Position Monitor Changes (PRGO, STKL, BJ, UTZ, LANC, WMT)
We are moving Perrigo, SunOpta, BJ Wholesale Club, Utz Brands, and Lancaster Colony higher on our long list.
PRGO moves to #2 long. The concern about the legal risk from Zantac has provided a buying opportunity. The Hatch Waxman Act provides strong legal protection from product liability lawsuits. The case is entirely different from the pharmaceutical companies that have much deeper pockets, a more straight forward case, and a larger base of claimants that are able to prove usage of the drug.
STKL moves to #3 long. Both segments came together in Q2. Plant-based milks continue to grow despite inflation and pressure on the consumer. Within plant-based milk SunOpta is gaining share. New capacity additions are leading to upside in estimates.
BJ moves up two spots. Top line trends have a tailwind in the current environment. Wholesale clubs are taking share in grocery.
UTZ moves up four spots. The PPI for fats and oils decelerated 1600 bps. Freight spot rates have also been falling and new contracts will be under pressure supporting an inflection in margins that have been driven by price increases so far.
LANC moves up one spot. Similar to the UTZ rationale plus strength in Chick Fil A.
Adding WMT to the long list. Earnings revisions are inflecting from negative to positive. 2H estimates appear too conservative. Excess inventory is not behind it, but it is in process. The inflationary environment is driving customers to the store. Driving traffic to the store is probably Walmart’s largest challenge pre-pandemic, but the environment itself is now taking care of traffic. Although Sam’s is a smaller segment, we continue to expect warehouse clubs to take share in food retail. We added BJ’s Wholesale Club to our long list last month. We will present our WMT Black Book on September 1.
Adding Walmart as a Best Idea Long (WMT)
After two negative guidance revisions, Walmart’s estimates appear to be inflecting positively. The consensus EPS estimates for Q3 reflect a more significant deceleration in sales trends and headwinds from markdowns than our model. We think now is the time to be overweight Walmart.
Historically Walmart outperforms in Quad 4 and on an absolute basis has had positive returns as seen in the charts below.
Q2 Review
Walmart reported Q2 EPS of $1.77 vs. consensus expectations of $1.62. Walmart pre-announced Q2 results on July 25 and lowered the EPS outlook for both Q2 and the year. Management cited the strength in consumables was offset by weakness in discretionary categories which had resulted in excess inventories. For Q2 EPS, management’s guidance for YOY growth to be flat to up slightly was revised to down 8-9%. The actual results of $1.77 vs. $1.78E are much closer to the original guidance.
Sales growth of 8.4% exceeded the preliminary estimate of 7.5%, which was raised from 5% at the time of the pre-announcement. Walmart’s U.S. comp store sales increased 6.5% ex. fuel, above expectations. Transactions grew 1% while average ticket increased 5.5%. E-commerce sales grew 12%, accelerating from 1% in Q1. Sam’s Club SSS ex. fuel and tobacco increased 10% due to transaction growth. Same store food sales increased mid-teens. Food units were slightly negative with trends flat exiting the quarter. Management said that households with annual incomes above $100,000 represented three-quarters of the company’s share gains in food. Internationally comps were up double digits in the three largest markets of Mexico, Canada, and China.
Gross margins contracted 132bps and were slightly less than expected due to markdowns and a greater mix of consumables. Management called out higher penetration of private brands, particularly in food categories. At the end of Q2 inventory was up 26% YOY, decelerating 7.5% sequentially. Management noted that 40% of the growth is due to inflation. The company said shipping containers in its supply chain have been cut by half from Q1. Walmart leveraged SG&A expenses by 45bps with sales leverage somewhat offset by higher wages.
Other notables include:
- Membership income grew 9% for Walmart+ as membership count continues to grow.
- Q2 discrete items include a favorable insurance settlement of $173M and a $182M special dividend that were previously disclosed.
- Sam’s Club added more new members in the quarter than any quarter in recent years.
Management’s guidance for the year remains similar to the revision provided on July 25 adjusted for the upside in Q2 results. Management now expects EPS for the year to decrease 9 to 11% YOY, up from an 11 to 13% decrease previously. Revenue is still expected to grow ~4.5% YOY with U.S. comp store sales ex. fuel growth of 3% in the 2H.
For further details and our Black Book invite please see our separate note.
Canadian CPI (L.CN)
CPI in Canada decelerated to 7.6% YOY in July from 8.1% in June due to a deceleration in gasoline prices. The CPI for food increased 9.1% YOY, accelerating from 8.8% in June. The CPI for food at home increased 9.9%, accelerating from 9.4% in June. Food items with accelerating price increases include bakery products +13.6%, non-alcoholic beverages +9.5%, eggs +15.8%, and coffee & tea +13.8%. Food inflation is seeing similar trends north of the border, which makes sense given the size of the food trade between the countries.
