The Implications of Wal-Mart's Warning

The retail giant lowered its profit forecast for the rest of 2007, in part because of the rising economic pressures on consumers

by Pallavi Gogoi

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Maybe it's time to start worrying about whether American consumers can keep propping up the U.S. economy.

On Aug. 14, Wal-Mart Stores (WMT) provided a bleak outlook for the second half of the year, even as it reported record sales and profits for the second quarter. H. Lee Scott Jr., the company's president and chief executive, said that consumers slowed their spending markedly in the last weeks of the quarter, as rising interest rates and gas prices took a toll on paychecks. "Consumers are under difficult pressure financially," he said, in an unusually grim conference call, prerecorded for investors and analysts. "Consumers are running out of money by the end of the month."

Scott didn't place all the blame for the company's difficulties on consumer concerns. He said that the company has also created problems for itself, particularly in merchandising, as its push into upscale apparel and home furnishings has floundered. "Although some people will report that Wal-Mart has had record sales and earnings, our underlying operating performance this quarter is not what we expect of ourselves and not what our shareholders expect of us," Scott said. "For the remainder of this year, our management team is focused on inventory improvements, delivering quality products at low prices, and store execution at the highest standards."

The Housing Downturn Strikes Spending Habits

But what spooked Wal-Mart shareholders and investors more broadly is the idea that the American consumer, free-spending for years, may now be cutting back. Rising interest rates are hurting those with adjustable-rate mortgages and other debts, while the downturn in the housing market has made many Americans feel less well off than they did just months ago. At the same time, the stock market is gyrating wildly and gas prices have remained stubbornly high. "We are in a tough economic environment with the consumer being affected by the housing market, tightening credit, and even gas prices," says Michael Niemira, chief economist for the International Council of Shopping Centers, which tracks sales at shopping centers.

Wal-Mart shares dropped 5% on Aug. 14, to close at $43.82, while the Dow Jones industrial average tumbled more than 200 points, to close at 13,028.92 (see BusinessWeek.com, 8/14/07, "Stocks Tumble on Credit Fears, Wal-Mart"). The news came one day after Sears Holdings (SHLD) reported disappointing results for the second quarter, and Chief Executive Aylwin Lewis said, "The housing market slowdown and other economic pressures have presented a noticeable headwind to the business."

For the quarter, Wal-Mart reported an 8.8% increase in sales, to $91.99 billion, propelled by 16% growth in its international operations. Net income increased 49%, to $3.10 billion, although profits in the year-earlier period had been reduced because of a charge for the sale of its German operations. Income from continuing operations in the second quarter rose 4.1%, to $3.11 billion.