Deflation ahead, Q3 review (WMT)
Walmart reported Q3 EPS of $1.53 vs. consensus expectations of $1.52. Q3 results included 40bps of higher legal expenses and the impact from the hurricane in Mexico offset partially by lower LIFO charges.
SSS were 5.0%, beating consensus expectations of 3.9%. U.S. SSS ex. fuel increased 4.9%, with traffic up 3.4%. U.S. SSS were driven by grocery and health & wellness while discretionary was down modestly. Sam’s Club SSS increased by 3.8%, with traffic up 4.0%. Sam’s Club gained share in grocery and general merchandise categories, including apparel and automotive. International sales grew 5.4% in constant currencies. Grocery inflation moderated by nearly 300bps from Q2 to a MSD% increase. General merchandise prices deflated low to MSD%. Management said, “In the U.S., we may be managing through a period of deflation in the months to come.” E-commerce grew 24%, contributing 300bps to U.S. SSS, and Sam’s Club grew 16%, contributing 170bps to SSS.
Gross margins expanded 32bps. U.S. gross margins expanded only 5bps due to lower markdowns and supply chain costs, while the sales mix was a headwind. International gross margins expanded 151bps, mostly due to the timing of Flipkart’s BBD. The company did not record a $50M LIFO charge as it expected. The company incurred 40bps of unexpected legal expenses in Q3. SG&A was deleveraged by 37bps due to higher wages in the U.S. and store remodel costs. Sam’s Club membership income grew by 7.2%. Inventory was down 1.2%, with U.S. inventory down 5%.
Management raised EPS guidance for the year from $6.36-6.46 to $6.40-6.48. SSS guidance was raised from 4-4.5% to 5.5%. In Q4, the company anticipates charges of 20-30bps for unplanned store closures and recovery costs from the hurricane in Mexico. Management no longer expects LIFO charges which is a 40bps benefit compared to previous guidance. Walmart is gaining share when the consumer is under strain. As far as modeling, the gross margin comparison is similar between Q3 and Q4, ~-80 to 90bps but 35bps easier sequentially in the U.S. Due to the deflationary headwinds, management’s plan appears passive about the top-line growth figure but focused on gaining share and delivering value. Management is confident that operating margins will still expand due to their automation plan and digital businesses.
Swapping shares for wine (NAPA)
The Duckhorn Portfolio announced an agreement to acquire Sonoma-Cutrer Vineyards from Brown-Forman in exchange for a partial purchase. Sonoma-Cutrer, one of the largest luxury Chardonnay brands, will bolster The Duckhorn Portfolio’s fine wine portfolio. It owns 1,121 acres in the Russian River Valley and Sonoma Coast. The brand will plug into the company’s portfolio well, and the sales team will be able to market the brand, creating top-line synergies. Sonoma-Cutrer had approximately $84M in sales for the year ended in July. The Duckhorn Portfolio believes the EBITDA margin will be similar to its own. That values the acquisition at 13.3x TTM EBITDA or 1.5 times higher than its valuation multiple. Management also expects run-rate synergies of $5M in F2025. The acquisition is expected to be accretive in the first full year. Brown-Forman will receive 31.5M shares of Duckhorn Portfolio valued at ~$350M. The stake represents 21.5% of The Duckhorn Portfolio. Brown-Forman will also receive $50M in cash and nominate two board directors.
The transaction makes it less likely in our mind for The Duckhorn Portfolio to be acquired in the next 1-2 years. It also ties The Duckhorn Portfolio to Brown-Forman strategically in a manner that we can not fully assess today. The Duckhorn Portfolio was on our long bias list because it was valued less in the public markets than in a transaction, in our view. A luxury wine company headed into quad 4 without the optionality of a takeout is not what we contemplated. We have no insight into the reasons that led to Alex Ryan retiring as the CEO of a company he worked at for 35 years, but we are left to think he disagreed with the transaction.
Grocery behavior changes (GO)
According to a survey conducted by Divert, 72% of Americans are changing their grocery shopping habits due to high inflation and the cost of food. Divert is an impact technology company with the goal of eliminating food waste and driving social and environmental impact.
- 51% of respondents said that higher grocery prices have forced them to cut costs in other areas.
- 76% said they are shopping more for discounted food.
- 58% are shopping at less expensive grocers.
- 42% are shopping for less food at a time.
- 17% are purchasing food past the expiration date.
Grocery Outlet is the best-positioned public grocer because of consumer grocery shopping behavior changes. Grocery shopping is habitual, but consumers have made changes to meet their food needs in the highly inflationary environment since the pandemic. Grocery Outlet’s groceries are priced 40% below grocery competitors and 20% below discounters. It is accelerating store opening on the East Coast and benefiting from consumers looking for better value.
