Wal-Mart Stores (WMT) hurt by deflation and lower traffic

Wal-Mart Stores (WMT) dropped 1.09% today as fourth-quarter revenues missed expectations and soft guidance left investors unenthused.

The impact of deflation on operations is becoming increasingly obvious for a company that has traditionally been a back-door dollar play – WMT buys goods from foreign countries where the dollar is strong and sells them in the U.S. The company spent a good part of last year downplaying the impact of deflation in food and in other areas such as consumer electronics, but deflation cannot be ignored. Still, WMT has not publicly addressed with how it is dealing with this issue.

A decrease in traffic during the quarter was also responsible for disappointing results. I can’t help but assume some of the traffic decline is due to consumers trading. WMT’s low price advantage has been crucial in attracting recession-stricken consumers, but increasing signs of stabilization threaten to reverse this trend. Comparing WMT’s results to those from high-end grocer Whole Foods (WFMI) earlier this week makes the trade-up case even more compelling. WFMI raised its full-year forecast amid more store traffic and increased number of items per sales ticket.

Consumer sentiment won’t be going gangbusters until the unemployment rate moves significantly lower, but still investors should be less focused on WMT’s low-cost position and pay more attention to the company’s international sales.

Much of the company’s future leans on their international success. International operations have grown to roughly $100 billion in annual sales from nothing 20 years ago, but much of that growth came from directly acquisitions. And while international sales are growing faster than those in the U.S., profitability is lower – international operating margins are 5% and 7% in the U.S. An even bigger concern is that WMT has not been able to show the economies of scale or explicit synergies that were always the rationale for such expansion.

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Peter J. Lazaroff, Investment Analyst