Dueling Fools: Wal-Mart Bear

Wal-Mart (NYSE: WMT  ) may have an image problem with some folks, but it is well-loved by many of our top analysts at the Fool. Several of them, in fact, have declared on our site in recent months that the stock is an excellent value. For example, TMFBentham wrote: Wal-Mart is a great American success story with growing sales and profits that just happens to be extremely undervalued at the moment. Sure, it has an image problem, but it's not entirely deserved. Hey, workers willingly choose to work there, and shoppers obviously love to shop there, so it must be all right. The greatest good for the greatest number, I always say.

OK, so there's no TMFBentham, but I think the fictional quote is a reasonable summary of many of the arguments deployed in favor of Wal-Mart here at the Fool. And I suspect that Seth's take will be similar. According to this view, Wal-Mart is a great company, and its workers, many of whom live in opportunity-starved rural areas, should count themselves lucky to have the jobs. With the stock trading at an obvious discount to its competitors, the bulls see this as a buying opportunity.

I think proponents of this view greatly underestimate the connection between Wal-Mart's stock price and the company's well-publicized image problem. Ironically, the company appears to be well aware of its reputation problem, as we will soon see. So the key questions for those looking to buy shares of America's leading retailer are: Can the company successfully address its increasingly poor image? And will success in this area lead to the long-awaited upswing for its shares, which have gone sideways for the past five years?

Looks like a value, Sherlock
Let's first take a look at how Wal-Mart compares with its rivals. In the table below, I've put together a few numbers.

Company

P/E

Operating Margins

Return on Equity

Costco (Nasdaq: COST  )

21.9

2.9%

12.9%

Wal-Mart (NYSE: WMT  )

18.2

5.9

22.8

BJ's Wholesale Club (NYSE: BJ  )

15.6

2.5

13.2

Target (NYSE: TGT  )

22.4

8.1

17.6

Data provided by Capital IQ, a division of S&P.

Let's face it: You don't need to be Peter Lynch to see that Wal-Mart looks quite good compared with its competitors. Its return on equity leads the pack by quite a bit, and its operating margins, although low when compared with the likes of a Microsoft (Nasdaq: MSFT  ) , are superior to all but Target in the table. And Wal-Mart's P/E suggests that its shares are very attractively priced. All of this . yet the company has underperformed its competition (and the S&P 500) over the past year. The same is true over the past two years. Over five years, Wal-Mart trails two of its competitors, while slightly outperforming BJ's and the index. So what's going on here?

Hey, Mom, why don't we have health care?
Obviously, investors seem a bit gun-shy. First, I think there are worries that the company's margins will decline as its costs go up. For example, Maryland is currently considering whether Wal-Mart should spend a greater percentage of its revenue on health care. As the states become more demanding in this area, the company's costs will go up. In a recently leaked memo on its benefits strategy, the company reported that benefits are growing by 15% per year, and benefits costs could consume an incremental 12% of total profits by 2011. The trends in this area are not favorable.

This brings us to a second concern: the company's image problem. Every day, it seems, something new comes up. Allegations of employing illegal workers. Charges that workers are forced to "work off the clock." Lawsuits alleging sex discrimination. It goes on and on. Once again, the company's management acknowledges that it is quite vulnerable on this front. In the memo mentioned above, the company admits that 46% of its associates' children are either on Medicaid or are uninsured. Is there really much room to cut benefits even further? And if so, how is that going to help the image problem?

In America today, when you are faced with a dilemma, it's time to call in the spin doctors. Wal-Mart recently announced that it has enlisted Michael Deaver, who worked for Ronald Reagan, and Leslie Dach, who worked for Bill Clinton, to organize its next charm offensive. Will the spin doctors succeed, and will Wal-Mart's stock price skyrocket as a result? We shall soon find out. But if the company chooses to cut its benefits even further in the face of rising costs, things may get worse before they get better.

Home for the holiday
This year, Wal-Mart has launched a "Home for the Holidays" Christmas campaign. Alas, Victor Zavala, who worked for a cleaning crew at one of Wal-Mart's stores, would have had little time to spend at home during the holidays. For him, "home for the holiday" would have been more accurate. Zavala, an illegal immigrant from Mexico, was arrested by immigration officials two years ago. He allegedly worked seven days a week cleaning floors, with time off only for Christmas and New Year's Eve. According to Zavala, "We don't know nothing about days off. We don't know nothing about nights off, we don't know health insurance, we don't know life insurance, and we don't know anything about 401(k) plans."

An obscure, easily explained bit of bad PR for the company? Perhaps. But I feel that the company has created a difficult dilemma for itself in its drive to cut costs and thereby deliver "always low prices." And who wants to own shares in a company whose fortunes are now partly dependent on the dark arts of Washington spinmeisters?

Wait! You're not done. This is just a quarter of the Duel! Don't miss the Bull opening argument and the Bull and Bear rebuttals. Even when you're done, you're still not done. You canvoteand let us know who you think won this Duel.

Costco is aMotley Fool Stock Advisorrecommendation. Microsoft is a pick of theMotley Fool Inside Valuenewsletter service.

John Reevesdoes not own any shares of any of the companies mentioned.


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