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Wal-Mart Stores, Inc. Is Resetting the Bar

By Adam Levine-Weinberg - Feb 26, 2014 at 10:30AM

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Wal-Mart Stores whiffed on its FY14 guidance, and now it's looking for new ways to grow earnings.

Wal-Mart Stores, (WMT 0.11%) came into 2013 with high hopes for solid revenue and profit growth in the company's 2014 fiscal year. In October 2012, Wal-Mart provided its initial guidance for FY14, which called for 5% to 7% sales growth. The company gave its first earnings guidance last February, and at that time management projected that earnings per share would rise from $5.02 to a range of $5.20-$5.40, despite a higher tax rate.

Wal-Mart fell well short of these goals, necessitating a series of guidance cuts over the course of 2013. Ultimately, revenue grew just 1.6% in FY14, or 2.5% excluding the impact of currency fluctuations. Meanwhile, EPS increased just 2% to $5.11.

After this disappointing performance, Wal-Mart is looking to regroup in 2014. The company is implementing restructuring plans in some of its weaker international markets and in its Sam's Club division. Meanwhile, it will focus its growth in the U.S. on smaller Walmart Express and Neighborhood Market locations. These initiatives should help Wal-Mart return to more robust profit growth next year and beyond.

Downsizing at home
Of Wal-Mart's three business segments, the Walmart U.S. division was the best performer last year. That said, its 1.8% sales growth and 4% increase in operating income were hardly cause for celebration. Comparable-store sales declined 0.6% despite numerous initiatives designed to drive sales growth.

Wal-Mart is doubling down on smaller stores. Image source: Wal-Mart.

While Walmart U.S. sales were sluggish overall last year, small-format stores have been a bright spot. The company currently operates several hundred "Walmart Neighborhood Market" and "Walmart Express" stores, which are a fraction of the size of a Walmart Supercenter.

Both concepts generated solid comparable-store sales growth last year. As a result, Wal-Mart is literally doubling down on small-format stores in order to boost growth. The company will open another 270 to 300 of these smaller stores in the new 2015 fiscal year, nearly doubling the small-format store count.

At the Sam's Club warehouse chain, Wal-Mart won't be downsizing in a literal sense. However, the company will cut 2,300 positions at Sam's Club (roughly 2% of its workforce) in order to better match labor expense to sales at each club. Nearly half of the job cuts will affect salaried assistant manager positions, with the rest being hourly positions at underperforming locations.

Retrenching abroad
Wal-Mart is also looking to retrench outside of the U.S. In recent years, the company has grown aggressively in key developing markets like Brazil and China. However, the path to profitability in these markets has not been nearly as straightforward as Wal-Mart executives had expected.

Now, Wal-Mart is more focused on getting profitability to an acceptable level in Brazil and China rather than simply adding stores at a breakneck pace and assuming that profits will follow. In fact, the company closed about 50 underperforming stores in Brazil and China last quarter.

In Brazil, Wal-Mart has admitted that the company's cost structure is too high, and ongoing inflation there is presumably not helping. The recent store closures should help, but Wal-Mart still has more work to do to boost returns. In China, Wal-Mart is profitable, and the company still plans to add about 110 new stores there within the next few years. However, there were still stores that were not performing well enough to justify further investment.

Looking to the future
Wal-Mart is projecting very modest EPS growth for the new fiscal year. Resetting investor expectations in this way was a good idea, after Wal-Mart consistently underperformed its own guidance last year.

Some aspects of the company's strategy should pay dividends immediately, such as cutting unnecessary managerial labor at Sam's Club and closing loss-making stores in Brazil and China. However, the bigger opportunities will take a few years to play out.

For example, Wal-Mart's efforts to reduce its cost base in markets like Brazil will play out over a longer period of time. Similarly, Wal-Mart's decision to double down on small-format stores in the U.S. will have a minuscule effect on sales this year, and may even be dilutive to earnings. However, over the next five to 10 years, small-format stores represent a huge growth opportunity for Wal-Mart.

Thus, while Wal-Mart will probably post weak earnings growth for a second straight year in FY15, the company is laying a foundation for better performance in future years. This, combined with a retreat in its share price, makes Wal-Mart stock look more attractive today than it has been for several years.

Adam Levine-Weinberg has no position in any stocks mentioned, and neither does The Motley Fool. 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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