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Fashion, Image Issues Looming Over Wal-Mart As Shareholders Gather

Wal-Mart Stores Inc.'s annual stockholders' meeting, an extravaganza of executive presentations and high-octane entertainment.

Wal-Mart Stores Inc.’s annual stockholders’ meeting, an extravaganza of executive presentations and high-octane entertainment, gets under way Friday amid increasing pressure about blunders in apparel, the potential of a second-quarter earnings miss and challenges to the company’s corporate image.

The world’s largest retailer is facing myriad concerns as about 18,000 people, including more than 5,000 employees, suppliers, media and financial analysts, descend on headquarters in Bentonville, Ark.

The issues also include:

— Turnaround plans for Wal-Mart’s flagship U.S. division, which accounts for 65 percent of total revenue and, twice in the last 12 months, has fallen below Wall Street expectations on same-store sales.

— Accusations by fired marketing officer Julie Roehm that Wal-Mart executives, including president and chief executive officer H. Lee Scott, violated company ethics policies. Wal-Mart had accused Roehm of accepting gifts from suppliers and having an affair with a subordinate. Roehm, who is suing for breach of contract, alleged in court papers that the executives received gifts and discounts from companies doing business with Wal-Mart.

— Speculation that Wal-Mart has explored the sale or spin-off of the $41 billion Sam’s Club division.

— Fallout from an alleged clandestine investigation of some shareholder and activist groups by an internal Wal-Mart team, and electronic surveillance of a New York Times reporter.

Although the retailer declined to discuss the meeting agenda, Scott, possibly hinting at the tone, said in a letter to shareholders that 2006 was a “period perhaps of the most rapid and profound change in our company’s history.”

Most crucial for Wal-Mart, the stock has been lethargic for about five years, hovering around $50, after decades of share splits and stellar growth. The $226 billion U.S. division continues to struggle. Its core customer is under pressure from rising gas prices and low wage growth to such a degree that the retailer warned May 15 that it may not meet Wall Street’s consensus for second-quarter earnings.

Affluent customers have been underwhelmed by Wal-Mart’s forays into pricier, more fashionable apparel, and core basics for loyal shoppers have been missing. The Metro 7 line has been reduced and the first designer label, George ME by Mark Eisen, has been significantly scaled back. The Wall Street Journal reported Tuesday that Wal-Mart, with a glut of inventory, was cutting orders, creating shock waves in Chinese factories where the retailer produces goods on a monumental scale. Factories are scrambling to line up orders from other retailers to keep production lines full.

This story first appeared in the May 30, 2007 issue of WWD.  Subscribe Today.

“It’s logical that a slowdown in Wal-Mart’s domestic supercenter business and its heavy dependence on overseas production would lead to a slowdown in China,” said Richard Hastings, retail analyst with Bernard Sands. However, Hastings said the retailer’s U.S. troubles were not only in apparel, which “looks much better than it did seven to 10 years ago,” and were symptomatic of a maturing business.

The domestic stores division increased operating income 1.79 percent in 2006, a slender gain that Hastings believes is dependent on income growth from Sam’s Club and some one-time financial credits.

A.G. Edwards analyst Bob Buchanan, who will attend the meeting, said, “When I go to the clearance rack, I see signs of a retailer out of touch with their core customer. I see too many full size and color runs [of clothing styles] on clearance.”

Wal-Mart needs to refocus on “being on trend for the White Stag [misses’] customer that is 5-foot-4 [inches], weighs 165 pounds and has a household income of $20,000 to $40,000,” Buchanan said.

Gross margins will be pinched as Wal-Mart clears out apparel, but should improve for back-to-school selling, which starts in August, Wal-Mart U.S. president and ceo Eduardo Castro-Wright said on the company’s first-quarter earnings conference call May 15. Under John Fleming, who was named to the new position of chief merchant in January, the company has realigned its U.S. merchandising under five “power categories”: entertainment, grocery, health and wellness, apparel and home.

Despite miscues, Wal-Mart is growing. “But the problem with 9 percent earnings growth is that it is half of what it was the year before,” Buchanan said. “The company is also regularly missing its numbers for the first time ever; that’s an issue. And, arguably, the management is starting to resemble a revolving door” with a series of top executive changes in Wal-Mart U.S.

The appointment of former chief marketing officer Fleming in January presaged a string of changes this spring that included the departure of the top grocery and hardlines merchant, Doug Degn; the demotion of the leading softlines merchant, Claire Watts, and the elevation of Bill Simon, architect of the company’s successful $4 generic prescription drug program, to chief operating officer of U.S. operations.

Underscoring Wal-Mart’s focus on improving results at its largest operating division, Castro-Wright is reporting directly to Scott instead of to vice chairman John Menzer.

Apparel has been a drag on U.S. comps. But there may be fresh input from Allen Questrom, who led turnarounds as chief executive officer of Barneys New York and J.C. Penney Co. Inc., and will formally stand for election to Wal-Mart’s board. In Bentonville, Questrom will visit stores, attend official functions and likely perform his first Wal-Mart cheer, which starts, “Give me a W!” and substitutes a hip shake for the hyphen.

“I will dive into this on a board level,” he said. “There is no way I will understand in three days everything about the Wal-Mart culture.”

Questrom said, “Wal-Mart has to stay on that mission that’s so critical to the economy and to that family with a $70,000 annual income. The fundamental for Wal-Mart is [to] give the lowest price on everything we carry. They have to be careful not to be distracted by peripheral issues that the press focuses on.”

Those issues have been a costly distraction. The $345 billion retailer is still struggling with its image, despite funneling hundreds of millions into ad campaigns, consultants, advocacy groups and high-profile hires. Wal-Mart shareholders were angered this spring after media reported that the retailer had conducted surveillance on some shareholder groups to assess whether they were a threat to the company. Wal-Mart denied it obtained any information on shareholders through surveillance or other improper means. The retailer said the surveillance of a New York Times reporter by a technician was not authorized and the employee was fired.

The New York City Comptroller’s office, which holds about $400 million in Wal-Mart stock in government pension funds, publicly criticized the company and called on the Securities and Exchange Commission to investigate. The matter is being reviewed by an SEC regional office, said Jeff Simmons, a spokesman for City Comptroller William Thompson Jr.

“It’s a good idea for them to address the surveillance,” said Christine Augustine, analyst with Bear Stearns, who will attend the meeting. “They should be honest about it, but not dwell on it. Reputation is a factor on stock price because of ‘headline risk,’ but I think the real issue for Wal-Mart is same-store sales. If a retailer is not able to show consistency in same-store sales, it’s difficult to get multiple expansion [on stock price.]”

Some shareholder factions are more concerned about the stock price than about whether their privacy was invaded.

“The number-one concern for shareholders is not surveillance or anything like that,” said Peter Flaherty, president of the National Legal and Policy Center, a Washington watchdog organization that is among the groups Wal-Mart is said to have investigated. “It’s the share price, which has gone nowhere in years. We wonder why Lee Scott is so concerned with making a politically correct company instead of focusing on share price.”

Flaherty’s organization, which owns fewer than 100 shares in Wal-Mart and has similar small stakes in other major corporations for advocacy purposes, has sponsored a proposal seeking more public disclosure about Wal-Mart’s charitable contributions. It is one of 13 shareholder proposals on the ballot this year. Wal-Mart is recommending shareholders vote against all of them.

During the meeting, the company will likely pay tribute to Helen Walton, the widow of founder Sam Walton, who died in April. She was a popular figure in northwest Arkansas who gave a modest wave when her son, Wal-Mart chairman Rob Walton, singled her out at the shareholders’ meeting. In the next several years, there will be no significant sale of Wal-Mart stock related to Walton’s death. Over time, a “significant portion” of her $16 billion stake in the company will be given to charity, the Walton family said.

It is unlikely that Wal-Mart will directly address speculation that it is considering selling or spinning off Sam’s Club, the warehouse club division. Financial analysts have long said the disposition of Sam’s could unlock stock value and allow the warehouse club, which operates with its own ceo and merchant team, to compete more effectively with Costco Wholesale Corp. and Wal-Mart on pricing, merchandise and location.

Wal-Mart executives are candid about the need to boost performance and the risks inherent in steering a new course. Rob Walton acknowledged recent troubles in his missive to shareholders, but reiterated his support for management.

“Successful leaders are willing to fail as they try new things and to accept an occasional disappointment when things don’t work out as planned,” he wrote.