Wal-Mart stuck in neutral

By Robert Walberg

Taking the lead from Gen. William Tecumseh Sherman, the world’s largest retailer plans to steamroll the competition this holiday season with a scorched-earth pricing policy.

Though Wal-Mart Stores' (WMT, news, msgs) 12% jump in sales during the latest quarter was impressive considering the size of the company (total sales were $83.54 billion), it lagged Wall Street’s estimate of $84.48 billion. Same-store sales growth of 1.5% continued to trail the competition.

On an earnings conference call, CEO Leo Scott made it clear that goal one is rejuvenating sales growth. "This season, no one will doubt Wal-Mart's leadership on price and value," Scott said.

Toys and electronics are the first targets. While toy sales in November have been sluggish, management remains optimistic that the pricing strategy will lure holiday shoppers to its expansive, though often cluttered, toy departments. The unit could disappoint though because there aren’t many red-hot, must-have toys this season.

Taking aim at rivals

Electronics may be a different ballgame. Wal-Mart has gone more upscale to compete directly with the likes of Best Buy (BBY, news, msgs). It has been successful with strong flat-panel television and MP3 sales, and its $398 laptop special was also a big hit, selling out in many stores within an hour. CD and DVD sales may drag but overall this should be another strong holiday for electronics.

Wal-Mart also hopes for big sales from its generic drug program, where it will sell many for $4. Sales are already exceeding expectations. In Florida, pharmacy sales have been growing at twice the projected rate and sales are also ahead of plan in 26 other states.

Taking additional aim at Best Buy, as well as home-improvement retailers like Home Depot (HD, news, msgs) and Lowe's (LOW, news, msgs), Wal-Mart recently announced that it would slash prices on appliances. Cuts will apply to nearly 50 appliances including items from name brands such as GE, Sharp and Hoover.

Unfortunately discounting has a downside. Margins, which improved across all groups in the third quarter, are likely to take a hit. In order for the strategy to work, top-line growth must be strong enough to offset the impact of lower prices on the bottom line. Yet there is nothing to suggest that the aggressive pricing strategy will result in a big gain in sales.

Poor products and aging stores

To the contrary, the company is forecasting same-store sales growth of between 1% and 2% in the holiday-charged fourth quarter. By comparison, chief rival Target (TGT, news, msgs) is predicting same-store sales growth of between 4% and 7% -- without resorting to slashing prices.

Wal-Mart blames its soft same-store sales numbers in part on tough comparisons (due to the boom in 2005 sales from Hurricane Katrina), but the reality is that it has continued to lag behind the competition with its merchandise mix and aging stores.

Facelifts at about 100 stores a month over the next 12-15 months and better merchandise should help. Higher-end electronics have already made a difference, though Wal-Mart is struggling to win buyers for its upscale clothing lines. Another value retailer, Kohl’s (KSS, news, msgs) experienced similar difficulties when it first introduced more fashion-forward clothing but in time the switch proved successful. By contrast, the softer side of Sears Holdings (SHLD, news, msgs) never gained consistent success and has routinely dragged on sales.

A critical turning point

Obviously, Wal-Mart hopes that it will more closely mirror the Kohl’s model and that in time consumers will warm to its Metro 7 line. But the company hasn’t had much success going upscale with clothes in the past (remember the George line?). It may just be that Wal-Mart will need to cede that market to Target.

Either way, this is a pivotal time in Wal-Mart’s storied history because the company must jump-start sales to win favor on Wall Street. The aggressive pricing strategy is a return to the retailer's roots and may work over the long term. In the short term, however, the combination of discounted prices and higher expenses (like the store remodeling) will weigh on margins and slow profit growth. The company cut its full-year earnings forecast to $2.85 to $2.89, a few cents lower than earlier and below the Street estimate of $2.92.

Wal-Mart is still a decent value play in the retail sector. But look for Wall Street to take a wait-and-see approach on its pricing strategy before jumping back on board in a big way. The stock came close to my price target of $54 in late October and, assuming it hits its growth targets for the current quarter, another run at that ceiling is likely within the next six months.

But until investors get a better handle on how the company’s scorched-earth approach to pricing will impact holiday sales, look for the stock to be stuck in neutral.

Robert Walberg is a financial writer based in Chicago and a regular guest on CNN's "Moneyline." He was formerly chief equity analyst at Briefing.com and ran for Congress in Illinois in 1994.

At the time of publication, Walberg did not own or control shares of any companies mentioned in this article.