After flirting with mostly disastrous initiatives like high-end apparel and urban stores, Wal-Mart seems to have found the formula to ignite its next wave of growth: Cut inventory, spruce up the stores, wait for a recession to draw more budget-conscious shoppers and flaunt the improvements to keep them coming through the next economic upturn.  The view gaining momentum on Wall Street: A solid second-quarter earnings report and a slight boost to its third-quarter outlook aren't merely the results of a temporary onslaught of shoppers downshifting during the economic slump.  "Absolutely not," says veteran retail analyst Bernard Sosnick, who covers Wal-Mart ( WMT - news - people ) for Guilford Securities. "More important is that Wal-Mart has improved significantly over the past three years." He's bullish on Wal-Mart shares, which have dropped 19% since September 2008 after a nice run-up during the previous 12 months.  The discount giant reported a profit of 88 cents a share for the July quarter, a penny more than last year and 3 cents better than Wall Street's consensus. Revenue edged down 1.4% to just over $100 billion, thanks largely to a small decline in same-store sales and to lower gas prices that affected the company's Sam's Club unit.  Wal-Mart shares were up more than 2.5% in late-afternoon trading Thursday.  The overall retail environment remains difficult. U.S. retail sales dropped 0.1% in July, according to numbers released by the Commerce Department on Thursday. Analysts had expected a small gain, especially after a 0.7% rise in June. The dropoff was higher at general merchandise and discount chains (0.8%), after factoring out autos and other non-store retail businesses. New claims for unemployment insurance also rose slightly from June, the government said, a sign that consumers are still more inclined to save than spend.  Wal-Mart executives figure the downtrodden economy will play to their advantage a while longer, slightly raising the low end of the company's full-year profit outlook by 5 cents to $3.50 per share. They expect a good share of the back-to-school market, which is likely given various consumer survey results showing they plan to be frugal this year. (See "New School Year, Old Clothes.")  "There's a new normal now where people are saving more, consuming less and being more frugal and thoughtful in their purchases," CEO Mike Duke told analysts during Wal-Mart's earnings call Wednesday.  But Sosnick thinks it goes further than that. Wal-Mart is sinking about $1.7 billion into remodeling some 600 stores this year, the better to keep those current bargain hunters in the fold. A new emphasis on inventory controls means shelves are restocked more slowly, in time with shopping habits--the company took down inventory by 6% from last year's July quarter. And fewer shoppers have to tolerate dim lights and crowded aisles as they rush around to gather up a few goods on the cheap--Wal-Mart's customer satisfaction surveys are at an all-time high.  "People are surprised at the merchandise and at the ambiance of the stores," says Sosnick. "Early in a recovery, people resume spending slowly, and Wal-Mart has already got them in their stores." The company can thank the recession for that, but it's doing what it needs to do to keep them there.
Solid quarter isn't just due to appeal to bargain hunters--the discount giant has made changes that are pleasing shoppers.