Wal-Mart (NYSE:$WMT) reported a 9% increase in profits to $3.6 billion for the quarter ending 31^st October in line with analysts’ estimates. However, a 1.5% increase same store comps versus the expected 1.8% translated into a 3.6% dip in stock on the day of the earnings release. Net quarterly sales increased by 3.4% to $113 billion which includes 3.6% increase in U.S. sales. According to the U.S. Department of Commerce, the U.S. retail sales in the corresponding quarter were up 4.6%.

Walmex, Wal-Mart’s Mexican arm also reported 8.9% increase in sales in Mexico for November on the back of a Black Friday styled event. On a comparable store basis, sales increased by 5.5% but the total number of transactions dropped by 2.6%.

Wal-Mart has been able to increase its sales in five consecutive quarters now but that has come on the back of lowering prices of food and electronics and trimming margins, but that is a strategy that eventually has to end.  Amazon (NASDAQ:AMZN) is struggling with the same problem: a U.S. and European middle class that is being hollowed out by zero-interest rate policy and profligate fiscal policy which is creating a stagflationary nightmare that will not abate until the banks are forced to confront the poor quality of their balance sheet.  An environment like this will retard investment spending while at the same time inexorably pushing up base commodity prices.

For Wal-Mart, it has grown so big that creating a new one reverses the retail expansion process where location, location, location is paramount to success. Wal-Mart’s well documented struggles with local governments coupled with the store’s enormous size has saddled the company with a shopping experience that requires many people to plan their day around a trip to the store.  The higher gas prices push the harder it will be to justify the trip to the outskirts of town to go to Wal-Mart just to fight the crowds.   This is a subtle effect but it’s one where Amazon and Amazon Prime ‘s free 2-day shipping is eating into rural goods delivery.

Wal-Mart’s fourth quarter guidance with per share profit of $1.53-$1.58 is 1 cent lower than analysts’ estimates if Wal-Mart manages to touch the high end of its forecast. This was particularly disappointing because

a)      It reflects that Wal-Mart’s customers would remain cautious with their spending despite the holiday season and their lack of a comprehensive online delivery system is trimming sales at the margin.

b)     Its rival Target (NYSE:$TGT), which caters to a more middle class consumer demographic, has upped its forecast and is aiming to beat the analysts’ estimates. Excluding extraordinary items, Target has already beaten the estimated EPS of $0.78 by delivering $0.90 per share.

 Within U.S., the smaller retail store chain such as Dollar General (NYSE:$DG) and Dollar Tree (NASDAQ:$DLTR) now pose a threat to Wal-Mart’s dominance as their small store size offers a more convenient shopping experience, especially in rural or semi-rural areas where people are most travel sensitive. In particular, Dollar Tree’s “multi-price” and less than a dollar deals are gaining popularity.

On the other hand, Wal-Mart’s international sales were hit by fewer customers as well as the strong dollar and have shown a quarterly growth of just 2.4%. In China, the number of customers fell by 7.6% and in Japan, overall sales dropped by 1.8%.

Wal-Mart, whose brand with the political left is already abysmal, is recovering from the allegations that it paid $24 million in bribes to Mexican officials while its internal investigations have expanded the scope of inquiry to its operations in Brazil, India and China as well, which will undermine its standing with the political right in the U.S.

Currently Wal-Mart is under fire in the Indian parliament after it was revealed that the company had spent $25 million in lobbying for entering into new markets, including India. Although the SEC filing has shown that the money was spent in the U.S but Indian opposition parties suspect that a part of that expenditure happened in India. Unlike the U.S, lobbying is illegal in India and is often considered tantamount to bribing. The Indian government is now set to start investigations into the claims. Furthermore, Wal-Mart is already being investigated by government officials over a claim that its $100 million investment in the joint venture with the local Bharti Enterprises, the owner of Easyday Stores, has violated foreign exchange rules. The alleged corruption adds misery to the Indian’s ruling party, Congress,who is under severe criticism from various political forces, including some of its own allies, over opening India’s retail sector to foreign firms. It will therefore be a distinct challenge for Wal-Mart to expand in India, particularly in the opposition ruled states.

Moreover, the Nov 24 garment factory fire in Bangladesh that killed 112 people has turned out to be one of Wal-Mart’s suppliers. Although, officially, Wal-Mart had terminated its supplies from the ill-fated factory some time ago but as it turns out, another one of Wal-Mart’s suppliers, International Intimates, had subcontracted its Wal-Mart orders to the factory.

Retail in general will continue to have a difficult time finding growth in the current stagflationary environment.  Those with smaller footprints (read: rental costs), and a store size and pricing structure that compensates for travel costs and creates a more convenient experience have a good chance of providing value to customers.  Wal-Mart has built an empire on catering to those who saw value in getting low prices while the costs of getting there were cheap.  The threshold may have been passed for that model, if not now, then in the near future.   Until Wal-Mart creates a better online delivery model the company will be a value trap at best.