Wal-Mart Beats the Street

The chain's 3Q sales surpassed analysts' forecasts, as nervous consumers apparently opted for lower prices at the discount retail giant

by Pallavi Gogoi

Will early holiday bargains prove enticing enough to persuade shaky U.S. consumers to keep buying?

Maybe so. On Nov. 13, Wal-Mart Stores (WMT) reported third-quarter results that handily beat Wall Street expectations with a 9% increase in revenues, to $91.95 billion, and an 8% rise in net income, to $2.86 billion. That helped propel shares of the world's largest retailer more than 6%, to $45.97.

TJX Companies (TJX), the company that operates discounters T.J. Maxx and Marshalls, also reported fiscal third-quarter results on Nov. 13 and boosted its profit outlook for the rest of the year. The Massachusetts company's stock rose nearly 4% on the news, nearing a 52-week high. The optimistic retail reports helped boost the Dow Jones industrial average by 319 points to 13,307.

Still, there's ample reason for caution when considering the latest retail numbers. Sales at U.S. Wal-Mart stores open at least a year were up a mere 1% in the quarter; a key figure, indicating that sales independent of grand opening buzz were virtually flat. With such a moribund increase, it seems likely that apparel and other unsold merchandise from the third quarter will take up space in stores going into the holidays, which may mean less than good tidings for the crucial holiday buying season. Chief Executive Officer H. Lee Scott noted in a conference call the pressures on low-income shoppers who are feeling the pinch of high oil prices. "We are realistic about the environment we are in," says Scott.

But analysts say Wal-Mart's focus on low prices at a time when consumers are feeling pinched seems to be the right message. Scott says the company is seeing "improving trends" in its home and apparel divisions too, two areas that the company has struggled with for more than a year. Wal-Mart had strayed from the low prices message in both these areas in the last two years—with its new trendy Metro 7 apparel line and also its 400-thread count bed sheets. But now, as the company dials down its upscale expectations, consumers seem to be responding.

Home Improvement Hit Hard

Other retailers are feeling a more serious pinch: Home-improvement retailer Home Depot (HD) posted a 27% drop in third-quarter profit, to $1.1 billion, while revenues declined 3.5%, to $18.96 billion. The company has been hit hard by the housing downturn in the U.S.

With housing down, rising oil prices, and a spreading credit crunch, there have been concerns from economists and others that consumers may not be able to keep up the spending. This year retailers have started their holiday sales exceptionally early. Wal-Mart started its Black Friday-like sales on Nov. 2, three weeks before Thanksgiving, the traditional kickoff of the holiday shopping season. Still, it has been unclear whether such moves will be enough to persuade consumers to come into stores. "While discounting is the only way for stores to move merchandise, it can't be the silver bullet to release all the pressures that consumers are under right now," says Brian Bethune, an economist at financial analyst firm Global Insight.

There's reason to be skittish. In the first two weeks of November, the consumer sentiment index as measured by Reuters/University of Michigan fell sharply, to 75, from a reading of 80.9 in October. This was the lowest reading in two years. The survey attributed this sharp decline to pressure on lower-income households from higher gasoline prices on top of falling home prices. "Fuel prices, tighter credit, and growing job worries are the bigger drags on retail spending, particularly for lower-income shoppers," said Frank Badillo, senior economist and director at research firm Retail Forward.

Restaurants Are Feeling the Pinch

And as the housing market has crumbled and interest rates have reset to higher levels on some mortgages, there's not much left over to refurbish bathrooms and kitchens. Besides, renovations may not make much difference in a market where very few people are buying. Sales of previously owned homes fell 8% in September to a record low pace, while the national median home price for both single-family and condos dropped 4.2%, the National Association of Realtors said last month.

Little wonder then that home goods stores like Home Depot and Lowe's (LOW) have taken a beating this year in the stock market. Home Depot shares are trading close to a 52-week low, at $28, and Lowe's stock is also near the bottom of its yearly range, at $24.

Americans are worried enough that they are even tightening their belts when it comes to eating out. RBC Capital Markets' national consumer survey found that in November nearly 6 in 10 Americans, or 59%, plan to eat out less over the next three months. That's up from 54% in August. And when they do eat out, only 20% plan on ordering higher-priced entrées or having appetizers or dessert, compared to 27% in August.

Wal-Mart's results left little doubt that low prices are a draw in today's tough retail environment. Revenues rose 6.4% at its Wal-Mart Stores, to $57.7 billion, while revenues at its Sam's Club warehouse business increased 6.1%, to $10.8 billion. International operations saw a 16.9% boost in sales, to $22.4 billion. "During the Christmas and holiday season, our price leadership position will benefit both our customers and the company," Scott said in a statement. "We have set the stage for a successful fourth quarter."

Goldman Sachs (GS) retail analyst Adrianne Shapira believes that discounters like Wal-Mart will gain market share as consumers look for low prices. "This is the right strategy for the right time as consumers tighten their belts," she says in a report. "We believe today's plan of attack is one that makes the most sense for today's more challenging macro backdrop."

Gogoi is a contributing writer for BusinessWeek.com.