What Has Wal-Mart's Execs Worried in 2014?

Wal-Mart (NYSE: WMT  ) is the largest retail organization in the world with 11,137 stores worldwide, 4,800 of which are in the U.S. The company has 2.2 million associates across the globe, with 1.3 million associates in the U.S. alone. With nearly 245 million customers every week, investors like Wal-Mart for its market size -- it's a natural hedge against losses because of the variety of sales channels and volume --  but the company will face a few challenges in 2014 that have executives worried. These concerns were echoed throughout the earnings call.

Compliance is the golden word
Mike Duke, President and CEO of Wal-Mart, started the call off with a quick overview of earnings performance for the third quarter, but it wasn't long before he started talking about compliance. "Compliance," said Duke, "is the central part of our growth strategy." He went on to discuss the enhanced processes, procedures, and increased training that associates received in regard to compliance. This initiative cost approximately $69 million in the third quarter alone, which contributed to a 15.1% increase in core corporate expenses. Clearly, compliance has become very important at Wal-Mart, but why?

Wal-Mart, and Walmex the Mexican subsidiary to Wal-Mart, have been under investigation by the U.S. Department of Justice and the U.S. Securities and Exchange Commission. These are not light charges, and they could have a material impact on Wal-Mart's earnings.  Paul Pelletier, a former Justice Department prosecutor, says the impact could be huge. "Wal-Mart's having lost billions in market capitalization over these last few days is going to make companies in close cases more likely to err on the side of promptly self-reporting."


The story was first brought to light after a New York Times reporter unveiled bribes that the company paid to officials to gain approval to build stores in Mexico.

Shareholders are also filing suit against Wal-Mart. Former and current directors in the company, and current and former officers of Walmex, are named in the suits. Wal-Mart provided no estimate for the total financial impact in its most recent earnings report, only confirming that actions against the company could result in "...judgments, settlements, fines, penalties, injunctions, cease and desist orders, debarment or other relief, criminal convictions and/or penalties."

While the company provided no estimate of the potential impact of the lawsuit on earnings, Jeff Davis, EVO and Treasurer, discussed the impact of FCPA related compliance initiatives on Wal-Mart's financial performance. "Approximately $43 million of these expenses represent a cost incurred for the ongoing inquiries and investigations. Approximately $26 million is related to our global compliance program and organizational enhancements..." FCPA costs in the fourth quarter are estimated to be between $75 million and $80 million.

Large-box retailer woes
In addition to FCPA costs the company is also concerned about same store sales. Bill Simon, President and CEO of Wal-Mart U.S., expressed his concerns about same store sales declines on the earnings call, saying that comp sales went down by 0.3%, driven by a 0.4% decline in traffic.

In a comparison of seven discount retailers, Wal-mart came in sixth for same store sales growth in the calendar third quarter. The top three performing companies were Tuesday Morning, Dollar General, and Dollar Tree -- small-box competitors to Wal-mart. The bottom three were Target (NYSE: TGT  ) , Wal-mart and Big Lots (NYSE: BIG  ) with growth rates of .9%, -.2%, and -2.5%, respectively. Perhaps large box retailers are the less efficient business model.

Target, like Wal-mart, suffers from declines in traffic as the number of units per transaction fell by -1.1%. Big Lots had the worst same store sales growth rate, which it attributes to declines in the Home, Hardlines, Toys, and Electronics categories.

Rosalind Brewer, President and CEO of Sam's Club, also attributes some of the decline to softness in the tobacco business, a category Family Dollar and Dollar General have entered in the past two years. Dollar General actually attributes its growth in the third quarter of 2013 to cigarette sales.

The Foolish bottom line
Big-box discount retailers had a rough year in 2013, and 2014 will present many of the same challenges. Compliance, same-store sales growth, lower government spending, and volatile foreign currency rates top the list of concerns for this management team in 2014. We'll have to wait until Feb. 20 to see how well Wal-Mart handles these issues in the fourth quarter.

What else is wrong with Wal-Mart?
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