Wal-Mart: 4 Reasons To Buy Now

Feb.26.13 | About: Wal-Mart Stores, (WMT)

The share price of Wal-Mart Stores (NYSE:WMT) has declined by 9.3% from its 52-week high of $77.60 achieved in October 2012. At $70.44, the stock offers a 2.7% dividend yield. There are 4 reasons supporting my view that a buying opportunity has emerged amid the price weakness.

1. From a relative valuation perspective, Wal-Mart shares are priced attractively based on the company's financial performance relative to its peers' (see chart below). Consensus estimates on average predict the company's revenue, EBITDA, and EPS to grow at 2-year CAGRs of 4.9%, 4.6%, and 8.2%, respectively. The estimates are notably below the averages of 6.1%, 6.6%, and 10.0%, respectively, for Costco Wholesale (NASDAQ:COST) and Target Corp. (NYSE:TGT).

Similarly, Wal-Mart's long-term EPS growth is forecasted to be 9.6%, underperforming the peer average at 12.4%. On the profit side, however, Wal-Mart demonstrates a solid performance as all of the firm's profitability margins and capital return metrics are above the par. The company carries a relatively in-line debt load as reflected by its on-average debt to capitalization and debt to EBITDA ratios. In terms of liquidity, Wal-Mart's free cash flow margin is below the peer average. Both the firm's current and quick ratios are below the par, suggesting a mediocre balance sheet performance.

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To summarize, Wal-Mart's relatively weaker growth potential and below-average liquidity condition would likely the primary drag on the stock valuation. However, given the company's solid margin and capital return performance as well as its substantially larger operations around the globe, I believe the stock's fair value should not trade largely below the peer-average level. Nevertheless, the current valuation at 13.2x forward (next 12 months) EPS is trading at a 26.2% discount to the peer-average P/E ratio at 17.9x, suggesting that Wal-Mart stock appears to be trading near the low end of its fair value range or even modestly undervalued on a relative basis. Further, the stock's PEG ratio at 1.38x is 4.8% below the peer-average rate at 1.45, again indicating an attractive price level (see chart above).

2. Wal-Mart's trailing P/E multiple of 14.0x is trading at a small discount to its 5-year historical average at 14.6x (see chart below). The current valuation seems to be favorable to investors given the following positive fundamental developments in the past 5 years:

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a) The company has been able to sustain a steady ROA and ROIC performance and gradually improve its ROE over the past 5 years (see chart below);

b) Wal-Mart has also been able to maintain stable profitability and free cash flow margins over the same period (see chart below);

c) The market's consensus revenue, EBITDA, and EPS growth estimates for the current and next fiscal years are fairly in line with the historical rates experienced in late 2010 and 2011 (see chart below).

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3. Moreover, Wal-Mart's forward P/E multiple of 13.2x is currently trading at a 7.5% discount to the same valuation multiple of the S&P 500 Index, which stands at 14.3x now (see chart below). The below-market valuation presents a great buying opportunity in my view provided that 1) the daily P/E multiple difference between Wal-Mart shares and the S&P 500 Index averaged at only 0.6% in the past 12 months; 2) Wal-Mart's long-term EPS growth rate of 9.6% is notably above the average estimate of 8.2% for the S&P 500 companies; 3) the company has been able to generate a healthy level of ROE and ROIC and offers a significant international exposure to investors; and 4) the stock's 2.7% dividend yield is above the average yield of 2.2% for the S&P 500 Index.

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4. In a research note dated February 15, 2013, Daniel Binder at Jefferies elaborated on his bullish opinion which I tend to agree on (sourced from Thomson One, Equity Research):

"We believe the turnaround story is still playing out. While there are many initiatives to drive traffic and volume across this business, the core objective is still about the productivity loop, which means reducing SG&A, investing in price and driving top line…We have now seen five quarters of progress on comp store sales. EBIT margin has shown modest expansion in the last three quarters as SG&A leverage outpaces gross margin declines…Wal-Mart's valuation is still attractive relative to its comp group, whether measured against a broad group of retailers or S&P 500 Consumer Staples companies. We see potential for further multiple expansion as: 1) Wal-Mart share stabilizes and potentially shifts to share increases; 2) the company continues to execute well on the core fundamentals of the "productivity loop;" 3) unit growth accelerates for high-return smaller-format stores resulting in grocery market share gains; and 4) slowed growth in international operations and turnaround efforts yield an improvement in sales and ROI."

Bottom line, investors should take the current price weakness as an opportunity to acquire more shares given the company's healthy fundamentals and healthy growth prospects.

All charts are created by the author and all financial data used in the article and the charts is sourced from Capital IQ.

Disclosure: I am long WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.