Actually, Walmart's Q1 Report Was Better Than It Seems

With nothing more than a passing glance, it would be easy to come to a bearish conclusion about Walmart (NYSE: WMT). The world's biggest brick-and-mortar retailer topped its first-quarter earnings estimates, but its reported profits technically fell year over year. The company also cautioned shareholders -- and perhaps customers as well -- that new tariffs will likely force the company to raise its in-store retail prices.

Shares fell slightly following Thursday morning's release of Q1's numbers and second-quarter guidance, implying investors are at least a little bit worried about the foreseeable future.

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If you're one of the worried, you might want to dig deeper into the numbers... all of them. This company's doing far better than the market's initial response suggests. In fact, this stock's still a solid buy -- not despite economic challenges, but arguably because of them.

The rest of Walmart's Q1 story

For the three months ending in April, Walmart turned $165.61 billion worth of sales into a per-share operating profit of $0.61, versus expectations of $165.84 billion and $0.58 per share, respectively. That's top-line growth of 4% year over year, and a slight improvement on the year-ago per-share operating earnings of $0.60. Same-store sales within the United States grew 4.5%, slowing somewhat from the previous quarter's pace of 4.6%. Investors balked at what could be considered lackluster results compared to most of the retailer's other recent reports.

Look closer, though. Walmart's doing better than Q1's most-touted figures imply, and it's doing particularly well where it counts the most.

Take e-commerce, for instance. Although it only makes up a modest minority of its total sales, it's arguably Walmart's top growth driver right now. Online sales improved 22% year over year last quarter, accelerating from the fourth quarter's growth rate of 16%, and slightly outpacing the growth pace of 21% for the comparable quarter a year earlier. Although the company doesn't disclose how profitable or unprofitable its e-commerce arm is, greater scale can only help its overall bottom line.

Walmart.com isn't just facilitating more sales of merchandise, however. It's also generating more and more advertising revenue, collected by brands that wish to feature their goods at the retailer's shopping website. The company reported a 31% increase in Walmart Connect's ad revenue produced within the U.S., gaining steam from Q4's growth rate of 24%.

WMT Revenue (Quarterly) data by YCharts.

This is high-margin revenue too, meaning it has an oversized effect on companywide profitability.

Speaking of profits, despite concerns to the contrary, Walmart doesn't appear to be suffering any serious cost-centric problems just yet. Its cost of sales (or cost of goods sold) and operating expenses like payroll and administrative spending only grew in step with sales growth, facilitating a 4.3% year-over-year increase in operating income, versus the 2.5% uptick in companywide revenue.

Rather, the sole reason for the decline in GAAP/reported pre-tax net income is the $1.4 billion swing in "other gains and losses" that don't actually reflect anything about its operation. Taking these misleading numbers out of the mix makes for a much more impressive year-over-year comparison.

Don't sweat the tariff rhetoric

But the warning that newly imposed tariffs might force the retailer to increase retail prices?

It's nothing to dismiss, to be sure. Just consider the source, and keep things in perspective. Walmart may simply be aiming to keep investors' expectations in check by voicing the worst-case scenario. It's also unlikely that President Donald Trump will actually allow import tariffs to remain steep long enough to do significant economic damage. He's already agreed to a 90-day suspension of the sky-high import duties on China's deliveries to the United States, with new tariff talks between the two superpowers now being scheduled. It's possible all the chatter is simply part of a dance ultimately meant to provide Trump with leverage that will be used soon enough.

Image source: Getty Images.

On the chance that little to nothing about the current tariff situation changes, however, how vulnerable is Walmart, really? Arguably not as much as many investors are presuming.

Although a little more than half of the goods sold in Walmart's U.S. stores come from China, imports are a minority of its merchandise. About two-thirds of what it spends on inventory is made, assembled, or grown within the U.S. The retailer's also already been in discussions with a range of manufacturers outside of China anyway, seemingly preparing a means of sidestepping the biggest risk of the tariff standoff.

To the extent the company can't adequately offset its rising merchandise costs, it's still far from being in any serious jeopardy. Groceries remain its biggest business at more than half Walmart's total sales, after all, and the retailer's sheer size means it enjoys a scale-based advantage that competitors can't replicate. It matters simply because people are always going to eat, and they're still going to prefer shopping at their neighborhood's most convenient stores where food prices are lowest. With 4,606 stores in the U.S. alone, that's often Walmart on both counts.

For perspective, there are only 1,978 Target stores in the United States, and fewer than 2,800 Krogers.

Bottom line? Investors initially panicked at Walmart's first-quarter report and second-quarter outlook, rekindling worries that were first entertained in February. It's an understandable response, too. It's just not a concern that stands up to reasonable and realistic scrutiny.

Walmart stock is still a solid buy, and it's only more compelling thanks to this year's tepid performance.

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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target and Walmart. The Motley Fool recommends Kroger. The Motley Fool has a disclosure policy.