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Why Is Walmart Abandoning the World’s Third Largest Economy?

Leo Sun, The Motley Fool

Walmart (NYSE: WMT) could exit the Japanese market by selling its Seiyu stores according to a recent Nikkei report. Walmart initially partnered with Seiyu, one of the country's major grocery and merchandise chains, back in 2002. It gradually increased its stake in Seiyu until the latter became a wholly-owned subsidiary in 2008.

Seiyu generated about 700 billion yen ($6.2 billion) in sales last year, but it's struggling to stay profitable due to intense competition from convenience stores, drugstores, and online retailers. Seiyu is also burdened by the rising capital requirements for renovating its aging stores.

A Seiyu store in Japan.

Image source: Walmart.

Analysts estimate that Seiyu could fetch 300 billion to 500 billion yen ($2.7 billion to $4.4 billion) in a sale, and potential buyers include local retailers and trading houses. But it could be a tough deal, since the buyer would need to shoulder the costs of reorganizing Seiyu's distribution centers and 336 locations, along with additional labor expenses.

Walmart's planned exit isn't surprising, since French retailer Carrefour and British retailer Tesco both left the market for similar reasons in 2005 and 2011, respectively. But it still marks a disappointing end for Walmart's ambitions in the world's third largest economy.

Why Walmart is bailing out

Japan became a slow growth market after its economic bubble burst in the early 1990s. Retail sales generally rise 1% to 2% annually each month, but the fragmentation of the market and tough competition make it challenging for retailers to generate profits.

Amazon (NASDAQ: AMZN) is also the leading e-commerce player in Japan. Amazon Japan's revenue grew 10% annually to $11.9 billion last year, accounting for 7% of its top line. That growth, which is supported by its Prime ecosystem and Echo devices, makes it even tougher for brick-and-mortar retailers to thrive.

Earlier this year, Seiyu partnered with Amazon's biggest rival, Rakuten, to launch an online grocery delivery service. Other companies struck similar delivery deals to challenge Amazon. Seven and I Holdings, which owns 7-11 and Ito Yokado general merchandise stores, partnered with mail-order office supply retailer Askul to deliver fresh foods. Telco Softbank, Yahoo Japan, and retailer Aeon also teamed up to create a new online e-commerce platform.

Countering all that competition will require Walmart to boost its spending, and that's an option it doesn't have. Walmart's Japanese business posted a net loss of 200 million yen ($1.8 million) in fiscal 2016 and barely broke even in 2017. That would explain why Walmart is leaning toward a sale of the business.

Focusing on China, India, and the U.S.

Selling Seiyu would boost Walmart's cash flow and enable it to focus on three key areas where it's been significantly increasing its investments: China, India, and the U.S.

Walmart owns 443 stores in China, a market which generates much stronger sales growth than Japan. Retail sales in China could rise 10% to 11% annually over the next two years according to FocusEconomics. Walmart is also a major shareholder in JD.com, the second largest e-commerce player in China. Higher investments in China could enable it to counter the growth of Alibaba, which owns the country's top e-commerce platform and has an expanding footprint in brick-and-mortar retail.

A Best Price store in India.

Image source: Walmart.

In India, Walmart only owns 20 stores under the Best Price banner. However, it recently took a majority stake in Flipkart, the country's top e-commerce platform, in a $16 billion deal. Walmart believes online shopping in India will grow 36% annually over the next five years, and Morgan Stanley expects over 50% of India's internet users to buy goods online by 2026 -- compared to just 14% in 2016.

In the U.S., Walmart acquired e-commerce site Jet.com in a $3 billion deal in 2016. It also invested heavily in the expansion of its e-commerce ecosystem with new delivery and pickup services to counter Amazon. Those investments, along with rising wages, require lots of fresh capital.

Walmart expects all these efforts, especially the Flipkart deal, to throttle its earnings growth over the next two years. Jettisoning its Japanese business could soften those blows.

It would be wise for Walmart to sell Seiyu, but it could struggle to find a buyer. Regardless of what happens, investors should understand that Walmart is focused on exiting weaker businesses, investing in higher-growth markets like China and India, and widening its moat against Amazon in its home market. These moves could make it more resilient over the long term.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon, JD.com, and SOFTBANK CP UNSP ADR. The Motley Fool owns shares of and recommends Amazon and JD.com. The Motley Fool has a disclosure policy.