Walmart: Q2 Shows How Company Leverages GenAI To Stay Ahead

Summary:

• Walmart’s Q2 performance exceeded expectations, with revenue and EPS growth, strong same-store sales, and improved operating income.
• The company’s use of generative AI has enhanced the user experience, leading to increased profitability and efficiency in managing inventory.
• International business, including Flipkart, contributed significantly to Walmart’s top and bottom lines, complementing the company’s US business.

Investment Thesis

In my last article on Walmart (NYSE:WMT), I analyzed the company’s first quarter performance and explored the factors behind the company’s resilience during what was a challenging microenvironment. I had a HOLD rating on the stock.

Since my article was published in May 2024, the stock has gained nearly 14%, significantly outperforming the S&P 500, which gained nearly 7% during the same period.

In this article, I investigate the company’s Q2 performance and argue how the company’s use of generative AI and the continued growth of its international business has helped the retailer face the macro challenges, unlike some of its competitors.

Walmart’s Q2 Highlights

Once again, WMT surprised the street with its quarterly performance. Both second quarter revenues of $167.8 billion (up 4.7% y/y) and adjusted EPS of $0.67 (up 9.8% y/y) beat analyst estimates by $386.5 million and $0.02 respectively. Same-store sales in the US, a metric that is well-watched by investors, grew by 4.2%. Although this was a decline from the 6.4% growth experienced during the same period last year, the metric was well above estimates of 3.5%. Moreover, the growth also exceeded the average same-store sales growth registered by all other US general-merchandise stores during this quarter.

Adjusted operating income grew by 7.2%, driven by a combination of higher gross margins, strong growth in membership income, and a reduction in e-commerce losses. Both the company’s advertising business and its e-commerce business continued their upward trajectory, registering a growth of 26% and 21% y/y respectively. The company’s inventory levels were also healthy, down 2% y/y, with the US business seeing its inventory levels declining by 2.6% y/y.

On account of a better-than-expected consumer sentiment for its products, management raised the full-year guidance. More specifically, FY25 consolidated net sales are now expected to grow between 3.75% and 4.75%, consolidated adjusted operating income is projected to show a growth in the range of 6.5% and 8%, and adjusted EPS now forecasted to come in between $2.35 and $2.43. Q3 net sales growth is projected to be between 3.25% and 4.25% and Q3 adjusted EPS is projected to be somewhere between $0.51 and $0.52.

Generative AI Playing a Major Role in Boosting User Experience

There have been a lot of doubts surrounding the value proposition of generative AI, especially given the amount that companies are currently spending on it. While the technology continues to remain nascent, when it comes to WMT and its Q2 results, generative AI did play an influential role.

Given the weakness seen in consumer confidence in the US and given that the US consumer has become more price-conscious, user experience has become a key differentiating factor for retailers. Using genAI, WMT did manage to boost the overall user experience, especially in its e-commerce business. One example is how the company made its cross-category search more effective with the help of genAI, leading to improved visibility of its general merchandise items. The improvement led to a higher rate of “impulse buys,” which translated to narrowing losses for its e-commerce business.

Another instance of how generative AI played a crucial role was in improving the company’s overall product catalog, which boosted both the overall user experience and enabled the company to be more efficient with its inventory management. During the earnings call, management mentioned that they had deployed multiple large language models (LLMs) to improve over 850 million pieces of data associated with the product catalog, a task, which according to them, would have required “nearly 100 times the current headcount,” if it had to be completed in the same amount of time manually.

More features using generative AI are in the works, including a new shopping assistant, which is trained to answer questions like “Which TV is best for watching sports.”

The last time I wrote about WMT, I had talked about how the company remained resilient even in the face of a challenging environment. This quarter gave us more evidence on how the company has been able to do that: by leveraging generative AI and automation effectively to enhance user experience and convenience. The end results have been better inventory management, higher sales growth, and a better-performing e-commerce business.

International Business Becoming a Valuable Sidekick to the US Business

My last article on WMT had highlighted how the company’s India business, Flipkart, could be a potential catalyst for the company. During Q2, in addition to Flipkart, the likes of Walmex and its China business demonstrated strong growth, which subsequently resulted in a strong performance by its international business.

More specifically, the international business saw its net sales come in at $29.9 billion, a y/y growth of 8.3%. Operating income also delivered a strong growth of 15.7% y/y. International e-commerce sales experienced improved margins and narrowing losses thanks to increased penetration across the company’s various markets. Finally, driven by Flipkart and Walmex, the company’s advertising business registered a y/y growth of 23%, contributing to the 26% y/y growth of the overall advertising business during the quarter. This is on top of the 24% growth that the advertising business registered in the first quarter.

While WMT does not provide a detailed breakdown of each of its international markets, management did mention that Flipkart grocery registered a y/y growth of over 50%, and the subsidiary’s next-day delivery is now available in over 200 Indian cities. Flipkart, earlier this month, also successfully launched its quick commerce space business called Minutes, thereby entering a segment that is expected to grow at a CAGR of 24.33% over the next five years.

Although Minutes is only available in one Indian city today, Flipkart has concrete plans to scale up the business, in time for the country’s busy festive season. More specifically, it plans to operate around 100 dark stores, which are mini warehouses for its quick commerce business, before the festive season. While Minutes has a long way to go before it can compete with already established players, the growth of Flipkart in recent times as well as the subsidiary’s improving contribution margins would provide a strong foundation for the growth of Minutes in the coming months.

All things considered, WMT’s International Business proved to be a valuable sidekick to the US business for another quarter, and the segment, in my opinion, has the strength to support the company’s US business, especially in the event of a potential slowdown/recession in the US.

Changing Demographics of Members Bodes Well for Walmart

The final major takeaway from WMT’s quarter was the strong growth seen for its Membership programs. More specifically, membership-related income grew 14.4% y/y, and new records were set in terms of both total memberships and Walmart+ penetration during the quarter. Memberships, together with advertising, were also responsible for more than half of the company’s second quarter operating income growth.

A key pattern that occurred within Memberships segment was a shift in the demographics of new members. More specifically, the company’s Sam’s Club segment saw Gen Z and Millennials accounting for half of the new members in Q2. From a future growth perspective, this bodes well for the company, as onboarding a younger demographic, one who tend to retain their memberships, could shop at the company for decades to come.

Valuation

Forward P/E Multiple Approach
Price Target	$75.00
Projected Forward P/E multiple	28.4x
Projected Forward PEG Ratio	3.42x
Projected Earnings Growth Rate	8.3%
Projected FY26 EPS	$2.63

Click to enlarge

Sources: LSEG Workspace (formerly Refinitiv), WMT’s Q2 Earnings Report, Seeking Alpha, and Author’s Calculations

WMT, as mentioned earlier, has forecast adjusted EPS to now be anywhere between $2.35 and $2.43. As management has not seen any waning demand, and since deploying generative AI has led to improved user experience, I have assumed the higher-end of the updated guidance, $2.43, for my calculations.

According to LSEG data (formerly Refinitiv), WMT currently trades at a forward P/E of 28.4x, above its 5-year median multiple of 23.2x. However, relative to its peer Costco, which trades at a forward P/E of 49x, the stock is cheap. While Costco has always traded at a higher P/E multiple than WMT, the consistent growth shown by the latter, especially in a challenging environment, I believe that WMT deserves a higher multiple than where it traded historically. Therefore, I have assumed the current forward P/E multiple of 28.4x for my calculations, marginally higher than my previous assumption of 26x.

According to Seeking Alpha, WMT’s forward PEG ratio stands at 3.42, which is close to its historical 5-year average PEG ratio of 3.67. A forward PEG ratio of 3.42 and a forward P/E multiple of 28.4x results in an EPS growth of 8.3%, which is in line with the company’s long-term average EPS growth. I believe that this is a more reasonable growth estimate compared to my previous assumption of 11.2% since the macro backdrop has considerably weakened since. As such, I have assumed FY26 EPS to grow at 8.3%, which translates to $2.63, marginally below my previous estimate of $2.64.

At a forward P/E multiple of 28.4x and a projected EPS of $2.63, the price target comes in at $75, which is where the stock is currently trading at.

WMT has gained nearly 7% in the two trading sessions since its earnings release, and the stock is up nearly 40% YTD. As such, this little-to-no upside should not be surprising. Having said that, the stock has an A grade on Seeking Alpha’s Momentum scale. I wouldn’t be surprised, therefore, if the stock continues to set new all-time highs in the near-term. From a fundamentals’ perspective, however, I don’t see any upside at current levels. Therefore, I continue to have a HOLD rating on the stock.

Risk Factors

The macro backdrop, especially with respect to the US consumer, has only worsened since my last article. Although July retail sales data was strong, the combination of a weakening labor market and consumer sentiment, is a cause for concern. While management did say that they are not seeing any weakness in the consumer, one cannot fully ignore the possibility of a hit to the sales growth in the future. The US economy, in my opinion, remains more fickle than before, and as such, the threat of a weakening demand has to be factored in by investors.

Concluding Thoughts

It was yet another strong quarterly performance from WMT. Both revenues and EPS beat analyst estimates, and the management also raised their full-year guidance. Generative AI has really been a blessing for the company, especially for its e-commerce segment. The International business, driven by the likes of Flipkart and Walmex, continues to be strong and complements the company’s US business. The increase in memberships among the Gen Z and Millennials also bodes well for the company’s future growth.

The stock does have strong momentum in the near term. However, on the valuation front, I don’t see any upside at current levels. I do continue to like the company and should we get any sort of meaningful pullback in the stock, this is one evergreen name that I would be more-than-comfortable having in my portfolio.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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