Wal-Mart Stores (WMT 1.83%) shares are back on the discount rack following a lackluster Q1 earnings report. Investors were disappointed by a 1.1% increase in comparable sales at U.S. stores and by earnings per share that fell from $1.10 a year ago to $1.03 last quarter.
Management blamed foreign currency headwinds, investments in e-commerce, and higher wages for the decline in profit, but the market was unappeased. Beyond the headline numbers, however, investors should take note of some positive items hidden in the report.
1. Focus on investments, not currency
Wal-Mart said currency translation negatively affected EPS by $0.03, but its international stores contribute less than 20% of the company's operating income. For the quarter, companywide operating income declined from $6.2 billion to $5.7 billion, with the vast majority of that slide owing to a 7% drop in operating income at U.S. stores, from $5 billion to $4.6 billion.
Since comparable sales improved in the quarter, the profit dip was likely due to increased spending on wages, training, and e-commerce infrastructure, and not poorer operating performance.
In April, Wal-Mart lifted the minimum wage at all of its U.S. stores to $9 per hour, a cost effect that will triple in the current quarter as only one month of the wage increase was included in Q1. The company also raised wages at higher levels, and added back nearly 8,000 department managers in a move to improve customer service. All told, Wal-Mart plans to invest $1 billion in employee wages and training this year, and those investments shaved $0.02 off EPS in the first quarter.
On the e-commerce front, Wal-Mart's investments helped drive global online sales growth of 17% in the quarter. The retailer is rolling out a simplified checkout process on walmart.com and improving its mobile experience, which more than doubled mobile traffic in the quarter. Other investments include a new dedicated e-commerce fulfillment center in Brazil and four more corresponding sites in the U.S.
2. Customer service is improving
Wal-Mart customer service scores rose last quarter -- likely as a result of the investments in its staff. During its earnings call, management said, "our customer service scores have steadily increased this quarter with all geographic areas and formats showing positive results."
In addition to increased training and the additional department managers, Wal-Mart also continued its "Checkout Promise" program. This initiative, launched during the holiday season, aims to speed up checkout at the register by adding more cashiers during peak hours.
Improving customer service is key for the company to grow its comparable sales. Its customer satisfaction scores have been at the bottom of the industry recently, according to surveys, while fast-growing rivals such as Amazon.com and Costco Wholesale are near the top. As competition increases, both in e-commerce and other platforms, Wal-Mart must better please its customers in order to remain competitive.
3. Growth areas are delivering
Wal-Mart's two key growth areas, e-commerce and its Neighborhood Market locations, both significantly boosted sales in the quarter. Along with the 17% global growth, e-commerce sales were particularly strong in international markets such as Canada, where they jumped by over 40%.
Meanwhile, comparable sales rose 7.9% at the smaller Neighborhood Market format last quarter. As Supercenter comps have flattened and the larger format appears to be near saturation in the U.S., organic growth at Walmart Neighborhood Market is crucial -- that format is the company's best bet for in-store sales increases and overall store growth.
Last year, Wal-Mart for the first time added more Neighborhood Markets than it did Supercenters, and for 2015 it plans to open 200-220 of the former versus just 60-70 of the latter.
With the headwinds from a stronger dollar and the company's investments in personnel and e-commerce, Wal-Mart's profit is expected to fall this year, and might not grow much next year as it again raises its minimum wage to $10. Still, it's a mistake for investors to assume this quarter's results indicate long-term weakness.
The most important change Wal-Mart needs to make is improving its customer service. If Wal-Mart can get its customers to visit because they want to instead of because they have to, its performance and stock value will improve. That won't happen overnight, but the Q1 earnings report shows the retailer is clearly taking steps in the right direction.
