What Is Wal-Mart Doing in Asia?

Walmart.com

Wal-Mart Stores (NYSE: WMT  ) sees China, Japan, and India, as growth opportunities. Taken together, these three countries account for approximately 60% of Asia's population. Unfortunately, Wal-Mart has seen many challenges in these countries recently, which we'll cover below. Considering these recent challenges, it might seem impossible for Wal-Mart to have a shot at long-term success in Asia. But the company has a game plan, and betting against Wal-Mart usually isn't a good idea..

Challenging terrain
Beginning with India, Wal-Mart just ended an agreement with Bharti Enterprises. Wal-Mart's plan to open retail stores throughout India was scratched due to government restrictions on foreign retailers. Currently, Wal-Mart has a small presence in India, with 20 wholesale outlets that supply small retailers.

In China, Wal-Mart must contend with government austerity measures, which has affected the Chinese consumer. Despite this headwind, Wal-Mart still plans on opening 110 stores in China over the next three years. Wal-Mart thinks the big-box store format will work well for more than a decade in China.

Wal-Mart is also keeping an open mind for acquiring smaller retail operations in tier-three and tier-four cities (lower population/rural cities), which are expected to grow in the future. The idea is to establish a retail presence prior to these cities growing. Wal-Mart's big-box stores will also enter tier-three and tier-four cities where and when possible.

While Wal-Mart is optimistic about its growth prospects in China, there's another problem in addition to austerity, and it's an ironic one. When Americans think of products made in China, they think of poor quality. The irony is that many Chinese consumers also see cheap products as low quality, and the Chinese consumer is very focused on quality. Even if Wal-Mart were to sell high-quality products at its everyday low prices, it would have a difficult time selling this concept to the Chinese consumer.

The Japanese consumer is on the other end of the spectrum. After seeing the consumption-tax increase to 8% from 5%, Japanese consumers are seeking low prices wherever and whenever possible. Therefore, Wal-Mart's everyday low prices work well. Wal-Mart currently has 440 retail outlets in Japan. The problem is that despite Japanese consumers looking for value, the consumption-tax increase has still led to extreme caution with spending.

With all these headwinds in mind, let's examine some actual numbers and initiatives. Since not much is taking place in India at the moment, we'll focus on China and Japan.

Misleading comps number and more
Wal-Mart's first-quarter comps sales (sales at stores open at least one year) declined 2.5% year over year in China. However, if you look closer, you will see that comps would have come in flat excluding the timing of the Chinese New Year. Therefore, demand for Wal-Mart merchandise isn't as negative as is perceived.

Wal-Mart is focused on improving margins and reductions in expenses in China, and despite the Chinese consumer habits mentioned above, it will continue to invest in price reductions. Fortunately, operating income increased 26.2% in China year over year -- a good sign for future potential.

That's not the only good news in China. Wal-Mart's subsidiary, Yihaodian.com (Wal-Mart owns a 51% stake), had a registered user base of 57 million at year-end 2013 from 29 million in 2012. Yihaodian also generated $1.89 billion in sales in 2013 (overall Wal-Mart China sales were approximately $10 billion). In the first quarter alone, site traffic grew in the triple digits (percentage-wise) on a year-over-year basis. It's safe to say that Wal-Mart has added a strong revenue stream.

As far as Japan is concerned, it's a much different atmosphere. Net sales and comps increased for the quarter, but don't get too excited since much of the buying related to consumers buying merchandise ahead of the consumption-tax increase on April 1, but Wal-Mart still announced market-share gains and strong performances across Japan since the consumption-tax increase. Wal-Mart is confident in its future prospects in Japan because the consumption-tax increase will lead consumers to search for value.

Getting back to Internet growth potential in China....

E-commerce growth potential in China
E-commerce in China holds a great deal of future potential. According to the China Internet Network Information Center, China ended last year with 618 million Internet users and 500 million mobile-Internet users. Keep in mind that there are "only" 310 million people in the United States.

According to a recent Reuters report, (NASDAQ: YHOO  ) Alibaba -- China's largest e-commerce company -- sells more merchandise than Amazon.com and eBay combined.

Now keep in mind that free cash flow is one of the key drivers of future growth. Wal-Mart is strong in this area, which could lead to future market share gains:

WMT Free Cash Flow (Annual) Chart

WMT Free Cash Flow (Annual) data by YCharts

The Foolish conclusion
Wal-Mart's strategy fits Japanese consumer demands, and Wal-Mart is almost guaranteed to invest more capital in its Chinese e-commerce operations, which could lead to market share gains. Also keep in mind that Wal-Mart is setting up shop in small-population Chinese cities that are growing rapidly, which could pay dividends down the road. 

Overall, Wal-Mart has some headwinds to deal with in Asia, but the long-term prospects look good, especially given the e-commerce growth potential in China.

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