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Why are Wal-Mart's profits falling?

This morning Wal-Mart announced a 7-percent drop in profit in the first quarter of 2015, falling short of Wall Street's predictions and raising questions about the health of consumer spending.

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    Two traders work at the post that handles Wal-Mart, on the floor of the New York Stock Exchange earlier today.
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Wal-Mart Stores Inc. reported sluggish sales and a 7 percent drop in first-quarter profit as worker pay raises, spending on e-commerce and currency fluctuations put pressure on the bottom line at the world's largest retailer.

The company also reported a 1.1 percent increase for a key sales measure at its U.S. Wal-Mart stores, its third consecutive quarter of increases. However, that growth came below analysts' expectations.

Wal-Mart's profit and total sales missed Wall Street estimates. The weakness adds to questions about the health of consumer spending. The latest government retail sales figures showed spending was flat in April, and Macy's, Kohl's and J.C. Penney announced disappointing results despite low gas prices and improvements in the job market.

The retail industry also is battling temporary issues, such as the labor dispute at West Coast ports that delayed shipments of merchandise.

Wal-Mart itself is a barometer of consumer spending. Its challenges reflect the struggles of its low-income shoppers, who are being squeezed by stagnant wages and higher living costs. Wal-Mart pointed out that its customers were either pocketing tax refunds and their savings from lower gas prices, or using them to pay pay down debt or bills like utilities.

Wal-Mart also is facing fierce competition from the likes of online king Amazon.com, dollar stores and grocers. It's also dealing with a shift among shoppers seeking the convenience of small stores or buying on their mobile devices and PCs.

In response, Wal-Mart is rapidly opening smaller stores. It is also increasing its spending for its online operations to between $1.2 billion and $1.5 billion this year, up from $1 billion last year. It announced last week it was testing an unlimited free-shipping service for $50 a year, undercutting Amazon's popular Amazon Prime, whose annual dues are $99.

In Wal-Mart's U.S. division, the company is trying to improve it selection and customer service, while making sure it has the lowest prices. Wal-Mart is also aiming to improve the freshness of its produce.

The company expects to see improved results by the holiday season, according to Greg Foran, who had been president and CEO of Wal-Mart Asia and took over Wal-Mart's U.S. business last summer.

As part of the strategy, the company raised the minimum wages for its hourly workers to $9 per hour in April. By February 2016, all hourly workers will make at least $10 per hour.

That comes at a cost. It's part of a $1 billion investment in its workforce that also includes improved training.

Wal-Mart is hoping that by investing in its people, Wal-Mart will improve customer service, resulting in higher sales.

"We're not interested in reaching our goals, but reaching them in a way which is sustainable for the long term," Foran said. "This requires a steady execution, a pace that is fast but calculated, and one that allows us to get it right."

But such investments are squeezing profits in the short term.

Wal-Mart said that net income was $3.34 billion, or $1.03 per share, for the three months that ended April 30. That compares with $3.59 billion, or $1.11 per share, a year earlier.

Net revenue was down slightly to $114.0 billion, from $114.2 billion in the year-ago quarter.

Analysts were expecting $1.04 per share and revenue of $116.27 billion, according to Zacks Investment Research.

By division, the U.S. Wal-Mart division, which accounts for 60 percent of total sales, had a 3.5 percent increase in sales to $70.2 billion. Its Sam's Club division had a 3 percent decline in revenue to $13.5 billion. And its international division saw a 6.6 percent decline in sales to $30.3 billion. The company is focusing on improving its business in Brazil, China and Mexico.

Wal-Mart said that its smaller Neighborhood Markets, which are a quarter of the size of a typical Wal-Mart supercenter and focus on groceries, enjoyed a 7.9 percent increase in sales at stores open a least a year.

Wal-Mart shares have declined roughly 7 percent since the beginning of the year, while the Standard & Poor's 500 index has climbed slightly more than 3 percent. The stock has risen almost 4 percent in the last 12 months.

Shares fell $1.87, or 2.3 percent to $78.05 in premarket trading.

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