Wal-Mart, Home Depot Hit Potholes

In an uncertain economic environment, the retail titans are struggling to find profit growth

Pricey makeovers, combined with the pinch of rising economic pressures, are putting a dent in the financial results for the nation's two largest big-box retailers, Wal-Mart Stores (WMT) and Home Depot (HD). Wal-Mart, saying it was "disappointed" at logging its first quarterly decline in profits in 10 years in its second-quarter report on Aug. 15, saw its stock drop 1.22%, to below $45. At Home Depot, executives posted sluggish second-quarter results and warned that they're in for only modest gains for the rest of the year. Wall Street shrugged off the gloomy outlook to hike the Atlanta outfit's stock 3.55%, to above $34.

Still, both companies vowed to continue costly overhauls of their marketing, merchandising, and staffing, insisting the investments will pay off over time. "Characteristically, companies would probably pull back, given the downward pressure on the economy. Uncharacteristically, we are going to accelerate investments despite the uncertainty in the economy," argued Home Depot Chief Executive Robert Nardelli in a conference call. Likewise, Wal-Mart Chief H. Lee Scott Jr. told analysts, "We are confident that we will see good returns on the capital that we are investing."


  The changes are well along at Wal-Mart, making its profit decline all the more troubling. For much of the past year, the company has been updating the apparel, electronics, and home departments in many of its stores, aiming to touch some 1,800 locations over the coming 18 months, this in addition to top-to-bottom remodeling efforts at some 300 stores each year. The full-scale remodeling efforts can take up to 13 weeks to pull off at each store, according to Chief Financial Officer Thomas Schoewe, who noted that they bring "a great level of intrusion" to customers and staff but pay off in sales hikes afterward. The outfit is now racing to get more work done before taking a break in the overhauls during the holiday retailing season this fall.

The problem for Wal-Mart is that higher costs have been outstripping gains in sales. Total expenses as a share of sales are up, compared with last year, with everything from increased maintenance costs to higher ad spending in back-to-school advertising pinching the bottom line, Schoewe says. Indeed, total sales for the quarter rose 11.3%, to $84.5 billion. But net income dropped from $2.81 billion in the quarter last year, to $2.08 billion this year.

Even while the retailer has been struggling to make its U.S. overhauls pay off, the main cause of its financial stress in the latest quarter came from overseas. The chain pulled out of South Korea and Germany and took an $863 million charge for the sale of its stores in Germany (see BusinessWeek.com, 7/28/06, "Wal-Mart's German Retreat"). Without the disappointments in those countries, operating income actually grew 4.5%, compared with the second quarter last year.


  On the U.S. front, the store remodels are coming at a bad time. Higher gas prices have been forcing customers to consolidate their shopping trips, Scott noted, driving up the average ticket, but not by enough. Wal-Mart's same-store sales rose just 1.7% in the quarter in the U.S, and that was lifted by bigger gains at the company's Sam's Club unit. No wonder Scott said executives are "quite honestly disappointed in the sales performance of Wal-Mart U.S."

Wall Street analysts were, too. Charles Grom, a retailing analyst with JPMorgan (JPM), said that while Wal-Mart's overall earnings were in line with forecasts, the quality was low. Same-store sales increases in the U.S. were well below expectations and not even half the growth rate in Wal-Mart's first quarter. "It is hard to find a true positive in this release," Grom said in a note to investors. "All in all, we believe the stock will trade off and would not buy on weakness." Wal-Mart's stock has been weak. It has slumped 34% over the last five years, vs. an 8% decline in the Standard & Poor's 500 stock index.

Grom also said in an interview that Wal-Mart management is being overly optimistic in sticking with its bullish full-year projections. For one, consumers likely will be penny-pinching for the remainder of the year, he said. Also, Wal-Mart has its own internal difficulties as it remodels stores and attempts to refresh its image for the first time in a decade. "It certainly seems like a stretch to hit those numbers," he said. "I would have preferred them to lower the bar and be a little bit more prudent."


  Home Depot, starting its makeover process a bit later than Wal-Mart, is likewise running into troubling economic headwinds and a weakening housing market. The Atlanta-based outfit reported that second-quarter profits rose 5.3%, to $1.9 billion on total sales of $26 billion, but it told analysts that full-year earnings would likely come in at the low end of its 10% to 14% expected growth range. The sluggish second-quarter profits were driven, in large part, by dismal sales at Home Depot stores open a year or more, which slipped 0.2%.

Nardelli did retreat from one battle with Wall Street. At the end of the first quarter, Home Depot had said it would stop reporting same-store sales, a key retail industry benchmark, but it reversed course this quarter after a vigorous outcry from Wall Street in recent months.

Nardelli unveiled a retail investment plan that marks another retreat of sorts. Nardelli has pushed hard to jump-start growth at Home Depot, which reported $82 billion in sales for the most recent fiscal year, by expanding aggressively into the contractor supply business through a new unit called Home Depot Supply. The company has spent more than $7 billion in the last three years to acquire some 37 companies as part of the expansion. But some analysts worry the ascension of Home Depot Supply has come at the expense of Home Depot's 2,079 stores, where sales, customer service, and employee morale have declined.

Now, after months of criticism and stiff competition from arch-rival Lowe's (LOW), the company is pushing hard to spiff up its stores and put more people on the floors to help customers. It announced plans to invest $350 million in a variety of in-store programs. Nardelli plans to halt normal autumn cutbacks in store staffing, adding an additional 5.5 million man-hours to Home Depot sales floors. And the company plans to accelerate resets of merchandise displays in 540 stores. "We are committed to providing the best possible shopping experience for our customers and, as a result, are accelerating investment in merchandising, in-store appearance, and in our associates," said Nardelli. The company is also adding a 1-800-Home-Depot customer service line. It'll be open 24 hours, to handle any and all customer inquiries.

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