Wal-Mart Isn't Just Closing Stores, It's Exiting A Business

| About: Wal-Mart Stores, (WMT)

Summary

The headlines were mostly about Wal-Mart shutting nearly 270 stores.

Retailers open and close stores all the time.

The real information was that it decided to shutter Walmart Express.

Wal-Mart (NYSE:WMT) has over 11,500 stores around the world. It shouldn't be any surprise that it would shut a few each year, but that's what so many headlines blared after a company announcement on store closures. The roughly 270 stores the mega-retailer is shutting account for around 2% of the company's total outlets and 1% of revenues, according to the company. And, to be fair, it's opening some new locations along the way as well, which retailers do all the time too. So the impact from the closures won't be that big. But there's still valuable information here because what's really going on is Wal-Mart is abandoning its small store format. And that has notable implications.

Growth
Wal-Mart's original growth engine was the big box store located in rural locations. It was able to grow this business for many years. Eventually, however, growth slowed and the company had to find a new source to fuel its expansion. It found grocery stores. That allowed the retailer to continue growing and was copied by one of its main rivals, Target (NYSE:TGT).

Walmart store logo. Source: Wal-Mart But a company can only grow in a sector for so long before growth has to top out. Wal-Mart appears to have again reached that point. It's not that there's no room for growth in its mega-stores, club stores, and erstwhile grocery stores, but that its growth in the future isn't likely to be as robust as growth in the past. Add in low inflation and its hard to raise prices or, more to Wal-Mart's style, widen margins. Note its been pushing hard on suppliers of late, and hearing more grousing than usual.

But after downshifting from the mega-store to the grocery store format, Wal-Mart thought it had found another niche, one additional step down: convenience/dollar stores. It had talked up the growth potential here for a bit, but after a few years of trying now seems to have decided that it isn't a workable project. That's good and bad.

The bad
The bad news from the decision to exit the small format space is that Wal-Mart has lost a potential growth engine. Not one that would push the top line up for a year or two, but one that could have done so for maybe a decade or more as it expanded out the concept. At this point, there's nothing on the horizon to suggest Wal-Mart has anything but low single digit growth ahead of it. Granted global expansion could eventually provide more than that, but Wal-Mart is already huge globally and right now the world isn't exactly a hotbed of growth. Since Mr. Market doesn't like to wait, there's little credit given for the potential of global expansion right now.

Exiting the small store format, however, is worse than that because there are players expanding in the niche, most notably Dollar Tree (NASDAQ:DLTR). This company has been expanding quickly and recently completed the acquisition of Family Dollar. This gives it two concepts, one that's based on selling an assortment of cheap stuff for a buck (I love to the store, you never know what you'll find!) and another that's based on selling a broader assortment of cheap stuff locally. However, both sell daily need items and food that you might otherwise find in a grocery store or Wal-Mart.

Essentially, Dollar Tree and its competitors are taking over the small format space that Wal-Mart has just given up on. Wal-Mart's decision could be read as an admission that it can't compete. So two potential issues from the store closing announcement. One, Wal-Mart's shutting down what it once believed was a growth opportunity. Two, it's giving up the space to competitors which will make it harder to take on later and allowing Dollar Tree and the like to scale up and better compete with their giant peer.

The good
But I'm not certain that this is an all bad scenario. Certainly it's unfortunate to see Wal-Mart throw in the towel on an idea. However, the company has other issues its working on right now, like revitalizing its core concept. If it can't get that right, opening small format stores isn't going to help it much. So why waste the time and energy?

Management teams only have so much mental bandwidth. It's simply a human nature thing, we can only focus on just so many things before we lose track of what's going on. It's the same reason why a portfolio of 20 stocks is a better option than a portfolio of 100 stocks for a do-it-yourself investor. You just can't keep track of 100 stocks-20 is hard enough.

So as Wal-Mart starts to face its demons, this is one distraction that it didn't need to deal with. Clearly, if the effort was going really well they would have kept pushing it. But my guess is that it wasn't going to be an easy effort, so relatively new CEO Doug McMillon chose to put his time and effort where it was needed most. That's a good call at a time of important change for the company.

Is the model broken?
I've noted this before, but I see Wal-Mart facing a material existential crisis today. Being cheap was great for a long time, but it isn't working as well as it was. The retailer needs to switch gears in some way. McMillon himself pretty much admitted as much to CNBC when he asked rhetorically in an interview, "But the real issue is, are we doing the right things to position Wal-Mart for the future? Are we investing in the business to strengthen it?"

The company's current push is three-fold. First, improve relations with employees. Second, improve the store experience. Third, try to step up the socioeconomic ladder to find wealthier customers. None of that sounds too hard, until you think back to the store count, which is massive. And, of course, competitors are already doing some of these things. For example, Target has staked it's claim on wealthier customers and a more pleasant shopping experience. Costco (NASDAQ:COST) is known for treating employees really well. In other words, making these changes is no slam dunk.

And then there's the DNA shift that some of these things might require. Wal-Mart's bread and butter is wringing out every expense it can. But paying employees more and upgrading stores isn't exactly a clean fit with that. It could be harder than many people expect to get the company's lower ranks to change how they think. Which is where the real issue lies in my opinion: Can Wal-Mart rethink how it does business quickly enough to remain relevant and without imploding?

A good call, in my book
While the idea of shutting the small-store format does suggest that a potential growth engine is gone, I think Wal-Mart has bigger issues to deal with. And on that score, I think focusing on the core is the right call at the moment. It doesn't mean the giant retailer will succeed in, "...doing the right things to position Wal-Mart for the future," but I believe its the right place to start. There's just too much to lose if it takes its eyes off the larger business.

So as you look at the store closure headlines, take them with a grain of salt. First, retailers are constantly opening and closing stores-that's not too big a shock. Second, shuttering the small-format store concept is troubling in some ways, but the bigger picture right now is figuring out what Wal-Mart wants to be in the future. And the smaller stores were likely more of a distraction than management could afford. In the end, McMillon has his work cut out for him and I think he's making the right choice to put his team's energy into the core business.

Disclosure: I am/we are long TGT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.