Walmart (WMT 0.15%) investors were bracing for some tough news in the retailer's recent earnings report -- and that's just what they received. The chain revealed falling profit margins and weaker cash flow in the second-quarter selling period while predicting more sluggish results in the second half of the year.
Yet many parts of Walmart's business are on the upswing. It is winning market share in the key grocery category, against rivals like Kroger (KR -1.52%). But the real standout metric is the chain's rising customer traffic levels, compared to booming results a year ago.
The bad news
There's no sugarcoating the bad news around profitability. Walmart had to cut prices to keep inventory moving in previously popular niches like home furnishings. And customers were less eager to spend thanks to generally rising inflation.
WMT Operating Margin (TTM) data by YCharts
These factors combined to push operating income down 6% after accounting for currency exchange rate swings. Net earnings declined, too. CEO Doug McMillon said in a press release: "The actions we've taken to improve inventory levels put pressure on profit margin for Q2 and our outlook for the year."
Good news on traffic
Yet customers aren't abandoning Walmart as a trusted retailing brand. On the contrary, more people are shopping there for groceries as budgets have been squeezed by rising prices on things like gasoline. Customer traffic was up 1% on top of a 6% boost a year ago. Compare that result to Home Depot, which saw traffic fall 3% in the same period.
Add the nearly 6% increase in average spending to that 1% uptick in customer traffic, and Walmart's sales rose nearly 7% in the core U.S. market. "We're pleased more customers are choosing Walmart during this inflationary period," McMillon said.
The long-term outlook
Walmart raised its earnings forecast for the rest of fiscal 2023, but still expects sales to fall in the double-digit percentage range. Free cash flow trends aren't as impressive as they were last year, either. These two factors help explain why the stock is down so far in 2022.
But long-term investors can look beyond the current profitability struggles to a brighter earnings picture ahead over the next several quarters. Walmart appears to be through the worst of its inventory adjustment process, after all.
Its expanding market share implies higher profit margins over time once inflation calms down. And its newer business lines, like e-commerce and digital advertising, are seeing strong growth. Sure, the retailer is likely to generate disappointing earnings this year, especially compared to earlier phases of the pandemic.
But its ability to attract more shoppers in key niches like grocery confirms that Walmart remains an essential weekly destination for people looking for essentials or consumer discretionary items like apparel.
It will take a few more quarters before the economic value of that market position shows up in Walmart's profits. Yet the time to buy the stock is before such an earnings recovery, rather than afterwards. Walmart's stock had a boring first run through mid-August but might start exciting investors again soon.
