Wal-Mart's Slowdown a Mixed Blessing for Retailers

ELLIOT ZWIEBACH

BENTONVILLE, Ark. — The pending cutback by Wal-Mart Stores in the number of supercenter openings over the next three years could ease competition a bit for supermarket competitors, industry analysts told SN last week

However, the company's intention to use the cutback to focus more on improving the customer experience at store level could keep competitive pressures intense, they pointed out.

Wal-Mart disclosed plans at its annual meeting in Fayetteville, Ark., to reduce the number of supercenter openings this year by more than 26% — targeting 190 to 200 locations rather than the 265 to 270 originally scheduled — and to open no more than 170 new supercenters in each of the next two years, with capital spending dropping 9% this year from $17 billion to $15.5 billion.

According to one analyst, the cutback is “shocking, in the most positive way, because it's more than investors wanted, and it will allow Wal-Mart to focus on what's happening at the stores.”

Growth plans for other Wal-Mart divisions will remain unchanged, with between 20 and 30 Sam's Clubs, 15 to 20 Neighborhood Markets and five to 10 Wal-Mart discount stores still scheduled to open this year, the company said. International growth plans also remain unchanged.

According to company executives, the majority of cutbacks will result from pushing back 80 supercenter openings into fiscal 2008 that were slated for January, while some locations scheduled to open next year will be deferred or delayed until 2009 or canceled, with the properties rejoining the company's land bank.

Despite the cutbacks, Wal-Mart will still be adding 20 million square feet of new supercenter space this year, Lee Scott, president and chief executive officer, told reporters after the meeting. “And it will enable us to improve sales growth and to make our existing stores more productive and profitable,” he said.

“We must improve merchandising and execute store standards and customer service more efficiently, especially at the checkout.”

Tom Schoewe, executive vice president and chief financial officer, said, “We will still grow at a nice pace, but we will focus on merchandising, operations and the core parts of our business to get better returns for shareholders.”

Schoewe also said Wal-Mart plans to allocate $15 billion this year to buy back shares, abandoning a $10 billion buyback authorization that still had $3.3 billion remaining.

Analysts contacted by SN were generally upbeat about Wal-Mart's new-store slowdown and share buyback program.

“[The cutback] is clearly a directional positive for anyone that competes with Wal-Mart, especially those in slower-growth merchandise categories like food, where reduced capacity could be more impactful,” said John Heinbockel, an analyst with Goldman Sachs, New York.

“But we would caution against an overreaction,” he added, “[because] the beneficial impact will probably not really be felt until the second half of 2008, [and] any real step-down in competitive activity would probably not be felt until several quarters later. In addition, the company will still be adding noticeable capacity to a mature market. And it is possible a reduced level of capacity growth could enable management to better focus on areas of weakness, thus driving better comp growth.”

Gary Giblen, executive vice president at Goldsmith & Harris, New York, also said the impact of the cutbacks is likely to be modest for competitors.

“On the one hand, the cutback would seem to be a huge positive for all supermarkets,” he said. “But on the other, it will allow Wal-Mart to probably execute better at store level. Over the last 12 to 18 months, Wal-Mart has been focusing on things other than supermarket competition anyway, which has enabled companies like Kroger and Safeway to do better while Wal-Mart's top priority was getting more competitive in apparel to catch up with Target. So most of the positive impact has already happened.”

Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said Wal-Mart will still be adding a lot of square footage despite the cutbacks, “so while its actions will have some direct positive impact on supermarkets, it will not really be a lot.”

Mark Husson, New York-based managing director for HSBC Securities, London, said he expects Wal-Mart to experience “modest sales upticks” from its action, as the company makes “better quality decisions about use of assets and less self-inflicted damage to existing assets.”

Comparable-store sales at supercenters have been slipping, he pointed out — from above 6% in 2005 to approximately 5.8% in 2006, with expectations of gains of less than 5% this year and dropping into the plus-4% range in the next year or two.

By slowing down store growth and buying back shares, Husson said he believes Wal-Mart could create value and halt some of the sales cannibalization that destroys value, estimating the share buyback program could add about 15 cents per share to earnings — a 5% premium.

Among the challenges Wal-Mart still must resolve at store level, he said, are cheap-looking clothing; poor quality and low prices that reinforce that image; variable department-by-department execution; uninspiring brand selection; and slow checkouts. “Management is aware of most of these, is on top of a few and is making progress on the rest, such as checkout experience.”

According to Heinbockel, future financial gains hinge on turning around the operating fundamentals, which will not be easy to do.

“However, management has bought themselves some goodwill and time by strategically aligning themselves with a more realistic approach to improve returns — slowing square footage to relieve stress on the core operations, reinvesting some money back into the base and buying back stock,” he said.

“But EPS growth needs to be driven by more than just buybacks as a result of reduced cap-ex. Management needs to demonstrate that, by de-stressing its core operations with less growth, it can get back on track to deliver better sales and margins.”

Ed Weller, managing director at ThinkEquity Partners, San Francisco, said Wal-Mart expects to focus its attention and resources on markets with the best opportunities to create a more competitive position and drive higher comps and improve margins — “markets where it has fewer stores and where it wants to have more,” he explained.

“With better store productivity should also come improved profitability, especially if labor productivity and profitability are among the key management efforts,” Weller said.

In terms of operating profits, he estimated margins at supercenters could rise from 7.43% last year and an estimated 7.25% this year to 7.78% by 2010.

During the annual meeting and the analyst presentation that followed, Scott discussed some of Wal-Mart's store-level problems. “The stores are very choppy,” he said. “When you go into a Crate & Barrel, it looks like everything was purchased by one buyer. But we have a ways to go there.

“We must improve merchandising in the U.S. and execute consistent store standards and customer service, especially at the checkouts. We have plans in place, and we will be executing against them.

“Wal-Mart needs work in marketing, in understanding customers and in communicating with them to emphasize the values of the company, its pricing and its assortment.

“The keys are getting the right merchandise at the right price and being in stock, and I'm convinced we'll see some improvements by the fall.”

Food is not a problem area for Wal-Mart, Eduardo Castro-Wright, president and CEO of Wal-Mart Stores USA, told analysts. “The grocery business, with its price message, is doing very well and continues to grow in the mid-single-digit range,” he said.

Asked about cannibalization that has resulted from opening supercenters closer together, Castro-Wright said cannibalization impacts sales by about 1%.

“But that is not the focus of reducing supercenter growth,” he pointed out. “The slowdown has to do with aligning store-level strategies with our growth and defining where we should grow, and as a result we will see less density in some markets, which should result in improvements in the degree of cannibalization.”