Wal-Mart's Earnings Warning

The retail giant reported record quarterly numbers, but cut its profit forecast for the rest of 2007, citing troubled operations and economic pressure on consumers

On Aug. 14, Wal-Mart Stores (WMT) reported record sales and profits for the second quarter, but warned that the rest of the year will be more difficult than expected. The company trimmed its forecast for profits for the remainder of 2007 because of "economic pressure" on consumers and troubles in its own operations. "The quarter was challenging," said H. Lee Scott Jr., the retail giant's president and chief executive, in a prerecorded conference call. "Merchandising is not where it needs to be."

The company's comments could fuel concerns that consumer spending may not hold up in the months ahead. Scott said that because of rising interest rates and gas prices, Americans are seeing their paychecks stretched thin. "Consumers are under difficult pressure financially," he said. "Consumers are running out of money by the end of the month."

For the quarter, Wal-Mart reported an 8.8% increase in sales, to $91.99 billion, propelled by 16% growth in its international operations. Net income increased 49%, to $3.10 billion, although profits in the year-earlier period had been reduced because of a charge for the sale of its German operations. Income from continuing operations in the second quarter rose 4.1%, to $3.11 billion.

Pessimistic Outlook

While the quarterly performance was solid, the outlook for the rest of the year is less clear. Wal-Mart says it now expects to report earnings per share from continuing operations of between $3.05 and $3.13 for the full fiscal year. It had previously said that it expected to make between $3.15 and $3.23 per share.

"The company's current earnings projections reflect the need to continue to improve our underlying operating performance," said Tom Schoewe, the retailer's executive vice-president and chief financial officer, in a statement. "This guidance also reflects the economic trends that have developed in many of our major markets." Wal-Mart's stock dropped 5%, to $44, in early trading on the New York Stock Exchange (NYX).

The report comes as the once-high-flying retailer is struggling to regain its momentum after a series of stumbles in recent years. The company's stock has stalled as growth has slowed, and the company has had difficulty moving into new markets. In addition, Wal-Mart has come under fire for its employment practices and its effect on smaller retailers (see BusinessWeek.com, 4/30/07, "Wal-Mart's Midlife Crisis,").

"Too Far Too Fast"

Two years ago, the company launched a concerted effort to move upscale in a number of areas, including home furnishings, apparel, and electronics. Wal-Mart launched the initiative by placing an eight-page ad insert in Vogue magazine promoting its new fashion line Metro 7 and sponsoring a fashion show at Times Square in New York. A spokeswoman said at the time that it was Wal-Mart's way of showing that it was "trend-right and fashion forward."

Within months, however, the company ran into difficulty with the upscale strategy, and Wal-Mart pulled back its Metro 7 line. In an interview with BusinessWeek earlier this year, CEO Scott said that the company struggled because it tried to move "too far too fast." He said: "We are defined by our customer, not by us. And we can't wake up one morning and say we're going to be something different and something more to you and not earn it. We just can't." (see BusinessWeek.com, 3/30/07, "Wal-Mart: 'On the Side of the Angels'").

The one area where Wal-Mart's move upmarket has worked out well is in consumer electronics. While the company's electronics department had long been uninspiring, two years ago it added the kinds of products that consumers crave, such as the iPod from Apple (AAPL) and liquid-crystal-display televisions from Toshiba (TOSBY). It bulked up its offerings more recently by adding popular brands such as Dell (DELL) computers, Samsung (SSNKF) TVs, Sony (SNE) home theater systems, and Canon (CAJ) professional cameras.

Consumer Electronics Push

Experts say that Wal-Mart's expansion into consumer electronics has been more successful than its other upscale moves because it has been able to depend on the reputations of its suppliers. "There is a halo effect from these well-known brands," says Robert Passikoff, president of brand consulting firm Brand Keys. "These brands are already placeholders for the categories they represent like TVs, whereas it would be hard for people to believe that Wal-Mart would be a place to buy fashionable attire, even if they bought many pages of ads in a fashion magazine." (see BusinessWeek.com, 11/14/06, "Wal-Mart: Back to Basics for the Holidays").

How much Wal-Mart's success in consumer electronics will help the company as it faces a difficult second half of 2007 remains to be seen. Some experts say that profits from the electronics push will give the company more latitude to experiment in other lines of business (see BusinessWeek.com, 7/6/07, "Wal-Mart: Stay out of Banking, Period"). "Electronics may be the solution to revenue and earnings risks while they tweak apparel and other, nonmerchandise service initiatives," says Richard Hastings, vice-president and senior retail analyst at research firm Bernard Sands.

But Scott was unusually downbeat in the company's second-quarter report about consumer spending and the economic outlook, at a time of increasing concerns for the world economy. Growth in the U.S. and many other countries has remained solid in recent months, but uncertainty in the credit markets and the U.S. housing sector has fueled fears of trouble ahead. "Many customers around the world continue to be under economic pressure and they expect Wal-Mart to be their advocate," Scott continued. "We will continue to be the undisputed price leader."

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