Wal-Mart [WMT] has been a relative market winner over the past year. Why do you think it’s still attractive?
Ralph Shive: I had never owned Wal-Mart, mainly because it was a growth stock but also because I hated how it had destroyed mom-and-pop stores in downtown America. But I started getting interested in it a couple years ago when it seemed like every week there was a story in The Wall Street Journal about this or that group criticizing it for seemingly endless transgressions. In addition to the stock being cheap, I also saw Wal-Mart as a company that would do well if I was right that we were late in the business cycle and the consumer was due for a nasty hangover.
Mike Shinnick: Now that the recession is here, Wal-Mart has done well because its value proposition increasingly appeals to both its core middle- to lower-income demographic, but also to a broader range of customers. The company also hasn’t gotten the credit it deserves for expanding into new categories like grocery – it’s now the largest grocer in the U.S., ahead of Kroger – pharmacy services and electronics. They have a great opportunity to capture additional share of wallet as people seek out value more broadly and Wal-Mart is able to deliver it all in one place. The change in tagline last year – from “Everyday Low Prices” to “Save Money. Live Better.” – pretty well captures what they’re trying to do and we think it will continue to resonate with consumers. The period of heightened consumer focus on value has not at all run its course.
The international side of the story also strikes us as underappreciated. They’ve had some high-profile setbacks in places like Germany and South Korea, but international revenues now make up 25% of the total and are growing very nicely in several parts of the world, particularly Latin America. Wal-Mart’s value proposition should continue to translate very well outside the U.S.
What upside do you see for the shares, now trading at $51.75?
MS: The P/E multiple is around 15x, which is higher than the market’s, but that’s to be expected given the highly regular nature of the company’s earnings. We could imagine earnings growing as much as 10% annually over the next few years. They also recently announced a dividend increase (the current yield is 2.1%) and that they’re allocating more capital to share buybacks. In this type of environment, that’s a huge demonstration of strength.
Could the P/E increase as well? Sure, but even if it doesn’t, earnings growth, share buybacks and dividends should produce a low- to mid-teens annual return on the stock. We’ll take that in this environment, especially when we believe the downside is very low.
RS: This isn’t the cheapest stock we own, but given the risk that we’re looking at years of sluggish consumer spending, it’s the type of defensive idea we’re happy to have in the portfolio. If conspicuous consumption is “out” on a secular basis and gaudy becomes even more uncool, Wal-Mart is a good way to play that over time.
MS: One additional item to keep in mind is exchange rates. As international revenues have become more prominent, the company feels it when the dollar is strong, as it has been. Longer-term, however, we’d argue that the increasing non-dollar exposure will work in their favor as various pressures on the dollar take hold.
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