How Wal-Mart Can Grow Again

Wal-Mart's latest earnings report showed more evidence of a slowdown. However, smaller and outperforming Neighborhood Market locations offer ample opportunities for growth.

May 22, 2014 at 11:17AM

It seems as if the fears of a slowdown at Wal-Mart Stores (NYSE:WMT) are coming true. In fact, it seems to be getting worse. Like many other retailers, Wal-Mart blamed its poor first-quarter results on the weather, but there seems to be something more fundamental going on. People are shopping less at the company's bread-and-butter superstore locations, which is eating into the top and the bottom lines. However, the retail behemoth is still seeing very solid growth at its smaller Neighborhood Market stores. Is this where Wal-Mart's future lies?

Can't stand the weather
Analysis of retail-chain earnings has become a bit of a bore over the last few months, with more or less every major corporation attributing weaker-than-expected results to the harsh winter weather. In any case, America's largest retailer was unable to escape the winter chill. Net income of $3.58 billion was down some 5% year over year, with earnings per share of $1.10 down from $1.14 a year ago and $0.05 shy of the analyst consensus. Overall revenue rose 0.8% but also came up short of expectations.

Revenue growth was at its weakest in five years. The company hasn't posted revenue growth lower than 1% since the second quarter of 2010. Moreover, comp- store sales were down 0.2% for the fifth quarterly decline in this crucial retail metric, as customer visits dropped by around 1.4% for the period. Wal-Mart superstore locations, often located on the outskirts of town, were not easily accessible during the unusually harsh winter. Still, according to management, the underlying business is solid.

This is debatable. Wal-Mart's second-quarter guidance did little to alleviate fears of a slowdown as earnings are now forecast to be in the range of $1.15-$1.25 per share, largely less than last year's EPS of $1.24 as well as analyst expectations. Comp- store sales are again expected to be mostly flat. According to retail analysts, the company is having trouble getting shoppers into its massive stores, which is the real problem faced by the company.

Wal-Mart was not the only major retailer reporting subpar results due to the harsh winter. Department-store operator Kohl's (NYSE:KSS) missed on both the top and bottom lines for its first-quarter report, EPS of $0.60 missing by $0.02 and earnings down 15% year over year. Same-store sales were down by 3.4%, well below calls for 0.2% growth. Kohl's of course blamed the weather for the decline, as store shutdowns and a disturbance of consumer shopping behavior weighed on traffic. Consistent with these weather-related disturbances, the Northeast and Mid-Atlantic regions posted the worst performances.

Think small
Aside from the weather, which was undoubtedly a challenge for most US retailers, Wal-Mart's problems seem to go deeper than one poor quarter. Growth is drying up at its massive megastore locations, which calls for a new approach. One of the few bright spots from the report was the encouraging growth at the company's smaller Neighborhood Markets, of which it now operates around 400 locations.

Roughly one-fifth the size of the big-box stores, these shops are often located closer to residential areas; as such, they are more easily accessible to shoppers unwilling to drive long distances and traipse through gargantuan stores for daily necessities. Wal-Mart's Neighborhood Market stores delivered sales growth of 5% for the quarter, which is a strong performance by most standards. Moreover, the percentage of overall revenue derived from this store concept has doubled over the past two years.

With the outperformance of these smaller locations increasingly evident, Wal-Mart should sharpen its focus on this type of retail outlet in order to sustain growth. The massive company indicated earlier this year that it will be speeding up expansion plans for its Neighborhood Market and Express locations, although it may take some time before this translates into tangible overall revenue gains.

The bottom line
Things don't seem to be improving at Wal-Mart, the world's largest retailer. With yet another quarter of declining same-store sales, it is becoming increasingly clear that Wal-Mart has some serious underlying problems that go beyond a bad quarter or two. As traffic is declining at the company's megastore locations, the company would be wise to invest more in its smaller locations, which seem to be delivering far stronger results.

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Daniel James has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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