The confluence of these struggles -- which Wall Street calls "headline risk" -- has weighed heavily on Wal-Mart's stock. But analysts now say the biggest threat actually comes from within: rising costs.
Wal-Mart used a simple strategy to become the world's biggest retailer -- buy low, sell low. Now the Bentonville, Arkansas-based behemoth is grappling with rising expenses in areas ranging from labor to gasoline, and earnings are under pressure.
Cost controls are critical for a company that generated a slim profit of 3.7 cents per dollar of goods sold in the recently completed second quarter -- nearly 1 cent per dollar less than rival Target Corp.
"You can't sell for less if you're spending more," Wal-Mart Chief Executive Lee Scott said in a speech to Chicago executives earlier this year.
"We look at expenses every day and we look at them very, very carefully," he said. "We just try to make sure that our earnings are equal to or greater than our sales growth."
But Wal-Mart's key U.S. stores division has missed that goal for two consecutive quarters, and Wall Street is beginning to wonder when profitability will get back on track.
"The market seems to have come to the conclusion that the 28 percent operating returns that (Wal-Mart) earned before the 2001 recession are a thing of the past," said ThinkEquity Partners analyst Edward Weller.
Indeed, Wal-Mart's stock now trades at almost the same price as it did five years ago, before the recession. Target's stock has more than doubled over that period.
"Wal-Mart will have more than doubled earnings per share between 1999 and the current year but to no avail," Weller said. "It appears that the stock -- if and when it recovers from recent losses -- will have spent seven years in a trading range."
POINT A TO POINT B
Wal-Mart's success depends on getting goods on shelves as cheaply as possible. Critics say this low-cost obsession puts pressure on store managers to overwork employees, and the retailer has been hit with dozens of lawsuits claiming violations of wage-and-hour laws.
Wal-Mart also faces a barrage of bad press as it seeks to defend the largest ever class-action lawsuit that charges it with discriminating against women in pay and promotions.
Many on Wall Street think a multibillion-dollar settlement is likely. Wal-Mart appealed the class certification, but the court is not expected to decide for several more months.
For its part, Wal-Mart says it pays its employees fairly, with the average hourly pay at nearly twice the federal minimum wage. The company also boasts about the thousands of salaried managers and executives who rose though the hourly ranks.
But labor costs have increased recently, in part because of a "pay equity" program that hiked wages for some workers. Many Wal-Mart watchers saw the program, which started in June 2004, as a direct response to the sex discrimination case.
The increasing labor costs come as oil prices top $68 per barrel, which raises both raw material and transportation expenses.
Wal-Mart estimates that utility expenses rose by $100 million in its second quarter, when it also spent $30 million more to truck merchandise from its U.S. distribution centers to stores. Those additional costs add up to almost 5 percent of Wal-Mart's second-quarter profit of $2.8 billion.
HOLDING THE LINE
With sales growth muted as steep gasoline prices cut into household budgets, the rising costs are magnified.
Sanford Bernstein analyst Emme Kozloff estimates that Wal-Mart needs sales at stores open more than a year -- or same-store sales -- to grow by at least 6 percent in order to keep expenses under control. The retailer has forecast just 3 percent to 5 percent growth for the current third quarter.
Kozloff recently lowered her six- to 12-month share-price target for Wal-Mart to $51 from $53, still 12 percent above Wednesday's close of $45.55.
On a price-to-earnings basis, though, the shares would be trading at just a 6 percent premium to the overall stock market, far below their 38 percent average of recent years.
"A slight premium to the market is about as far as the P/E multiple should go until management provides us with a clear action plan to lower controllable costs," Kozloff said.
Wal-Mart says it has no intention of raising prices to make up for rising expenses, and has even pressed suppliers to hold the line on price hikes despite soaring raw material costs.
Instead, Wal-Mart's answer is to stock more-upscale merchandise in hopes of getting wealthier shoppers to buy clothing or home decor instead of just low-margin groceries. That strategy puts the company on a collision course with Target, which has found its niche by selling fashionable goods at low prices.
Wal-Mart said it was pleased with its trendier back-to-school and fall fashions, but Target raised the bar once again this month with plans to add luxury items like Riedel wine glasses and 600-thread-count sheets.
A.G. Edwards analyst Robert Buchanan called Wal-Mart's fashion offerings "decidedly dull," and said the retailer's stock merits only a "hold" rating until a return to the double-digit profit growth that used to be routine.
That doesn't look likely to happen this year, with forecasts calling for only about a 9 percent earnings increase. Analysts are looking for a 13 percent rise for next year, but Wal-Mart has yet to provide its outlook.
