News hit recently about an allegation that Wal-Mart Stores, Inc. (NYSE:WMT) allegedly invested illegally in India. While such issues have not prevented the retailer's stock from gaining so far this year, the retailer's managers do use short-term thinking in their approach to boosting profit.
The New York Times reported last spring that Wal-Mart's Mexican unit paid bribes to obtain permits in its rush to build stores, as we had discussed in an article at the time. More recently M.P. Achuthan, a Kerala member of the upper house of parliament for the Communist Party of India, reportedly wrote to the country's prime minister Manmohan Singh that Wal-Mart had "clandestinely and illegally invested" there, the Financial Times reported on October 18. India's government is now considering whether to act on the complaint, the Wall Street Journal reported. Reuters said that officials had not yet ordered a probe. Wal-Mart reportedly denied wrongdoing and said it had acted in compliance with all Indian laws.
To be sure, negative headlines about Wal-Mart are nothing new - the company's shares have risen around 28% in the year to date and were trading at around $76.50 apiece early Friday. Indeed, Wal-Mart's CEO Michael T. Duke and his team have done much to impress the market. With their gargantuan operations around the world, they've generated $419 billion of sales in 2011 alone. The company has increased its earnings per share in every year since at least 1989, overcoming headwinds ranging from the financial crisis to the bursting of the dot.com bubble.
But some of this fantastic performance is fueled by borrowed money. Wal-Mart had $54.6 billion in debt as of July 31, or nearly 78% of its total equity versus the industry median of 25%. Of course debt is cheap these days and Wal-Mart is huge so they can afford this move, but they are not always using their money to grow the business' operations. Wal-Mart's managers say in their proxy statement that they "returned an additional $6.3 billion to shareholders in the form of share repurchases in fiscal 2012." While that sounds good for investors, it only helps to boost stock prices momentarily, and improvements in earnings per share from buybacks are not as meaningful as those from improved business.
Wal-Mart has taken other steps that prioritize the short-term. For example, the trailing-twelve month average of its selling, general and administrative expenses amounted to $87.3 billion as of July 31, or 20% of operating expenses versus the industry median of 28%. Managers who make their teams more efficient by facilitating productivity differ from those who obtain the same end by lowballing their staff, as the latter approach can backfire later. In one recent indication of a divided team at Wal-Mart, a tiny fraction of its employees, joined by labor unions and community groups, have begun protests in recent weeks for better conditions and wages, the New York Times reported on October 9. Clearly, not everyone at this earnings powerhouse is motivating the others to try and sell more during the holiday season. Even assuming that a resentful staff can pull off the same performance as a grateful one, Wal-Mart does itself no favors by holding down wages. As the standard of living declines in the global economy, everybody loses customers and investors.
In part due to abovementioned concerns such as recent litigation, Wal-Mart has an Accounting and Governance Risk (AGR®) score of 5, indicating higher accounting and governance risk than 95% of companies. The company is also rated "F" on its environmental, social and governance (ESG) risk.
These low ratings don't mean the retailer has necessarily done anything wrong, as India's M.P. Achuthan recently alleged. But they do suggest that in the long run, Wal-Mart profits don't come as cheap as they might seem.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a financial reporter at GMI. The reporter has no business relationship with any company whose stock is mentioned in this article. Nobody paid GMI to write this article on his or her behalf.