Wal-Mart's Missing Spark

Despite its surprisingly good June growth, Wall Street wants far better. Persistent legal problems are also dampening investor enthusiasm

By Pallavi Gogoi

There's a saying in the retail sector: "When Wal-Mart sneezes, the entire industry catches a cold." Good thing for retailers that it works the other way, too. When Wal-Mart (WMT ) reported on July 7 that its June same-store sales rose 4.5% from last year, exceeding all forecasts, it boosted Retail Metrics index of 67 U.S. retailers for same-store sales, or stores open at least a year, by 5.4%, beating the research firm's forecast of 4.8%.

Yet the positive news surprise boosted Wal-Mart's share price by only 13 cents, to $49.51. Year-to-date, despite a 10% increase in sales, the stock is down 7%, underperforming the 2.5% gain of the Standard & Poor's Retail Index.

Wall Street's reaction provides a window into the challenges confronting the world's largest retailer. Indeed, no sooner had Wal-Mart released its positive sales numbers, when two employees plus a former worker filed a lawsuit in Oklahoma alleging that the retailer retaliated against employees who file workers' compensation claims. This mix of good and unsettling news is likely to shadow the giant for the rest of the year, prompting many investors, perhaps, to sit on the sidelines.

LAGGING BEHIND TARGET.

  No question, Wal-Mart is retail's undisputed king. It racks up annual sales of $285 billion from its 5,350 stores worldwide and still wields such power that its encroachments can put even large chains like grocer Winn-Dixie into bankruptcy (see BW Online, 2/23/05, "No Comfort for Winn-Dixie").

But when you're the biggest gorilla in the jungle and throw your weight around, somebody else is always gunning for you, it seems. And that's what haunts modern-day Wal-Mart. Indeed, its once-spectacular growth now lags behind some of its more nimble competitors.

While its June growth numbers were better than expected, they were anemic compared to chic discounter Target (TGT ), where sales in the same period were up 9% as shoppers snapped up high-end designer apparel and housewares at low prices.

FOOD HERE, APPAREL ELSEWHERE.

  At more than 20 million shoppers a day, Wal-Mart's customer base is huge. But they have less disposable income, with an average annual salary of $35,000 compared with $50,000 for Target's typical customer, according to researcher Retail Forward. Small wonder one of the megaretailer's highest priorities this year is to get more affluent customers through its doors.

Wal-Mart CEO Lee Scott lamented at the recent annual meeting in Bentonville, Ark., that many customers will shop for basic goods like food and paper towels at Wal-Mart but go elsewhere for apparel. Time to get those folks to buy their clothes along with their groceries and household goods at Wal-Mart, Scott told his employees.

The CEO said he wants a "George effect," referring to the Wal-Mart exclusive apparel line named for British fashion designer George Davies. This is a page ripped out of Target's playbook. However, Davies has gotten little marketing or promotion, the way Target has promoted designers such as Isaac Mizrahi in its stores.

ONLY FOUR BUYS.

  Indeed, Wal-Mart management is approaching its fashion strategy a little gingerly -- and that has caught analysts' attention. "Fashion tends to be seasonal, which leads to markdowns at the end of the season, which Wal-Mart wants to avoid, which leads it to focus on everyday fashions," says Gib Carey, a partner in the consumer products practice at consulting firm Bain & Co. But Wal-Mart is definitely trying -- it now sells Nike (NKE ) shoes under its Starters brand, without the Swoosh, and it sells Levi's jeans under Wal-Mart's Signature brand.

Wall Street isn't that bullish on Wal-Mart's future prospects, either. A consensus of 10 analysts that follow the retailer expect revenues to grow 10%, vs. 14% for the industry. Only 4 out of the 10 recommend that investors buy the stock, while 6 have a hold or underweight rating.

Key obstacles to Wal-Mart's growth are the civic protests and local government rulings against it. Earlier this year, class-action lawyers sued 30 cities in California for approving 200,000-square foot Wal-Mart supercenters, citing the state's tough environmental laws. The suit could stall development of many of the 40 new giant outlets that Wal-Mart wants to build in the Golden State. At the same time, Inglewood, Calif., and Montgomery County in Maryland have scheduled referendums to try to keep Wal-Mart's megastores out of their jurisdictions. By Pallavi Gogoi

DICEY PROSPECTS ABROAD.

  While Wal-Mart struggles to expand in the U.S., it's charging into other countries, especially China, where it's going head-to-head with French retailing giant Carrefour. Wal-Mart has 3,700 stores serving a U.S. population of 280 million. In China, "we have a 46 stores in a country with 1.2 billion people. Do you think we have an opportunity? You bet we do," said Tom Schoewe, Wal-Mart's chief financial officer, at the annual meeting. The retailer plans to open up to 15 new stores in China by the end of 2005, compared to 325 new outlets in the U.S.

But international expansion has long been a risky proposition, especially for retailers. A Bain & Co. study of retailers that expanded in 100 international locations over 15 years found that less than one in three was successful, defined as continuing to expand after recording high margins and profits. The rate of success was higher in Western industrialized nations -- as high as 80% in Canada -- but only about 30% in Asia. That's because most of the retailers are familiar with the shopping habits of consumers closer to home and get thrown off in countries with unfamiliar populations.

"A perennial challenge for global food retailers and suppliers is the diversity of shoppers around the world," says Frank Badillo, director of global retailing at Retail Forward Intelligence System, a syndicated research service. "Although some similarities exist, consumer behavior varies significantly from country to country."

UNIONIZATION PUSH.

  Another problem dogging Wal-Mart: litigation related to sex-discrimination and wage issues. According to Wal-Mart's own walmartfacts.com, 40 pending cases are pending against the retailer, alleging wage abuses that include nonpayment for off-the-clock work, altered time records, and missed meal and rest time breaks that are seeking class certification status.

Last year, a California court certified a gender-discrimination class action, which could represent claims for 1.5 million women. All together, litigating could cost Wal-Mart many millions if dollars. Already it has paid $11 million to settle a four-year U.S. Immigration & Customs Enforcement investigation into the hiring of hundreds of illegal immigrants to clean floors.

As lawsuits proliferate against Wal-Mart, so does the hostility from other areas. The United Food & Commercial Workers and the Service Employees International Union are uniting to try to introduce labor representation at Wal-Mart. They're also lobbying local governments to pass ordinances that ban big-box retailers from opening stores.

MULTILAYERED WOES.

  While a lot of antagonism is from outside, many of the lawsuits facing Wal-Mart stem from its own employees. It's hardly a wonder that consumers often find their shopping trips less than satisfying, say analysts. "Wal-Mart has to improve its in-store experience and do a more sophisticated job around labor scheduling and displays to help consumers navigate a large store," says Robert Garf at AMR Research.

It's big. It's phenomienally successful. But its problems increasingly are multilayered. For Wall Street to get excited about Wal-Mart again, retailing's 800-pound gorilla will have to start showing progress in putting its legal woes behind it -- and posting growth gains that put the other Wal-Mart wannabes to shame.

Gogoi is a reporter for BusinessWeek Online in New York

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