is not the impression Doug McMillon, the CEO and his team are helping to give. But I'm left with the impression that they seemed surprised by the impact of inflation on this quarter. What did you think when you saw the results and the commentary from management?

Asit Sharma: I mean Chris I think. Yeah, like other big retailers are taken aback by the pace of inflation, the magnitude of it, and the fact that it looks like it's going to stick around for a while. But I thought this earnings report maybe makes the case for longer-term investors. Why you want to invest in a company like Walmart if you're going to invest in the retail space and we have this environment. I hail, not directly because I was born in Massachusetts, but I hail from an agricultural region through my parents of India, where they have a lot of great rustic sayings. One of those is, I'm not a goldsmith, I'm a blacksmith, meaning thereby sometimes it's good to wield a heavy hammer on an iron forge rather than be someone who is very good with intricate design and molding small earrings and such. This is what Walmart -- they are paying for over-resourcing.

They overstaffed last quarter because they had a lot of employees on COVID leave. Those employees came back before they thought they would. They spent a ton on inventory, I should say invested here because that's something that comes off of your cash flow statement into your assets. It's not really an expense, but, let's put it this way, they bought a ton of inventory because they suspected that they would have increasing problems with supply chain. That turned out to be the case. It totally turned their cash-flow around from a very nice positive complexion to negative cash flow this quarter. But these are the things, if you're a long term investor, you want to have these big, mammoth companies in your portfolio so they can react ahead of time. If there are over resourcing for a problem, so be it. You don't want to be on the other end of things where you've got a company that doesn't have the resources to deal with higher inflation over time or can't manage inventory problems in advance. I actually I'm giving them a lot of credit this quarter.

Chris Hill: Certainly Walmart, when you consider its size, moved so nimbly early in the pandemic, in the way it was able to staff up safely, invest in curbside pickup, beef up their delivery, all those sorts of things. I think we're going to find out pretty quickly if this quarter that we're seeing right now is a stumble, or if it's a pattern, because I don't think anyone expects inflation to drop dramatically in the next three months. Maybe Walmart is just taking it on the chin all at once with this one quarter. Things get smoothed out three months from now. But again, long term you want to give McMillon and his team the benefit of the doubt because they've earned it. But if this were a less seasoned management team, I would absolutely understand people looking at them saying, you just blew it. You just blew this quarter, particularly in the wake of Home Depot, which we're going to talk about in a minute. But I think that's part of the challenge for Walmart from an investor relations standpoint is they're not doing this in a vacuum. There are other major retailers on deck this week. Home Depot reported this morning as well, but you'll like to hope that they're going to just smooth this out over the next few months because right now this looks bad.

Asit Sharma: I mean, I agree with that. As far as Doug McMillon and team are concerned, they've got some really good muscle memory that they will proud awake now. During the pandemic, they faced challenges. I mean, Amazon was really taking it out on the rest of the retail world by boasting about how much it paid its employees. Walmart was forced to react, some of their wage growth was reactionary. They had that muscle of cutting costs, being very agile with distribution, with merging their inventory. For years that's how they made their bottom line, is by being a cutthroat type of retailers. I think they'll prob those skills back awake this year. Having spent the last couple of years just trying to catch up, invest in e-commerce, make sure that they had competitive wages. All the investments and rising of costs that they've willingly endured in the near-term. I think that will serve them, but more than that, just going back to some of their old playbook to manage cost during inflation and makes a little bit more of the sales. Which remember, these sales are rising because prices are higher. They've got that part that's helping them make more of that revenue drop to the bottom line. I think it's an open call. We're just going to have to watch. My guess though Chris would be that they do manage this better than people seem to expect today on the ground, looking at the stock price.

Chris Hill: One of the things that you talked about, was how the impact of inflation in terms of what are people buying at Walmart. It was more heavily slanted toward essentials like groceries and less nice-to-have things, additional things that which would drive up the average ticket. Different story at Home Depot, first quarter profits and revenue came in higher-than-expected. Home Depot raised guidance for the full fiscal year. It's the first full quarter that Ted Decker is installed as CEO. I was a little surprised at the boldness of that call because we got three quarters to go in the fiscal year. I'm assuming you don't raise guidance like that unless you are confident that whatever comes your way in the next nine months, in terms of inflation, in terms of supply chain issues, you're going to be able to deal with it.

Asit Sharma: Chris, I think that they feel very confident about one thing. Which is the direction of interest rates for the rest of the year. If we were to wind back the clock a year-ago today, the 30 year average mortgage, according to the St. Louis Fed, which tracks this number, was sitting at 2.96 percent. Today that number is 5.11 percent. Now that's the average. If you have less than, average credit that interest rates to take out a 30-year mortgage is going to be a lot higher, maybe closer to six percent. Did some number crunching right before you and I tapes today. At 30-year mortgage at the median US home price of 375,000, that monthly payment is 1,573 bucks. Now, that's what you would've been in store for last year if you'd taken out a 30-year mortgage a year-ago today.

This year, same mortgage, same house. It's $2,000 payment, 2,038 bucks so you've got a $465 monthly delta. This is something that is, I think pushing Home Depot's results this quarter because those rates didn't rise overnight. They've been creeping up over the last year, and I think there are thousands of potential home-buyers who have put off purchases. We'll start to see these numbers more and more as we look at the pace of home sales. But I think you see the effect on the DIY business, the do-it-yourself business at Home Depot, and also their pro-business. These are the installers who help people with projects, who help put stuff into new homes. Both of these components contribute when we go into a period where people are delaying home purchases. We saw this at the beginning of the pandemic. I think Chris, you and I talked about this on a podcast, how they benefited.

It's the same thing again, except it's not COVID [laughs], it's interest rates. You see this all over their numbers. They, like Walmart had roughly three percent growth, but they brought most of that home to the bottom line and they had this very nice steady growth. I'm looking at their gross profit margin. Their total gross profit dollars grew about three percent, so almost following the sales growth, company had net earnings of 4.2 billion sales and nice two percent increase year-over-year. But the good news here as investors are breathing a sigh of relief. Home Depot is making some money in this environment. Big ticket purchases are still moving along strongly. They've seen some weakness in parts of their business. There was a delayed spring season. Some of the items that are seasonal haven't done as well. But overall, you've got the case of a company that's enjoying this environment, and I think that's what's driving their confidence going forward for the rest of this year.

Chris Hill: You also have same-store sales in the US up 1.7 percent which is not a big number, but that's off over a year ago, it was up 30 percent, so part of the guidance that we're seeing out of Home Depot is just that low to mid-single-digit comp growth the rest of the year. Every time Home Depot reports, I can't wait for 24 hours into the future because we're going to get Lowe's reporting and typically these two go in concert. It's going to be interesting to see if we get similar results and similar optimism about the rest of the fiscal year out of Lowe's as well.

Asit Sharma: I'm guessing both companies have done a pretty good job of working on their stores over the last few years. The stores, they just look more spruce. If you walk into Lowe's or Home Depot, they are using more digital technology. Lowe's has been playing behind in terms of its distribution and warehousing for years from Home Depot. It's catching up, so I'm guessing they had a good quarter as well. But the bottom line here, Chris, you said they've managed to maintain their pandemic gains. People are still going out in mass. This just shows up in the numbers we were talking about Walmart having negative cash flow, I think they're negative free cash flow number. When you take their cash burn add what they invested in their fixed assets, something like seven billion bucks, and here we have Home Depot, which again, they are investing in inventory as Walmart is. While they didn't generate as much operating cash flow, this quarter is still $3.8 billion. Very healthy quarter of cash-generation. Now watch the market, prove me wrong [laughs]. But I think we'll also see some pretty nice results out of Lowe's.

Chris Hill: Want to go back to one thing before I let you go, which you touched on, which is the digital investments that both Home Depot and Lowe's have made. Because it's one of those things that I feel like has gone a little bit under the radar for the investment community. There hasn't been, in either case, some huge splashy acquisition that either of them have made over the past decade or so. They've just steadily invested in improving that customer experience, their own logistical network so that if you are either going into a Home Depot or Lowe's location or just going to their website, both of them are so much better than they used to be in terms of telling you what they have, where they have it, when you can pick it up. Just a communication that both these businesses are able to do with customers is so much better and it is one of those things that doesn't necessarily show up in a quarterly report unless you look at it through the lens of same-store sales and then it makes sense.

Asit Sharma: It makes you wonder why they made it so hard to buy to search and return stuff in the first place. You'll note these are sometimes minor four changes coupled with the digital experience, Home Depot's a great example. They've rearranged in many stores how they present their customer service. They have now multiple kiosks set up. Not weird line they used to have I called it like a labyrinth type of line. Just makes it easier to get to someone to talk to them and they usually have now, a handheld device or could access via the computer their station to help you quickly return something were or find an item in store. Touches like this, just are really great and I'll put in one last thing, which is also an area that neither company has invested in, an area of digital prowess that they benefited from and that's the prowess of people like you and me who become very adept at using YouTube to figure out how we can swap out a bathroom fixture or properly applied paint to twit ourselves. [MUSIC] This is something that is also underappreciated as well as the availability of knowledge that we all have access to, to give us the confidence to go out and do a project ourselves.

Chris Hill: Asit Sharma, always great talking to you. Thanks for being here.

Asit Sharma: Appreciate it. Thanks, Chris. [MUSIC]

Chris Hill: Flipping cardboard boxes and RVs tell us about the economy. Allison Southwick and Robert Brokamp continue their conversation with business insiders, Mark Reeth, about unusual economic indicators and just how accurate they may be. [MUSIC]

Alison Southwick: Last week, you may have noticed a leading indicator that would tell you that this week we're going to talk about more leading indicators. Yes, that's right, Mark Reeth is back and we're going to talk about a few more leading indicators that in theory, maybe predicts the future health of the economy and the markets. But I don't know, we're going to talk about them, and then we're going to rate them on our breathability scale, which Mark Reeth hates the name of but he doesn't have a choice because it's not his show. Mark, welcome back.

Mark Reeth: Hello. I standby the breathability scale, I will have you know, the patent is pending, and that means that you can use it anymore in the future.

Robert Brokamp: Or we have to give you a nickel every time.

Mark Reeth: Done, sold.

Alison Southwick: Your nickels is in the mail. Last week we talked about the men's underwear index, the lipstick index, and also the recession index. How much the word recession shows up in the news. Today, we're going to kick it off by talking about an indicator that feels like one particularly well-suited for the age of Amazon. That's the cardboard box index.

Mark Reeth: That's correct. The cardboard box index is pretty straightforward. The more cardboard boxes are being produced, the better the economy will perform. The idea is that the production of cardboard boxes is a leading indicator that goods manufacturing is rising, and that's a great sign for the economy. As you said Alison, in the age of Amazon post-pandemic, when all of us were trapped at home and I don't know about you, but there's an Amazon box arriving every single day in my front door. Cardboard boxes are suddenly a probably not a bad indicator of how the economy is doing. It's not super-duper accurate, but it is a good informal indicator. In fact, there is a formal following of this indicator.

The Federal Reserve Bank of St. Louis keeps tabs of the price of corrugated shipping containers, cardboard boxes, and the production of paperboard containers, cardboard boxes. If you take a look at the Federal Reserve St. Louis websites, it will show you that the price of cardboard boxes bottomed out in April 2020, and then skyrocketed it later that year, November 2020, as supply chain started to sort themselves out a little bit and people realized, oh, this is real now. We're going to have to be trapped at home and start to order all of our goods on Amazon. You see, if you look at the chart, its this crazy skyrocket up into the right from November 2020 until October 2021.

It steadies out at that all-time high in October 2021. It's about even with where we are today, as opposed to the actual production in the amount of boxes being built or being made, skyrocketed again from May 2020 until March 2021. But it since trended a little bit lower. The problem there is supply chains, which is ironic because when you think of supply chain issues, you think about the goods being shipped and not the containers they are being shipped in. But it's those containers that are a good informal indicator of manufacturing capacity and consumer goods. For me personally, just the fact that the Fed actually does track this one, they don't put an intern in the Huntsville at Target counting men's underwear, but they do have somebody actually keeping track of cardboard box production and prices tells me that this one is at least a little bit more formal than the last couple of indicators, and indices that we've analyzed here today. I'm going to give this one a solid four breathability nods. That's 1, 2, 3, and for the people watching at home four nods on the breathability scale.

Alison Southwick: Our listeners should know that when we say how many thoughtful nods we're giving it, we're giving you those thoughtful nods aren't you, Mark?

Mark Reeth: Darn tooting.

Alison Southwick: All right, Bro, what's your take?

Robert Brokamp: I'm going to give three thoughtful node's just because the evidence shows that the accuracy of this indicator is not superdy duperdy. But that said, it's still interesting. I'll do like looking at anything that indicates how the economy is performing in terms of demand, so this type of thing is good. I like to look at how much it costs to ship things both overwater and overland. By the way, the cost of both of those are down significantly over the last couple of months. Could either mean a good thing because inflation is coming down or can be a bad thing because demand is drying up. Either way, I like to put them all together and take a look at them. I'll keep this one on.

Alison Southwick: Darn tooting and superdy duberdy. This is the level of economic analysis you're going to get.

Mark Reeth: Forget the breathability index, let's get the superdy duperdy scale going [laughs].

Alison Southwick: I give it three darn tootin'. Next, we're going to talk about one that feels particularly timely because who among us doesn't want to live that sweet fun life? Me I don't. We're going to talk about the RV index.

Mark Reeth: That's right. The RV index, the idea is that a decline in RV sales proceeds a recession. The logic there is that if you're uncertain about the future, maybe you're putting off buying big-ticket items like an RV and to the RV indexes credit, it actually has been superdy duperdy accurate at least recently. We will talk about my change of tone of voice there in a moment. But RV sales slipped in 2018/2019, and then of course 2020 happened and we had ourselves a recession. Actually declines in RV sales have proceeded all three of the most recent recession. There might be something there, but of course 2020 comes along and the pandemic throws a wrench into every economic indicator right there. Because with people afraid to leave their homes and afraid to travel, RVs suddenly became a very safe option for getting out of their house without sacrificing safety.

RV sales have skyrocketed in the last couple of years. Now I mentioned, the St. Louis Fed tracks cardboard boxes, they also track RV sales. You can see if you take a look at their website, it was a slow but steady rise over the last few years with a big bump beginning in September 2020. Again, as people realized, hey, I'm trapped at home and this sucks. What if I bought a big old van, packed my life into it, and got the heck out of dodge. I would give that a strong superdy duperdy look if I was still trapped at home, rootin-tootin' etc. [laughs]. But seriously no, the price of RV has gone up over the last two years is starting to flatten since November of 2021. But RV sales themselves are very strong right now, there is a year-over-year increase of about 18.7 percent in RV sales according to the RV industry association. Sales are strong despite the fact that people might be a little bit more worried about a recession now more than ever. For me, personally, I'm going to give this a solid three-and-a-half nods. That's 1, 2, and then a tilt to the side for the three-and-a-half there. The RV index, again, it's been accurate in the past, but I think 2020 threw a wrench into everything maybe it's not so accurate going forward.

Robert Brokamp: I'm going to give it five thoughtful nods because I just love RVs and that's the first thing I'm going to do when I retire is buy an RV and drive around the country. Just say RV and you're going to get lots of nods for me. As an indicator, I like it because you certainly have to have a good deal of money to buy one and costs anywhere from 10,000-200,000 dollars. I think what's interesting now is that sales are going up even though the price of gas going up because these things get like 6-10 miles per gallon. Usually what you see is when gas goes up, people start buying smaller cars. As Mark said, I think the pandemic threw this one off, but I'm still going to stick with it because man, it's in RV.

Mark Reeth: Rob, when are we going on a road trip? You, me, the setting sun Americana I'm in.

Robert Brokamp: With wholly underwear I can't wait.

Alison Southwick: The idea a little bit like a turtle with you guys. I don't know. That doesn't sound like freedom to me. Now it is time to talk about our last leading indicator. Our listeners, Mark, they maybe don't know all about you. We used to work together at the Fool you're now at business Insider and also you're about to get married.

Mark Reeth: Nine days. Nothing on calendar.

Alison Southwick: So exciting. I thought, you know what? Let's close with the leading indicator of love and so for that, I'm going to look to Bro. Bro, what do you feel is a good leading indicator for the success of a marriage? Help Mark out here.

Robert Brokamp: Well, for successful marriage, not necessarily love and as we know, they're not always connected there. But here's what I'll tell you, and it comes down to credit scores. This comes from a 2015 study from the Federal Reserve called credit scores and committed relationships. What they found was the higher the couple's credit scores, the more likely the relationship will last. A significant difference in a couple of individual scores is predictive of potential trouble ahead. It turns out as not really just about the money. Their Park includes that "Credit scores reveal an individual's relationships, skill, and level of commitment". Mark, we wish you and your fiance all the best, including FICO Scores above 800.

Mark Reeth: Wow, Bro. Thank you for that. I think you just wrote my wedding vows actually you're romantic. Thank you [laughs] I was struggling with them and now I know FICO Scores are going to make up the core concepts of my romantic love at the wedding. Thank you, Robert.

Robert Brokamp: I predict success.

Alison Southwick: Ultimately, aren't we all looking for a leading indicator of love and marital success. Because even if we can't predict the bull and bear markets, [MUSIC] the inflations and recessions and depressions and robot uprising, at least we'll go through them together with someone who loves nutritious sludge as much as we do. Mark, thanks again for joining us.

Mark Reeth: Great to see guys. Thanks for having me. [MUSIC]

Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.