Wal-Mart's Missing Spark

Despite its surprisingly good June growth, Wall Street wants far better. Persistent legal problems are also dampening investor enthusiasm

There's a saying in the retail sector: "When Wal-Mart sneezes, the entire industry catches a cold." Good thing for retailers that it works the other way, too. When Wal-Mart (WMT ) reported on July 7 that its June same-store sales rose 4.5% from last year, exceeding all forecasts, it boosted Retail Metrics index of 67 U.S. retailers for same-store sales, or stores open at least a year, by 5.4%, beating the research firm's forecast of 4.8%.

Yet the positive news surprise boosted Wal-Mart's share price by only 13 cents, to $49.51. Year-to-date, despite a 10% increase in sales, the stock is down 7%, underperforming the 2.5% gain of the Standard & Poor's Retail Index.

Wall Street's reaction provides a window into the challenges confronting the world's largest retailer. Indeed, no sooner had Wal-Mart released its positive sales numbers, when two employees plus a former worker filed a lawsuit in Oklahoma alleging that the retailer retaliated against employees who file workers' compensation claims. This mix of good and unsettling news is likely to shadow the giant for the rest of the year, prompting many investors, perhaps, to sit on the sidelines.

LAGGING BEHIND TARGET. No question, Wal-Mart is retail's undisputed king. It racks up annual sales of $285 billion from its 5,350 stores worldwide and still wields such power that its encroachments can put even large chains like grocer Winn-Dixie into bankruptcy (see BW Online, 2/23/05, "No Comfort for Winn-Dixie").

But when you're the biggest gorilla in the jungle and throw your weight around, somebody else is always gunning for you, it seems. And that's what haunts modern-day Wal-Mart. Indeed, its once-spectacular growth now lags behind some of its more nimble competitors.

While its June growth numbers were better than expected, they were anemic compared to chic discounter Target (TGT ), where sales in the same period were up 9% as shoppers snapped up high-end designer apparel and housewares at low prices.

FOOD HERE, APPAREL ELSEWHERE. At more than 20 million shoppers a day, Wal-Mart's customer base is huge. But they have less disposable income, with an average annual salary of $35,000 compared with $50,000 for Target's typical customer, according to researcher Retail Forward. Small wonder one of the megaretailer's highest priorities this year is to get more affluent customers through its doors.

Wal-Mart CEO Lee Scott lamented at the recent annual meeting in Bentonville, Ark., that many customers will shop for basic goods like food and paper towels at Wal-Mart but go elsewhere for apparel. Time to get those folks to buy their clothes along with their groceries and household goods at Wal-Mart, Scott told his employees.

The CEO said he wants a "George effect," referring to the Wal-Mart exclusive apparel line named for British fashion designer George Davies. This is a page ripped out of Target's playbook. However, Davies has gotten little marketing or promotion, the way Target has promoted designers such as Isaac Mizrahi in its stores.

ONLY FOUR BUYS. Indeed, Wal-Mart management is approaching its fashion strategy a little gingerly -- and that has caught analysts' attention. "Fashion tends to be seasonal, which leads to markdowns at the end of the season, which Wal-Mart wants to avoid, which leads it to focus on everyday fashions," says Gib Carey, a partner in the consumer products practice at consulting firm Bain & Co. But Wal-Mart is definitely trying -- it now sells Nike (NKE ) shoes under its Starters brand, without the Swoosh, and it sells Levi's jeans under Wal-Mart's Signature brand.

Wall Street isn't that bullish on Wal-Mart's future prospects, either. A consensus of 10 analysts that follow the retailer expect revenues to grow 10%, vs. 14% for the industry. Only 4 out of the 10 recommend that investors buy the stock, while 6 have a hold or underweight rating.

Key obstacles to Wal-Mart's growth are the civic protests and local government rulings against it. Earlier this year, class-action lawyers sued 30 cities in California for approving 200,000-square foot Wal-Mart supercenters, citing the state's tough environmental laws. The suit could stall development of many of the 40 new giant outlets that Wal-Mart wants to build in the Golden State. At the same time, Inglewood, Calif., and Montgomery County in Maryland have scheduled referendums to try to keep Wal-Mart's megastores out of their jurisdictions.

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