Things are going from bad to worse for Wal-Mart Stores (NYSE:WMT).
At its analyst day last Wednesday, the world's largest retailer drastically scaled back its forecast for the coming years, sending shares to its worst one-day loss in more than a decade, falling 10% in the session.
The company said it expected net sales growth of just 3% to 4% over the next three years, and flat revenue growth this year due in part to foreign currency translation. What really seemed to kill the stock was management's projection that earnings per share would decline by 6% to 12% next year as the company raises its minimum hourly wage from $9 to $10, boosting annual expenses by $1.5 billion.
It's clear what's happening here. After years of flatlining comparable sales at its supercenters, increasing competition from Amazon.com (NASDAQ: AMZN), and poor customer service, Wal-Mart has been forced to reckon with its business model.
CEO Doug McMillon has chosen to invest in employees and e-commerce in order to improve performance and bring back growth. Long derided by labor organizations for its low wages, Wal-Mart raised hourly rates to $9 in April, and will lift them to $10 in February -- an about-face in its traditional bare-bones spending strategy. Though the plan was greeted warmly by some analysts, the near-term costs have clearly turned off the market. McMillon argues that the investments in wages are necessary to deliver a "seamless customer experience."
The labor question
As Wal-Mart has struggled in recent years, competitors with alternative business models like Amazon and Costco Wholesale (NASDAQ:COST) have seen their sales consistently grow. One key advantage for those retailers has been that they have been far better at leveraging their human resources. As the chart below shows, the two companies generate nearly three times the revenue per employee that Wal-Mart does.
This gives both Amazon and Costco the freedom to pay their employees more, providing yet another advantage over Wal-Mart. Over the last 10 years, Wal-Mart has increased its revenue per employee steadily, but based on complaints about poorly stocked shelves and long lines, those increases seem to be the result of underinvesting in staff rather than of real improvements in efficiency.
Slower store growth
Mostly ignored in Wal-Mart's forecast is that its store expansion is being dialed down significantly from previous years. The company plans to open between 142 and 165 stores next year, down more than half from last year's total of 375. Wal-Mart is also slashing capital expenditures from $12.4 billion this year to $11 billion a year for the next three years, and dramatically slowing growth of its Neighborhood Market segment. It expects to add just 85 to 95 of the small-format stores next year, down from 235 opened last year. The performance of those Neighborhood Market stores has been a rare bright spot for the company, with comparable-store sales growth in the high single digits, so it's surprising to see the format's expansion so sharply curtailed.
The move underscores the urgency of Wal-Mart's need to improve its customer service and store performance, but making up for $2.5 billion in additional wages will not be easy. With a gross profit rate around 25%, Wal-Mart would have to generate around $10 billion in incremental sales from its U.S. stores, and as the company's projections make clear, that is not going to happen for at least two more years.
McMillon clearly believes Wal-Mart has the capability to beat Amazon at its own game, but the e-commerce leader is continually finding new ways to speed up its delivery and stuff new benefits into its Prime loyalty program, making it tougher to match. McMillion, meanwhile, is touting the advantage of Wal-Mart's store network as the company implements programs like ship-from-store, in-store pick-up, and curbside grocery pick-up.
Wal-Mart's store network is a potential advantage, and McMillion understands what the company needs, but it has yet to execute in any of those areas that need improvement.
Every update from the retailer seems to be worse than the previous one. With earnings per share expected to fall next year, the company doesn't expect to see meaningful profit growth until fiscal 2019. Competing against Amazon is never easy and giving its online rival three more years to improve will only make things harder. Wal-Mart needs to fix its stores and turn around its performance much sooner than that if the company is going to return to its former glory.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com and Costco Wholesale. 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.