Walmart: deflating prices can be good for business

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Consumer price inflation is easing in the US. The economy remains resilient, following a number of “Goldilocks” data readings this week. But you would not know any of that occurred by looking at the share price of Walmart.

America’s biggest bricks-and-mortar retailer kept the tills ringing during the third quarter. Both its top and bottom lines rose at a healthy pace. That prompted it to raise its sales and profit guidance for the year.

Yet the share price fell 8.1 per cent on Thursday — the equivalent of $34bn in market value. Market consensus seems to believe that this is as good as it gets for Walmart. Management’s comments on “uneven” consumer spending and deflationary pressure worried investors much more.

But context is important.

Deflating prices is not necessarily a bad thing for Walmart. Yes, sales have been boosted by higher ticket prices on everyday goods. In terms of foot traffic, it has also benefited as penny-pinching Americans pack its food aisles to stock up on cheaper goods. Walmart’s massive grocery business generated nearly 57 per cent of total US revenues last year. As prices for some food items decline, top line growth — which hit 5.2 per cent in the third quarter — will slow.

But grocery is a low-margin business. Lower food prices could revive demand for Walmart’s higher-margin discretionary products, such as appliances or furniture. That means profit growth can continue even when its sales growth normalises.

Walmart has taken a number of steps in recent years to diversify its business away from low-margin grocery sales. These efforts, which include building a third-party online marketplace and selling digital advertising, should help support its profitability along with Walmart’s 25 times price to forward earnings multiple. Margins from its ad business, where sales grew 20 per cent during the quarter, are between 70-80 per cent.

That suggests Walmart’s substantial valuation premium over rivals such as Target can continue.