In this article, I'm going to show how much Wal-Mart (WMT) stock is worth according to a discounted cash flow analysis using reasonable assumptions.
I will be posting a link to the valuation model (in an excel file) that I used along with describing the assumptions that went into it. This file will contain all the cash flow data from Wal-Mart going back to 1993. (The last year in which there is EDGAR data for WMT in the SEC website.)
In order to make this a conservative approach, I will be using safe assumptions in order to make sure a buy or sell rating in the stock is not based on predictions that are difficult to make. A DCF analysis can be made through all kinds of ways; I'm using my personal method that I believe is more realistic than other ones I have read about. If you have any disagreements with this method/assumptions, let me know.
The assumptions that went into my DCF model were:
-I defined Free Cash Flow (FCF) as Operating Cash flow minus Capex minus Other plus Asset Sales/leaseback (when there are any). Why add back asset sales? They represent a recovery from old Capex and M&A so in a way, it's old operating cash flow coming back home. Notice that in the file there is a M&A line with all the data from 1993 to today as well; the M&A values are not being used for free cash flow calculations, I'm simply keeping it there so I can see what kinds of risks shareholders are taking. In this front, WMT is safe because M&A as a percentage of operating cash flow has been in the low single digits for decades.
-I assume WMT will have another 10 years of above FCF growth of 7.5% then normalize to 3%. The average rate of growth in FCF for WMT over the last 10 years is 43% (24% since 92); the compounded rate of growth over the last 10 years is 10% (15% since 92). I believe 7.5% is a conservative number.
-WMT's required return is 8% (the rate at which the future cash flows are discounted back to the present). I'm assigning a higher discount rate than CAPM would suggest due the risks associated with the end of the Great Moderation. Economic growth is now weaker in most advanced economies and the debt overhangs make it likely these economies will struggle more than in the past.
-Long-term normalized growth is 3%. This is even lower of what World Nominal GDP is likely to be going forward. Earnings growth tends to be quite similar to Nominal GDP growth over long periods of time. I also believe WMT has a very good chance of achieving these types of long-term growth rates because it has a big moat in the retail market. The company typically puts all kinds of small stores out of business when it opens a store in a new location, it has a very good cost control system, and the company benefits from economies of scale in a way that is hard to compete with. The bigger it gets the better prices it can get buying in bulk and thus pass more savings to the consumer.
Plugging all these in the excel file, projecting the free cash flows and discounting it back to the present at the chosen discount rate yields a fair value price of $113.45. With the stock currently trading at $77 or so, I would call the stock undervalued.
Does that mean the stock is worth exactly $113? I wouldn't say that, because a DCF analysis will tell you how much a business is worth assuming you are the owner and have access to those cash flows. As a shareholder, you have access to a small part of the cash flow through dividends and indirectly through buybacks but the rest you don't control. Still there is some correlation between FCF and stock prices over time because when the two diverge too much over time, usually managements try to prop up the stock through dividend hikes and buybacks (business is a cash cow but market is not valuing it properly, e.g., AAPL) or equity compensation, equity offerings, insider sales, dumb M&A (when the market value is too high relative to cash flows).
According to a safe set of assumptions and a DCF analysis, WMT stock is undervalued. The company seems safe as it holds a virtual monopoly in the value oriented retail market and it also has a low level of M&A cash outflow. This removes further risks that shareholder value will be destroyed. I believe the stock is currently undervalued and I'm looking to buy it when the S&P 500 drops by 5-15% in a short period of time. I encourage readers to change the variables in the file to something the fits their own personal view of the company.
Additional disclosure: I can't guarantee the accuracy of every data point included in this article, I encourage the reader to double check the data and the formulas in the file. This article does not constitute investment advice.