Wal-Mart's plan to conquer the world

Failure in Germany, South Korea show the retail powerhouse is fallible. But as its home market shrinks, Wal-Mart has no choice but to find success overseas.

By Parija B. Kavilanz, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- Despite Wal-Mart's wobbly track record overseas, industry experts say it's becoming more crucial than ever for the world's largest retailer to get its international act together, and quickly.

Here's why.

* Wal-Mart and India-based Bharti Enterprises inked a joint venture this year to roll out a nationwide chain of supermarkets.

Wal-Mart (Charts) is running out of room to grow in the United States, its largest market, where it already operates about 4,000 stores. With each new store, it risks eroding sales at older stores.

Sure enough, sales growth at older stores open at least a year, known in the industry as same-store sales, have slowed considerably, growing 1 to 3 percent on average during the last three years from more than 5 percent previously. That puts Wal-Mart behind its archrival Target Corp. (Charts)

Wall Street rewards expansion but not through cannibalization. Therefore, Wal-Mart's stock has languished in a trading range for the past few years, unable to break it's all-time high of $69.

As slower sales growth and other negatives started to accrue - Wal-Mart became a lightning rod for critics about its labor practices, among other things - Wal-Mart executives realized that they need a shiny object to appease investors. To that end, Wal-Mart CEO Lee Scott late last year announced that the company would ramp up international growth while slowing domestic expansion.

"Think about it this way. The U.S. gives Wal-Mart some 260 million shoppers. The world gives Wal-Mart 6 billion shoppers. You do the math," said Edward Weller, analyst with Think Equity Partners.

Wal-Mart may rule the retail roost at home, but it hasn't met with the same measure of success abroad. In key markets like China, European competitors like Tesco, Carrefour and Metro have outperformed Wal-Mart and grabbed more market share.

Bentonville, Ark.-based Wal-Mart currently operates close to 3,000 stores in 13 countries outside of the United States. These markets accounted for about 23 percent of its total sales of $381 billion in 2006.

But last year it pulled out of Germany and South Korea after industry watchers said it realized that its low-price merchandise offerings and big-box, no-frills stores didn't really appeal to consumers in those markets.

"Many American companies have had a choppy history overseas because they assume they can replicate their U.S. business model in other countries," said Dana Telsey, a retail industry expert and founder of research firm Telsey Advisory Group.

Instead of rushing into a new market, she said, companies would be better off first learning the local tastes, scouting good locations and tailoring their merchandise accordingly.

At the same time, Telsey said Wal-Mart is learning from its mistakes. For instance, in China where it operates 73 stores, the discounter has started selling live seafood in its stores.

In February, Wal-Mart struck a $1 billion deal to acquire Chinese rival Trust Mart by 2010, challenging French chain Carrefour's dominance as the largest operator of the huge grocery and retail outlets known as "super-centers" in China.

In India, from where Wal-Mart already exports about $1.5 billion worth of merchandise to its stores, the company last year set up a liaison office to study the Indian market.

It subsequently entered into a joint venture with an Indian company to open hundreds of stores across the subcontinent.

Wal-Mart cannot enter the Indian market directly. This is because current regulations pertaining to foreign direct investment only allow "single-brand" retailers such as Nike or Gucci to own 51 percent of their business operations in India. But this still precludes market entry to global merchants like Wal-Mart that sell a variety of brands.

In line with what is permitted under existing guidelines, Wal-Mart said it will focus on the back-end supply chain management, giving Bharti access to its knowledge in information systems, logistics and supply chain management.

According to Wal-Mart spokeswoman Amy Wyatt, the stores in India "will be 100 percent owned, operated, managed and run by Bharti.

"In partnership with Bharti, and in full compliance with existing guidelines, we are setting up a wholesale cash-and-carry business in India," Wyatt wrote in an email to CNNMoney.com. "Our primary business philosophy for wholesale cash-and-carry is to sell merchandise at very low prices to our members, organized and unorganized retailers including the small neighborhood stores."

"As a Wal-Mart investor, China and India excite me," said Steven Baumgarten, an analyst with PNC Advisors, a Philadelphia-based investment firm that manages $54 billion in assets, including Wal-Mart shares.

"These are two very large markets with growing middle-class populations with disposable income. These are ideal Wal-Mart consumers."

Think Equity Partners' Weller also pointed to Wal-Mart's ongoing success in Mexico where Wal-Mart de Mexico has become the country's largest retailer.

And a recent note Goldman Sachs said Wal-Mart plans to open 10 Wal-Mart supercenters in Canada, adding to its base of 289 stores in the country.

As it gradually irons out its wrinkles overseas, Wal-Mart is reaping the financial benefits to both its top and bottom line.

For its recently completed fourth quarter, Wal-Mart's international sales soared 30 percent versus a 10.9 percent increase for its U.S. operations, which included its Wal-Mart discount stores and its Sam's Club Warehouse division.

Still, PNC's Baumgarten said, Wal-Mart has more challenges ahead. "In order to drive down expansion costs, it has to drive up efficiencies in those markets. It's not there yet," he said.

Both Baumgarten and Weller also shot down suggestions that instead of gambling on international growth, perhaps Wal-Mart is better off giving money back to investors or buying back shares in a bid to reignite its stock.

Earlier this month, Wal-Mart approved a 31 percent increase in its annual dividend to 88 cents share, yielding about 1.8 percent.

Said Baumgarten, "Wal-Mart has consistently paid out dividends to shareholders and bought back shares, but the stock still hasn't done much. So I don't buy that argument."

Meaning international growth for Wal-Mart is now more crucial than ever.

Clarification: An earlier version of the story did not clarify that under current Indian regulations, Wal-Mart cannot directly enter the Indian market. Therefore, Wal-Mart will provide back-end support while the new stores will be wholly-owned and operated by its Indian partner.

--Analysts quoted in the story do not personally own shares of Wal-Mart and their firms do not have an investment banking relationship with the company.

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