A few weeks ago I published an article (here) questioning the value of a handful of dividend growth stocks that have long been stalwarts of many DGI investors' portfolios.
I suggested that Cisco (NASDAQ:CSCO) was doing fine and merited its place there. But four others - Microsoft (NASDAQ:MSFT), Merck (NYSE:MRK), Coca-Cola (NYSE:KO) and Wal-Mart (NYSE:WMT) - deserved some hard consideration on whether or not one might want to continue to hold them. Not surprisingly I suppose, I took a fair bit of flack on KO and WMT. MSFT drew some criticism, and no one seemed to care about MRK.
I still feel KO investors really should take a hard, objective look at that holding, but I'm not that committed to the concept (although I do not hold the stock and will not any time soon). I became persuaded to temper my anxiety on MSFT and decided to hold my position. But I'm watching it carefully with a ready trigger-finger.
But Wal-Mart? To me this is clear as could be: Time to put that one behind you. And I did. I no longer have a pony in this race, so I would normally just forget about it. But I've been thinking about how much the case of WMT illustrates the blindness of love. Now, love-induced blindness could be an asset in your relationships with the love of your life (it surely is for me, thank you, dear), but it has no place in your relationships with your portfolio.
Today I want to concentrate on the retail giant and lay out the DGI case for dumping it now. I do this knowing full well that the typical DGI reader of WMT articles at Seeking Alpha is a card-carrying member of the WMT Investors' Society Holding Forever and United Long Thinkers - that's WISHFUL Thinkers (sorry, unforgivable, I know, but couldn't resist).
Since my last look, things have not gone well for Big W. More on recent events down the page a bit but let's start with the big picture. For openers, WMT is lagging the S&P by something like 900 bps YTD. Ok. I know, you're not in it for the short-term gain, but seriously, 900 bps? If you're not already asking yourself if you can be doing better, let me point out that 900bps is 3½ years' dividends. Couldn't you have found a place for 3½ years dividends?
Speaking of dividends, WMT investors are clearly in it for those dividends. They will recite the DGI mantra: "It has raised dividends for the last 39 years" as though nothing more needs be said. But, let's take a hard look at those dividend raises:Click to enlarge
Over the past 2½ years, dividend yield is up a very impressive 28.8%. Hard to argue with that. But, what about earnings yield? Well, it's down an equally impressive (albeit negatively so) -28.35%. One can, of course, point to payout, which is a solid 33%, but anyone who really thinks that rate of dividend increase is sustainable in the face of plummeting earnings yield should leave the room now, you're clearly not the audience I'm trying to reach. The next dividend increase should be coming soon. It will be telling to see how much it's up this year (oh, I'm sure it will be up again), but I'm guessing we'll see something well short of last year's 18%.
Those who are still with me will notice FCF is down an unhealthy -55.8% over the past 6 quarters. Now tell me that dividend growth is sustainable.
I submit that a 2.5% yield (nice enough, but nothing really spectacular) and highly questionable sustainability of attractive dividend growth rate is not the stuff of a solid DGI holding. There are many, much more appealing dividend opportunities.
On Wednesday, reports circulated from Bloomberg that WMT's inventory backlog is forcing it to cut orders. Does Bloomberg have an edgy source on this? Perhaps so: it was based on an ordering manager's email to a supplier, and it was denied by management. But troubling nonetheless. And the market was troubled indeed (see 2 week chart below) particularly following the disappointing earnings and sales outlook in its Q2 earnings report.
In that article, Bloomberg writer, Poonam Goyal, tells us, "Wal-Mart's inventory is well above their goal.... Most of the inventory increase was because of missed sales." BusinessWeek asserts "inventory growth at Wal-Mart outstripped sales gains in the second quarter at a faster rate than at the retailer's biggest rivals" for US stores. This is arguably worse news than the order reductions.
Consider that if we are to believe this report, the order reductions are coming as we are moving into retail's biggest quarter: Holiday Season. WMT is essentially telling us to look forward to dismal holiday sales. If so, the Q4 earnings report will not be a pretty thing. It will be another part of a dismaying pattern of bad news piling on bad news.
Competitors on the Rise
Competition is gaining on the lumbering giant. If the US income divide continues to grow (and I see no indication that it is not going to), we're going to reach a point where even Wal-Mart is beyond some budgets. The dollar store cohort-Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR) will take a bigger share of Wal-Mart's market as they did during the last recession.
Then there are retailers, such as Target (NYSE:TGT), that are providing a sufficiently more appealing shopping experience that some find justifies the marginally heftier hit at the check-out counter.
In a recent comment thread, I argued that dominant retail giants come and go (witness K-Mart, Sears, Montgomery Ward and a host of others).
Seriously, there was a time … when K-Mart ruled retail. It was the proto-Wal-Mart.... Wal-Mart kicked its butt. Just goes to show how fickle retail can be…. J C Penny? Sears? RadioShack? One-time giants all. Go back a little further: Montgomery Ward… it was the absolute king of retail…
There's a fairly low signal to noise ratio out there, but the signal is saying WMT is a giant in the early stages of decline.
I'm not saying Wal-Mart is going to disappear. But I am saying that its best days may well be behind it. The attractive growth and the attractive returns that were driven by that growth may be gone forever. I know WMT has been a great friend to dividend-income investors, but let's not forget, past performance may not predict future returns.
For those who consider themselves long-term investors especially, I submit that WMT's long-term is highly suspect, and this might be a fortuitous time to look at other places to grow that money for the long term.
For those who consider themselves dividend-growth income investors, I submit that you will grow income faster with something other than WMT. Let's accept that WMT will continue to pay +/- 2.5% dividends forever forward. But let's consider as well what that means if WMT continues to lag the market by hundreds of basis points. It means the WMT dividend-growth income-investor is losing money to the market. Losing money to a replacement paying that same 2.5% but is not lagging, or even to one lagging by a lesser rate. Swapping out of WMT into some other, more reasonably growing dividend-producer that gives you the same percentage yield means more income. The sooner you do it, the sooner your income is compounding at a higher rate.
When I discuss price growth to DGIs the responses go something like: "Unrealized gains. Don't care about price. Not gonna' sell. Hares and tortoises. Income is what matters. Yadda, yadda." Ok. I've got it. But, at any given percent yield, a holding that is growing at a higher rate is compounding its absolute income at a higher rate. Why take 900 bps a year out of the compounding machine? It should not be that hard to find a solid dividend producer that pays WMT's reasonable, but modest, 2.5% and isn't lagging the market nearly as much as WMT is.
There's the hare, and there's the tortoise. But there is also the slug, and either of those other runners will beat the slug every time.
We all know that we should never fall in love with a holding to the extent that our emotions override our ability to objectively evaluate the continuing worth of that holding. Love is blind. Working past that blindness would be a wise move for many readers currently in love with WMT.
Disclosure: I am long CSCO, MSFT, TGT. 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.