CHICAGO – For years, Wal-Mart Stores Inc.'s top executives forgot or just ignored a tenet of founder Sam Walton's: "Never get so set in your ways that you can't change."
But faced with challenging operational issues, rising expenses as well as lawsuits, political attacks and community resentment over its employment policies, the $285.2 billion house that Sam built now is all about change.
In fact, nearly everything surrounding Wal-Mart (WMT) these days is changing: the management structure, the merchandising mix, the marketing, the store experience, the public-relations image, the operational functions; perhaps even health-care coverage and wages and hiring practices.
"The company is changing today as radically as it has ever changed in its history," Chief Executive Lee Scott told analysts last week.
It is even taking the unusual, and risky, step of putting itself on display before a gathering of economists Friday in Washington who might not paint an entirely rosy picture of the retailer's impact on its surroundings, from the overall economy to individual communities.
But if this truly is an inflection point, and many believe it is, investors may have a long wait ahead of them before the changes make a difference in earnings and the share price.
"Wal-Mart is like a super-freighter oil tanker plowing down the Mississippi River to the Port of New Orleans," said A.G. Edwards (search) analyst Bob Buchanan. "If it sways off its course it takes a long, long time to get back on it.
"Why should I make a bet on that?" he said, voicing the concern on the minds of many investors.
Even after attending what he called an "uplifting" analysts' meeting near company headquarters in Bentonville, Ark., last month, Buchanan is encouraging clients to stay on the sidelines with his hold rating.
That's counter to most other analysts who support the initiatives and recommend the stock but heavily pepper their notes with caveats.
Under the radar
For nearly three decades, Wal-Mart (search) executives kept mostly out of the public eye as they built a retail juggernaut with nearly 6,000 stores spanning much of the globe. The now-familiar motto of "Every day low prices" resonated with low-income families and in rural areas.
The formula worked well.
Only 10 years ago Wal-Mart was a $78 billion company with only two divisions: Wal-Mart's traditional stores and Sam's Clubs. International sales were just getting started, and accounted for only 2% of total sales. By last year, international sales generated 20% of total sales — or a whopping $56 billion, more than FedEx Corp. (FDX) and Best Buy Cos. (BBY) combined.
But the giant's steps forward have slowed, setting off warning bells for analysts and investors who have long feared the time when Wal-Mart would move beyond the growth stage.
After a long run of solid middle to upper double-digit revenue growth, Wal-Mart turned in an 11.3% increase in net sales last year, its smallest percentage gain in more than a decade. It also marked the fifth straight year of declining sales gains.
By most measurements that's still pretty good.
And Wal-Mart executives have been quick to point that out, while rejecting suggestions the company's path to further growth could be getting rockier. They have at least 2,700 opportunities within easy reach in the United States alone.
But projections for future results suggest a further slowing of growth, even while Wal-Mart adds 60 million square feet annually to its retail footprint.
At Thomson First Call, net sales are forecast to grow at a 10.1% clip to $317.42 billion, earnings at 8.2% to $11.11 billion.
Expenses on everything from energy to land costs and now marketing are accelerating. It costs 13% more today to build a new store than it did a year ago.
Scott began last week on a good note. In a rare question-and-answer media teleconference, he unveiled four major initiatives that he hoped would calm the external attacks.
Scott described a plan to offer more affordable health-care insurance for employees that, in some cases, slashed monthly premiums to just $11.
He said the retailer would become more environmentally responsible by turning to solar power to help light stores, reducing greenhouse emissions by 20% and solid waste by 25%, and demanding greater mileage out of its vast fleet of trucks, among other things.
He called for a higher federal minimum wage that would not only help his own employees, but would fatten the wallets of millions of customers.
And he vowed to monitor the labor and environmental practices of foreign suppliers, another issue for activists.
"It is possible and probable we are going to do well by doing good," he said.
But days later an internal memo discussing ways to cut benefit costs was leaked to the press and drew a round of intense criticism.
Among the revelations was the company's acknowledgement that one out of every two children related to their workforce has no insurance or relies on government support.
Groups such as Wake Up Wal-Mart, seeded with money from the United Food and Commercial Workers International union, lambasted the company. "Wages at poverty levels, unsafe working conditions ... Wal-Mart ended up becoming not just the poster child for the ills of America, but the leader of those ills," said the group's spokesman Chris Kofinis.
"Wal-Mart has the ability to make changes but chooses not to," he added.
Headlines or fundamentals?
Chief Financial Officer Tom Schoewe has said repeatedly over the past eight months that the stock's decline has more to do with what he calls "headline impact" than fundamentals.
Wal-Mart's stock price has suffered as charges of sexual and racial discrimination, questionable hiring practices and insiders hands in the till have piled up. From March of 2004 until hitting a four-year low of $42.31 in September, Wal-Mart's stock fell 31%.
Friday's release of the documentary, "Wal-Mart: The High Cost of Low Price," by Robert Greenwald could push the shares lower.
But it's not just headlines. Wal-Mart's returns on invested capital are lagging and profit margins at its U.S. stores are falling.
Wal-Mart executives have predicted that return on investment will fall in the next 12 to 18 months before rebounding as the company shores up operations, distribution, purchasing, inventory turnover and cross-category selling.
"It is not going to surprise you that we look at return on investment each and every day inside of our company," Schoewe told analysts last week.
"Sam's (Club) over the last couple of years flattened out," he said about ROI, "and over the last several quarters actually improved. But the largest operation, Wal-Mart U.S. has actually seen a decline in its ROI. And why is that? Mainly because of the impact of earnings not growing at the same rate as sales."
The company pointed out two merchandising initiatives it believes will be a source of new sales: fashion and electronics. Fashion merchandisers, for example, are already in place to boost sales.
"We want to improve our marketing and communications. We want to improve the customer experience... all of that relates to sales growth," said Schoewe.
"The question you need to keep asking yourself and us (is) are the kinds of things that we're talking about enough to change that trend," Schoewe added.
Jaison Blair, for one, doesn't think so.
An analyst at Rochdale Research, Blair sees a declining ROI over the next decade as Wal-Mart spends more on building sites. Escalating community resistance to new stores is also likely to prove costly. Store development costs have risen 13% over each of the last three years, a climb that translates into lower returns from new stores.
"While management suggests that returns on new investment are still 'decent,' we believe that there are fewer no-brainers (for finding real estate) and that the low-hanging fruit has been picked clean," he told his clients. The company is also likely to face more lawsuits over store openings, he added.
By his account, Wal-Mart's ROIC peaked in 2004 and will fall for years to come. As a result, Wal-Mart is no longer a U.S. retailing story, but an international buyer looking for another acquisition like its 1999 purchase of Britain's Asda grocery chain.
"We believe a large acquisition is on the horizon and that the acquisition strategy faces considerable challenges," he said.
Among the initiatives Schoewe urged analysts to examine was Wal-Mart's strategy to raise the fashion quotient, and prices, on certain apparel lines as it tries to lure trendier value shoppers who turn to Target Corp (TGT) .
In that way, Wal-Mart will be able to appeal to a broader base of customers and get those who typically shop just for groceries to pick up clothes in the same trip. The company recently launched the Metro 7 line of hip apparel and accessories that it hopes will compete with, say, Target's line of designer Isaac Mizrahi casual clothing.
While analysts applaud the move, they are skeptical that Wal-Mart customers who shop for milk and detergent are going to stop for fashion, too.
"It is still unclear if the consumer will respond." Morgan Stanley's Melich.
Analysts also say they are worried that Wal-Mart is cannibalizing its own sales by building stores too close together.
Schoewe waves off those fears.
"You hear about this internal cannibalization, is there still a growth opportunity," he said at the analyst meeting.