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Will Higher Expenses Hurt Wal-Mart's (WMT) Q4 Earnings?

Wal-Mart Stores Inc.WMT is set to report fourth quarter fiscal 2016 results, before the opening bell on Feb 18. Last quarter, this retail giant posted a positive earnings surprise of 6.19%.

We note that the company has beaten earnings estimates in two of the last four quarters, missed estimates in one quarter and matched the same in the remaining quarter, making for an average positive surprise of 1.79%.

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 positive comps at Wal-Mart U.S. to continue in the soon-to-be reported quarter.

Wal-Mart expects U.S. comp sales growth of around 1% for the 13-week period ending Jan 29, compared with 1.5% comps growth last year. Sam's Club comp sales, without the impact of fuel sales, are expected to be flat to up 1% compared with 2% growth last year.

However, the Bentonville, AR-based company is facing severe challenges and showing signs of acute weakness. Wal-Mart expects to incur huge e-commerce expenses. In an effort to compete with the biggest online retailer Amazon.com 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 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, and 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 negatively impact performance in the to-be reported 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 small format Express stores due to price competition from local grocers in some markets.

As a result, the company plans to close 269 stores in the U.S and globally, which will affect about 10,000 jobs domestically and will eliminate 6,000 jobs overseas, with a majority of the international impact relating to the closures in Brazil. Moreover, the shutdowns will reduce fourth quarter earnings by about 19 cents to 20 cents per share.

Wal-Mart has also pledged to spend $1.5 billion to raise employees' wages and give them extra training in fiscal 2017, which 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 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.

Including these, earnings are expected in the range of $1.40 to $1.55 per share in the fourth quarter of fiscal 2016, compared with the prior-year quarter's earnings of $1.53 per share.

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 #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. That is not the case here as you will see below.

Zacks ESP: Earnings ESP for Wal-Mart is -0.69% as the Zacks Consensus Estimate of $1.46 per share is higher than the Most Accurate estimate of $1.45.

Zacks Rank: Wal-Mart has a Zacks Rank #3, which when combined with a negative ESP makes surprise prediction difficult.

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

Stocks to Consider

Here are some consumer staple companies, which are worth considering, as our model shows that they have the right combination of these two elements:

Foot Locker, Inc. FL , with an Earnings ESP of +1.79% and a Zacks Rank #2.

Target Corp. TGT , with an Earnings ESP of +1.30% 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

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

FOOT LOCKER INC (FL): Free Stock Analysis Report

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

TARGET CORP (TGT): 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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