Choosing food over summer wardrobes (WMT)
Walmart pre-announced weaker Q2 results last night. The company said U.S. comps ex. fuel are expected to be +6% in Q2, higher than the 4-5% previously expected. However, the mix of food and consumables was higher than expected, which weighed on gross margins. Management said double-digit inflation in food weighed on general merchandise sales. The company had to take further markdowns on general merchandise categories, particularly in apparel. Walmart has had more success in clearing inventories in hardline categories. Management is anticipating more margin pressure on general merchandise categories in the 2H, but school supplies are seeing an encouraging start. Management now expects U.S. comps ex. fuel to grow 3% in the 2H. Adjusted EPS is expected to decline 8-9% for Q2 compared to expectations of flat YOY. Q2 adjusted results will also include $.10 or a ~5% benefit from gains and proceeds. EPS is expected to decline 10-12% for the year, implying the 2H is expected to be 13% lower than consensus expectations and down ~6% YOY.
With the caveat that we do not know the magnitude of markdowns, the updated guidance still appears aggressive to us. Management still expects inventory orders to be more than demand in the second half and the current pressure on the consumer looks to worsen and spread beyond lower-income consumers. The lower-income consumer has been forced to choose between food/consumables and discretionary items due to inflationary price increases. Higher-income consumers have not made the same spending decisions, but there are indications they are borrowing more.
Formula Act (PRGO)
On Thursday, President Biden signed The Formula Act, a temporary suspension of tariffs on infant formula tariffs. The bill provides tariff relief on imported formula until the end of the year. On average the tariff rate is 27%, but the rate increases as the volume hits certain thresholds. The non-tariff barriers including testing and safety standards are often a larger obstacle than the tariffs. The National Milk Producers Federation has issued support for the bill and likes its short-term nature. The Milk Producers’ concern is to prevent a permanent dependence on imported formula. According to IRI, 28.3% of powdered baby formula products were out of stock for the week ended July 10, improving 120bps from the previous week which was the highest level to date. Last week, the White House announced two additional flights carrying baby formula, bringing the total imported eight-ounce bottle equivalents to 61 million. In total, that still represents less than one week’s demand. Temporarily reducing the tariffs, but not the nontariff barriers will not structurally change the competitive dynamics of the industry. Perrigo produces store brand infant formula comparable to Ensure, PediaSure, Pedialyte, and Similac. The category represents ~15% of Perrigo's sales.
Higher food inflation projected (KR)
The USDA raised its consumer food price forecast to 8.5-9.5% for the year. Initially the agency projected a 2-3% increase in prices, but ratcheted the estimates higher every month since February. Food at home prices are projected to rise 10-11% and food away from home is projected to rise 6.5-7.5%. For its initial 2023 forecast, the USDA is predicting 2.5-3.5%. Six consecutive revisions to its annual projection shows the USDA is not any better than the worst management guidance.
