Walmart Inc. (WMT.US) suffered a significant decline after earnings, marking the largest drop in four years! Wall Street collectively adjusted target prices downward, yet no one downgraded the stock. JP Morgan stated, "The sell-off is basically complete."

Walmart Inc. (WMT.US) recently reported a mixed Q2 earnings report: while revenue and profits continued to grow and the full-year performance guidance was raised, comparable store sales growth in the U.S. significantly slowed down. Coupled with headwinds from pharmacy regulations, the stock price plunged 9.2% in a single day after the earnings report was released, marking the largest single-day drop since May 2022. Subsequently, several investment banks, including JPMorgan Chase, BMO Capital, and TD Cowen, lowered their target prices, but most maintained a buy or overweight rating. The focus of market debate revolves around whether the drag from the pharmacy business is merely a temporary factor and whether Walmart Inc.'s high valuation can be supported by high-growth businesses like advertising, marketplace services, and membership. From the overall data, Walmart Inc. achieved revenue of $187.9 billion for the most recent quarter (ending July 31), a year-over-year increase of 5.9%; the non-GAAP adjusted earnings per share was $0.81; and operating profit rose by 28.8%, with a 17.4% increase when adjusted for constant currency. Profit figures were boosted by tariff refunds, but partially offset by the company's voluntary price reductions. Based on the above performance, management also raised the full-year guidance: they expect constant currency sales growth of 4% to 5% for the fiscal year, up from the previous forecast of 3.5% to 4.5%; adjusted earnings per share are projected to be between $2.80 and $2.87. Reasons Behind the Drop However, the market is particularly concerned about comparable store sales in the U.S. For the quarter, Walmart Inc.'s comparable store sales in the U.S. grew by only 2.6%, lower than the 4.6% growth in the same period last year and also below the 4.1% growth in the previous quarter. Transaction volume increased by 1.5%, while the average transaction value rose by only 1.1%, indicating that although consumers are still spending, they are becoming more cautious. Walmart Inc. CFO John David Rainey noted in an interview that consumers continue to spend, and real wage growth remains in sync, indicating resilience in this environment. However, the company provided sales growth guidance for the next quarter of 3% to 3.75%, implying that growth might further slow down. Additionally, management attributed part of the slowdown in comparable store sales to the pharmacy business. Rainey stated on the earnings call that pricing pressures related to the maximum fair pricing regulations in the pharmacy sector contributed approximately 125 basis points to the slowdown in U.S. comparable store sales for the quarter, higher than the company's earlier estimate of 100 basis points. Excluding health and wellness business, comparable store sales growth for Walmart Inc. during the quarter was close to 3% to 4%, consistent with the range the company has maintained over the past two and a half years. Furthermore, the company expects fuel costs to increase by over $2 billion this year, which will add some cost pressure. CEO John Furner remarked that overall it was a decent quarter, with sales growth at the upper end of the guidance range and adjusted operating income growing by 17.4% at constant rates. He emphasized that the headwinds in the pharmacy business obscured the strong performances of other segments, such as groceries, general merchandise, and e-commerce. However, investors are clearly more focused on the reality of slowing growth rather than management's explanations. Investment Banks Lower Target Prices, but Most Remain Bullish After the earnings report, JPMorgan Chase lowered Walmart Inc.'s target price from $137 to $125, maintaining an overweight rating. In fact, the bank had already reduced its expectations for Walmart Inc.'s comparable store sales three weeks before the earnings report, and the actual data still fell short of their downsized forecast. JPMorgan analysts described the situation leading up to the earnings report as a tangled mess, with multiple factors interwoven, making it difficult to judge the stock price direction. However, they believe the sell-off is largely complete, and as advertising, marketplace services, and membership businesses continue to expand, Walmart Inc.'s trajectory is expected to improve. Other investment banks took similar actions. BMO Capital lowered its target price to $126, citing comparable store sales slowdown and weakness in health and wellness business; TD Cowen lowered its target price to $125, also referencing the 2.6% comparable store sales growth; Bernstein maintained an outperform rating, pointing out that Walmart Inc.'s strong margins are a reason to remain confident. According to statistics, among the 32 analysts covering Walmart Inc., 29 recommend buy, 3 suggest hold, and there are no sell ratings. The average target price is approximately $130, implying about 25% upside potential from the current price of around $104. This suggests that Wall Street remains generally optimistic, though short-term expectations have been downgraded. New Businesses as Growth Engines Despite headwinds from the pharmacy business, Walmart Inc. is mitigating pressure by diversifying its revenue sources. During the quarter, global advertising revenue grew by 38% year-over-year; U.S. marketplace sales increased by 52%; global membership fee revenue rose by nearly 17%; and the number of new members in the Walmart Plus membership program for the first half of the fiscal year reached a record high. CFO Rainey indicated that nearly half of the profit growth for the quarter came from membership, advertising, and marketplace businesses, rather than traditional core retail operations. He also noted that e-commerce advertising is growing faster than overall e-commerce sales, driving incremental profit margins upwards. In e-commerce, global sales grew by 23% year-over-year. In international operations, e-commerce accounted for 30%, with strong growth in markets such as China, India, and Canada; U.S. Sam's Club e-commerce sales increased by 26%, and since launching a 1-hour delivery service in April, club delivery volume has increased threefold. CEO Furner also emphasized that the company conducted over 11,000 Rollbacks price reduction events during the quarter, up from 7,200 at the end of the previous quarter. He believes that price reductions will first boost sales and then lead to market share growth over the next several quarters. Market share data for food during the quarter was strong, seemingly supporting management's assessment. JPMorgan analysts stated that Walmart Inc. now has a more diverse profit channel than in the past, and these emerging businesses are growing rapidly enough to offset the drag from the pharmacy business. The bank further added that the bearish arguments against Walmart Inc. assume that price reductions do not lead to delayed benefits, meaning these promotions only erode profits without boosting traffic or market share. However, management's statements and food category share data indicate that the company holds a different view on the effectiveness of price reductions. Lessons from the Large Drop: Moderate Rebound and Valuation Pressure Walmart Inc. experienced a 9.2% drop in a single day last Thursday, marking the largest drop since May 2022 and the fourth largest single-day decline in the past 15 years. As of this writing, Walmart Inc.'s market capitalization is approximately $825 billion. Over the past decade, Walmart Inc. has generated over 400% returns for shareholders, adjusted for reinvested dividends. Historically, Walmart Inc.s performance following its three previous larger single-day declines has not been poor, but it has also not been spectacular: On October 14, 2015, the stock dropped 10% due to management warning of declining profits the following year. A year later, the stock was up approximately 14% compared to the closing price on that day; On February 20, 2018, the stock dropped by 10.2% due to slowing e-commerce growth during the holiday season and compressed profit margins. A year later, the stock was up approximately 6% compared to the closing price on that day, but still below pre-drop levels; On May 17, 2022, the stock plummeted by 11.4% due to soaring costs severely hurting profits. A year later, the stock was up about 14% compared to the closing price on that day, just returning to the level before the drop. Overall, investors who bought in during the aforementioned three significant declines had positive returns a year later, although the gains were modest; when measured from the day before the drop, the stock merely filled the gap and remained below previous levels. Additionally, on May 21 of this year, Walmart Inc. dropped 7.3% following its Q1 earnings report, and three months later, the stock was still about 14% lower than the closing price on that day, yet to recover. The important difference between this drop and the previous three is that the previous declines often came with negative news on profit fronts: in 2015, it was profit warnings; in 2018, profit margin compression; in 2022, soaring costs. This time, however, Walmart Inc. raised its full-year guidance and reported strong profit performance, but the Q3 sales guidance of 3% to 3.75% indicates continued slowing revenue growth. Investors did not react to profit shocks but to downgraded revenue growth expectations. In terms of valuation, based on the updated full-year adjusted earnings per share guidance median, Walmart Inc.'s current stock price corresponds to about 37 times expected earnings, significantly higher than its ten-year average P/E ratio of about 25 times. The forecasted compound annual growth rate for earnings over the next five years is expected to be 8.7%, and the current valuation is still not cheap. Even after the drop, the stock price remains approximately 9% higher than the 52-week low and about 23% lower than the 52-week high. It continues to be a stock with a high valuation, although it is now not quite as expensive.