One Retail Behemoth in Deep Legal Trouble

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Wal-Mart (NYSE: WMT) is embroiled in a multi-national bribery investigation. This will cost hundreds of millions of dollars to investigate internally and could cost more in fines and judgments. The investigation could slow international growth for Wal-Mart and further damage its reputation as details surface through the mainstream media.

Investors should not buy Wal-Mart shares until shares trade at a significant discount relative to its peers, because its competitors do not have challenges of this magnitude.

Bribery Scandal Now Global

The investigation into Wal-Mart’s violations of the U.S. anti-bribery law is not confined to Mexico alone, but has now expanded to China, India, and Brazil. These extremely important markets for Wal-Mart are among the company’s biggest.

International markets are important to Wal-Mart's future since the company’s international segment has been growing rapidly. Of Wal-Mart’s 10,524 stores, more than half are outside the United States. It has 2,230 stores in Mexico, 384 in China, and 534 in Brazil. Though the company does not expect international growth to be hindered due to the investigation, this is probably overly hopeful. If bribery was a catalyst for growth, taking it away would slow growth.

There was a report in The New York Times that about seven years ago, Wal-Mart had found evidence of payment of bribes to its subsidiary in Mexico for the purpose of building new stores. This is a violation of the Corrupt Practices Act. In October 2005, a former lawyer at the Mexico subsidiary of Wal-Mart told investigators that the leadership at Wal-Mart de Mexico had engaged in a vast bribery conspiracy in order to expand rapidly. He mentioned that bribes were paid for obtaining construction permits and other licenses. The accusations were really powerful, as the lawyer was in charge for obtaining the permits for new stores at Wal-Mart de Mexico. This led to the escalation of the investigation.

Internal Response

Reports indicate that Wal-Mart has found evidence of potential violations pertaining to the Foreign Corrupt Practices Act. This announcement indicates that Wal-Mart now recognizes that there may be corruption in its international operations. It has also alarmed the internal investigators of the company. A routine audit has turned into a full blown investigation that now involves several lawyers and three former federal prosecutors.

The accounting firm, KPMG, as well as the law firm, Greenberg Traurig, that have been hired to conduct the audit have conducted interviews as well as spot checks of the record systems in order to determine if the subsidiaries were carrying out the compliance procedures that are required. The investigation seems to reveal that the compliance procedures were not being properly followed by the subsidiaries. The cause of the non-compliance has been attributed to lack of training.

A source with full knowledge of the investigation indicated that this should not be taken to mean that Wal-Mart has concluded that bribes have been paid in China, Brazil, and India. The only indication is that the company has found enough evidence to raise a certain level of concern that is beyond an initial inquiry about its business practices in these countries. This would imply that the company has some serious concerns.

The company just issued a statement that confirms the new disclosures, but Wal-Mart has decided not to comment on the new allegations until investigations are over. There is also an investigation into the compliance of the anti-bribery law by the Justice Department, as well as the Securities and Exchange Commission, with the cooperation of the company.  

Internal investigations are expensive. The cost of the current investigation to the company in nine months has amounted to $99 million. The cost of the compliance program to Wal-Mart since spring 2011 has been around $35 million. There have been around 300 lawyers and accountants from outside the company that are working on the compliance program. The consequences of this investigation would have the consequences of slower expansion in the international markets as well as identification of new problems. There would be more scrutiny into the real estate projects that are being considered, and this could result in the slowing down of the process as there would be more controls that need to be taken into consideration.

There are also changes that have taken effect as a result of the investigations. Prior to the investigations, segment-level general counsels used to report to the CEO. However, if the CEO had engaged in corruption, this resulted in a conflict of interest. Now, the legal departments of each segment reports to the general counsel of Wal-Mart. It has also altered the protocol regarding the investigations. Foreign subsidiaries have been told to inform the global ethics office in Bentonville before beginning any inquiry into the wrongdoing. This will help Wal-Mart become more transparent.  The company will now alert the Justice Department as well as the SEC in detail regarding the investigations and the results thereof with the intention of receiving lesser punishment from them.  

Comparing Valuations

Investors shouldn’t buy Wal-Mart shares unless they trade at price multiples that are substantially lower than those of its peer firms. At present, this is not the case:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> </tr> <tr> <td> <p>BIG</p> </td> <td> <p>Big Lots</p> </td> <td> <p>10.7</p> </td> <td> <p>0.34</p> </td> <td> <p>2.57</p> </td> <td> <p>11.77</p> </td> </tr> <tr> <td> <p>TGT</p> </td> <td> <p>Target</p> </td> <td> <p>13.76</p> </td> <td> <p>0.56</p> </td> <td> <p>2.48</p> </td> <td> <p>20.04</p> </td> </tr> <tr> <td> <p>WMT</p> </td> <td> <p>Wal-Mart Stores</p> </td> <td> <p>14.74</p> </td> <td> <p>0.52</p> </td> <td> <p>3.26</p> </td> <td> <p>26.53</p> </td> </tr> <tr> <td> <p>DLTR</p> </td> <td> <p>Dollar Tree</p> </td> <td> <p>16.29</p> </td> <td> <p>1.3</p> </td> <td> <p>5.99</p> </td> <td> <p>23.55</p> </td> </tr> <tr> <td> <p>DG</p> </td> <td> <p>Dollar General</p> </td> <td> <p>17.85</p> </td> <td> <p>0.99</p> </td> <td> <p>3.23</p> </td> <td> <p>36.61</p> </td> </tr> <tr> <td> <p>FDO</p> </td> <td> <p>Family Dollar Stores</p> </td> <td> <p>19.5</p> </td> <td> <p>0.86</p> </td> <td> <p>6.21</p> </td> <td> <p>0</p> </td> </tr> </tbody> </table>

Many of these discount stores are expensive, priced for growth generated by consumers flocking to cheap deals. Sadly, this growth expectation is already “baked in” the stock prices of the dollar stores. Specifically, a multi-year boom in sales growth at Family Dollar (NYSE: FDO) after posting years of impressive sales growth of 20 plus percent annually since 2007, is exhausted. The comparables are getting much tougher to exceed year-over-year. The same situation holds for Dollar Tree (NASDAQ: DLTR) as well.

In both cases, Wal-Mart and Target (NYSE: TGT) are making inroads into the price points where Dollar Tree and Family Dollar make a market for ultra low-end consumers. The big box retailers have learned how to recapture the ultra-low dollar purchases that consumers make at dollar stores. Moreover, the average receipt at big box retailers like Wal-Mart and Target remains much higher than at dollar stores because of upsell opportunities for big-ticket items not carried at dollar stores.

Investors seeking defensive stocks in this industry should be choosy and only consider buying stocks that are trading at a discount to the broader stock market.  Fortunately, Target and Big Lots trade at lower price multiples than the S&P 500. They are cheaper, unlike Wal-Mart. 


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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