Why Investors Should Think Twice Before Betting on Walmart

Source: Thinkstock

Source: Thinkstock

Walmart Stores Inc. (NYSE:WMT), a company struggling to change course as the age of supercenters limps to an end, may be encouraging unlawful inventory accounting as a means of boosting the company’s supposed share price. Or at least, that’s what a recent report from The Nationseems to suggest.

The story goes something like this: in 2012, Erica Davidson became store manager of a struggling Greensboro, North Carolina Walmart store. Davidson was tasked with reducing what’s referred to as the store’s “shrinkage,” a term that is loosely defined as the value of stolen or lost goods. Davidson, who was hoping to prove herself, succeeded in reducing shrinkage at the Greensboro location. In fact, she reported such success that senior-level management executives sent her to conference meetings to train other Walmart store managers in her practices.

The problem? The practices Davidson’s superiors preferred weren’t always lawful. The managerment, she says, encouraged her to utilize techniques which made the store’s shrinkage loss appear better on paper than it actually was. She carried out these techniques, and was repeatedly praised for her efforts. “Those things were just like money in the bank to them,” Davidson told the Nation in an interview. “It was like, ‘oh, great job.’ There was never any accountability or any investigation that they went into why — not just in my store, but in any store throughout the region.”

Davidson added that often the inventory numbers should have raised “red flags,” but instead her superiors continued to offer up praise and encouragement. Davidson says that a former senior vice president of the company even wrote her handwritten notes commending her successful results.

All of that stopped when the region’s operations were examined by the company’s fraud investigators in 2013. At the end of August, Davidson told The Nation, her store’s inventory showed a huge reduction in shrinkage loss, down to just $350,000 from more than $2.1 million the previous year; Davidson received no more praise. The higher-ups remained silent. “There was none of that ‘rah-rah, congratulations’ stuff that I got the previous years,” Davidson said.

Davidson was then fired after nineteen years with the company, according to The Nation. Her exit interview form cites that she was fired for “Gross Misconduct – Integrity Issue.” For Davidson’s part, she claims that her superiors encouraged managers in her region to falsify data and utilize unlawful techniques. She added that she is just one among a number of different managers on the Eastern Seaboard who have been fired for similar allegations, in an attempt by senior-level management to deflect accusations of inventory fraud away from themselves.

Brook Buchanan, a spokesperson for Walmart, admitted for the first time last week that the company is conducting a “thorough review” of its “store-level processes.” The company also issued a statement to The Nation in which Buchanan said: “Walmart takes allegations of improper conduct seriously and we have strong programs in place to prevent, detect, and remediate issues that may arise.” The statement continues: “We have initiated a thorough review of our store level processes to help ensure we have the right policies and controls in place.”

Adding to suspicions that fraudulent activity might extend beyond the store-management level, this year, as the investigations continued, several of Davidson’s former superiors left the company. Including Ronny Hayes, Walmart’s head of operations in North Carolina, who retired, and Henry Jordan, who was responsible for leading the company’s gargantuan Eastern Seaboard division, who also supposedly retired. The Nation also notes that the company’s regional asset-protection manager, who was intimately linked with inventory tracking in the state, was fired in May, though the company has not released its reasoning for his dismissal.

But what does inventory accounting fraud have to do with Walmart’s share price? Well, to a certain extent, that depends on how deep and how widespread the company’s fraudulent accounting practices really are, but there is evidence to suggest that the company is encouraging similar behavior in other regions, The Nation reports.

Inventory fraud is an issue particularly in the retail industry. Retail businesses rely on narrow margins, so shrinkage, as a result of shoplifting or other losses can have a huge impact on a store’s profitability. It’s such a big issue that Sam Walton, Walmart’s founder, has commented on it several times, stating that: “Shrinkage, or unaccounted-for inventory loss — theft, in other words — is one of the biggest enemies of profitability in the retail business.”

Other store managers interviewed noted that there could be other reasons behind Walmart’s pervasive inventory fraud besides the ongoing struggle for profitability; The Nation notes that one manager cited understaffing in particular. Overstretched employees, the manager said, are often forced to fabricate numbers when they can’t possibly perform a proper count of physical merchandise on their own.

Regardless of the reasoning behind Walmart’s inventory fraud issues, if the phenomenon is as widespread as some managers claim it is, the company’s stock price could easily be artificially inflated by fabricated numbers. Further, it would be incredibly difficult to know just how inflated. If stores aren’t profitable, or not nearly as profitable as they report being, the entire company’s share price could potentially be affected, and that, of course, affects investors in a big way.

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