There's no denying Walmart (WMT 0.64%) is the big winner among retailers that have reported first-quarter earnings thus far. The company's top line improved to the tune of 7.6% last quarter, while rival Target saw its Q1 revenue roll in flat with year-ago levels. Home Depot reported a 4.5% year-over-year sales decline. No other store chain, in fact, has yet to show even similarly strong sales growth for the three-month stretch in question.
Home Depot, Target, and a handful of other names in the business were able to do something during the first quarter that Walmart hasn't yet fully achieved, however -- that is, get rid of last year's buildup of less-than-marketable merchandise.
Walmart continues to discount, because it has to
The world in general and retailers in particular were optimistic about a slow exit from the COVID-19 pandemic last year. Most businesses were looking for a swell of spending in 2022, so much so that retailers loaded up on a huge amount of merchandise beforehand.
As it turns out, they didn't need that much inventory. Sales did perk up last year, but spending never quite lived up to expectations. End result? Most retailers, including Target and Walmart, started the last half of 2022 with too much of the wrong inventory at the time. Discounting ate into profit margins, and even then, persistently bloated inventory levels were clogging up stores and limiting the purchase of newer, more marketable merchandise.
Good news: As of the end of last quarter, Target has solved the problem. Its inventory levels (compared to sales) as well as its gross and net profit margin rates were both back to pre-pandemic norms. Ditto for Home Depot. But Walmart, not so much.
The two graphics below put things in perspective. The first of the images is a comparison of the company's quarterly sales to its quarterly inventory levels, plotted with a comparative ratio of the two numbers called an inventory/sales ratio.
Prior to the pandemic Walmart's typical inventory/sales ratio averaged on the order of 35% to 40%, a target that's ideally between too much and too little merchandise. Inventory dried up in the wake of the pandemic in 2020, but jumped to uncomfortably high levels in early 2022. The retailer finally knocked the comparison back to just under 35% during the final quarter of last year. Last quarter's jump to 37.7%, though, is a sizable step back in the wrong direction.
Data source: Walmart. Chart by author. Revenue and inventory figures are in billions of dollars.
A fatal level of inventory? No. But, it's well above the average headed out of the first calendar quarter and into the second.
The real red flag from last quarter's results, however, is the hit to profits the company is still taking in order to get rid of goods. Total gross profits fell back to their recently stagnant average, while Walmart's gross profit margin rate of 23.6% remains well below its pre-pandemic norms between 24% and 25%. That's no big deal for most businesses. In the paper-thin-margin world of retailing, though, it's an alarmingly weak number.
Chart by author. Gross profit figures are in billions of dollars.
This below-average gross margin rate indicates Walmart is still doing some deep discounting to keep merchandise moving off its shelves. But even then it isn't quite enough.
Reason enough for concern
Again, it's hardly a death knell. This is Walmart, the country's -- and the world's -- biggest brick-and-mortar retailer. It's the biggest for a reason. It can use its fiscal and physical muscle to take on growth-driving initiatives while at the same time keeping competitors in check.
Last quarter's industry-leading sales growth may largely be the result of deeper discounting, though. If that's the case, it's not exactly a long-term formula for the sort of smashing success the company's produced in the past.
Current and would-be shareholders would be wise to keep their finger on the pulse of this particular aspect of Walmart's income statement. It makes the otherwise-healthy outfit a little bit tougher to own. If the company can't find a way to start charging relatively more again, the persistent dynamic could make Walmart stock a lot tougher to stick with now.
