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Will Higher Expenses Dampen Wal-Mart's (WMT) Q3 Earnings?

Wal-Mart Stores Inc.WMT is set to report third quarter fiscal 2016 results, before the opening bell on Nov 17. Last quarter, this retail giant posted a negative earnings surprise of 3.57%.

We note that the company has posted positive earnings surprises in two of the last four quarters, a negative surprise in one quarter and matched estimates in the remaining quarter, making for an average positive surprise of 0.92%.

Let's see how things are shaping up prior to this announcement.

Factors to Consider

Wal-Mart has been delivering positive comps in the U.S of late. This is the result of lower fuel prices, which eased consumers' spending power. E-commerce has also contributed to the company's sales. The company expects the trend of higher comps at Wal-Mart U.S. to continue in the soon-to-be reported quarter.

However, Wal-Mart is also witnessing lower margins at Wal-Mart U.S. due to two factors - reduced reimbursement rates from pharmacy benefit managers, which administer drug plans for employers and insurers, as well as a drop in high-margin cash transactions. Wal-Mart expects pharmacy headwinds along with higher-than-expected ongoing shrink in Wal-Mart U.S. to continue to negatively impact third quarter.

In addition, Wal-Mart is facing intense competition on all fronts, ranging from dollar stores to traditional grocery store chains and online business. Its international operations are also under pressure with a stronger dollar eating into sales. At the same time, Wal-Mart projects slower growth in new stores. Price competition is one of the reasons for the slower growth. Wal-Mart is finding it difficult to compete with local grocers in some markets, which compelled it to scale back expansion plans for smaller stores.

Wal-Mart also expects to incur huge e-commerce expenses over the near term. In an effort to compete with the biggest online retailer Amazon.com, Inc. AMZN and to improve customer service, Wal-Mart is aggressively investing in its e-commerce business. Wal-Mart's focus on e-commerce will in turn lower profit margin potential, given shipping costs and price competition involved in it.

Wal-Mart has also pledged to spend $1.5 billion to raise employees' wages and give them extra training in fiscal 2017. The initiative of paying higher wages is expected to help reduce turnover and increase retention. It will also improve its customer service and ultimately that will encourage shoppers to spend more. But it will further raise the expense burden on the retailer. We note that Wal-Mart had increased its minimum wage to $9 an hour in April, and expects to increase it to $10 per hour in Feb 2016. Higher labor costs along with the company's efforts to overhaul its stores and invest in its online operations will weigh on its earnings.

In the third quarter of fiscal 2016, investments in the new wage structure and training are likely to reduce earnings by 8 cents per share. The company also expects headwinds in its U.S. businesses from reduced pharmacy reimbursements rates, which are negatively impacting gross margins, and shift in the mix of cash versus insurance transactions. Pharmacy headwinds along with higher-than-expected ongoing shrink in Wal-Mart U.S. are expected to impact third quarter earnings by 3 cents per share.

Including these, earnings are expected in the range of 93 cents to $1.05 per share, compared with the prior-year quarter's earnings of $1.15 per share. Wal-Mart expects U.S. comp sales growth in the range of 1% to 2% for the 13-week period ending Oct 30 compared with 0.5% comps growth last year.

Sam's Club comp sales, without the impact of fuel sales, are expected to be flat to up 2% compared with 0.4% growth last year.

Earnings Whispers?

Our proven model does not conclusively show that Wal-Mart is likely to beat earnings this quarter. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank of #1, 2 or 3 for this to happen. That is not the case here as you will see below.

Zacks ESP: The Earnings ESP for Wal-Mart is 0.00% as both the Most Accurate estimate and the Zacks Consensus Estimate stand at 97 cents per share.

Zacks Rank #5 (Strong Sell): We caution against stocks with Zacks Rank #4 or 5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions.

Stocks to Consider

Stocks in the retail sector that have both a positive earnings ESP and a favorable Zacks Rank and are therefore worth considering include:

Kohl's Corp. KSS with an Earnings ESP of +0.53% and a Zacks Rank #3 (Hold).

Costco Wholesale Corporation COST with an Earnings ESP of +1.72% and a Zacks Rank #3

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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

WAL-MART STORES (WMT): Free Stock Analysis Report

AMAZON.COM INC (AMZN): Free Stock Analysis Report

COSTCO WHOLE CP (COST): Free Stock Analysis Report

KOHLS CORP (KSS): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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