Editor's note: A previous version of this story did not include Walmart's statement.
After a recent Nikkei report suggested that Walmart (NYSE:WMT) could exit the Japanese market by selling its Seiyu stores, the retail behemoth made clear that it isn't planning on leaving the world's third-largest economy.
"Walmart has not made a decision to sell Seiyu, we are not in any discussions with prospective buyers, and we continue to build our Japan business towards the future to meet the changing needs of customers there," the company said in a statement to media outlets.
Seiyu, one of Japan's major grocery and merchandise chains, generated about 700 billion yen ($6.2 billion) in sales last year, but it's struggling to stay profitable because of intense competition from convenience stores, drugstores, and online retailers. Seiyu is also burdened by rising capital requirements for renovating its aging stores.
Even though Walmart says it isn't planning to sell Seiyu, given the challenges it faces, the possibility of a sale didn't seem out of the question. Let's take a closer look at why.
Why it would make sense to bail out
Walmart initially partnered with Seiyu back in 2002 and gradually increased its stake until the latter became a wholly owned subsidiary in 2008. The Japanese market became a slow growth market after its economic bubble burst in the early 1990s. Although retail sales generally rise 1% to 2% annually each month, the fragmentation of the market and tough competition make it challenging for retailers to generate profits.
Amazon (NASDAQ:AMZN) is the leading e-commerce player in Japan. Amazon Japan's revenue grew 10% annually to $11.9 billion last year, accounting for 7% of its top line. That growth, which is supported by its Prime ecosystem and Echo devices, makes it even tougher for brick-and-mortar retailers to thrive.
Earlier this year, Seiyu partnered with Amazon's biggest rival, Rakuten, to launch an online grocery delivery service. Other companies struck similar delivery deals to challenge Amazon, as well, providing even more competition. Seven and I Holdings, which owns 7-11 and Ito Yokado general merchandise stores, partnered with mail-order office supply retailer Askul to deliver fresh foods. Telcom Softbank, Yahoo Japan, and retailer Aeon also teamed up to create a new online e-commerce platform.
Countering all of those rivals would likely require Walmart to boost its spending, and that's an option it doesn't have. Walmart's Japanese business posted a net loss of 200 million yen ($1.8 million) in fiscal 2016 and barely broke even in 2017.
Analysts estimated that Seiyu could fetch 300 billion to 500 billion yen ($2.7 billion to $4.4 billion) in a sale, and potential buyers could include local retailers and trading houses. But it could be a tough deal, since the buyer would need to shoulder the costs of reorganizing Seiyu's distribution centers and 336 locations, along with additional labor expenses.
Focusing on China, India, and the U.S.
A sale would have boosted Walmart's cash flow and enabled it to focus on three key areas where it's been significantly increasing its investments: China, India, and the United States.
Walmart owns 443 stores in China, a market which generates much stronger sales growth than Japan. Retail sales in China could rise 10% to 11% annually over the next two years according to FocusEconomics. Walmart is also a major shareholder in JD.com, the second largest e-commerce player in China. Higher investments in China could enable it to counter the growth of Alibaba, which owns the country's top e-commerce platform and has an expanding footprint in brick-and-mortar retail.
In India, Walmart only owns 20 stores under its Best Price banner. However, it recently took a majority stake in Flipkart, the country's top e-commerce platform, in a $16 billion deal. Walmart believes online shopping in India will grow 36% annually over the next five years, and Morgan Stanley expects over 50% of India's internet users to buy goods online by 2026 -- compared to just 14% in 2016.
In the U.S., Walmart acquired e-commerce site Jet.com in a $3 billion deal in 2016 and invested heavily in the expansion of its e-commerce ecosystem with new delivery and pickup services to counter Amazon. Those investments, along with rising wages, require lots of fresh capital.
Walmart expects all these efforts, especially the Flipkart deal, to throttle its earnings growth over the next two years. That would make jettisoning its Japanese business to soften those economic blows make sense.
While Walmart says it has not decided to sell Seiyu, investors should understand that the retailer seems to be focused on exiting weaker markets, investing in higher-growth markets like China and India, and widening its moat against Amazon in its home market. Those priorities could make it more resilient over the long term.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon, JD.com, and SOFTBANK CP UNSP ADR. The Motley Fool owns shares of and recommends Amazon and JD.com. The Motley Fool has a disclosure policy.