Holiday season, a critical time period for companies operating in the retail sector, is approaching its peak, and the shopping period during Christmas time accounts for as much as 30% - 40% of annual sales for retail companies. Millions of customers expect the retailers to offer great discounts, low prices and a one-stop-shopping experience. Wal-Mart (WMT), the largest retail store in the US, specializes in the aforementioned qualities and offers discounted prices, great deals and a one-stop shopping experience. The company has announced that it will hire 55,000 seasonal associates and will switch 35,000 associates from temporary to part-time status and another 35,000 associates from part-time to full-time status.
Wal-Mart Stores Inc. operates as a discount retail store in various formats under sixty-nine banners around the world. Its operations are comprised of three reportable business segments including Wal-Mart US, Wal-Mart International and Sam's Club. Currently, Wal-Mart US is the largest segment of business, accounting for approximately 59% of its fiscal 2013 net sales. It operates retail stores in various formats in all 50 states in the US and Puerto Rico as well as its online retail operations on walmart.com.
Wal-Mart International consists of retail operations in 26 countries and generated around 29% of Wal-Mart Inc.'s fiscal 2013 net sales. The Wal-Mart International segment includes numerous formats of retail stores, restaurants, wholesale clubs, including Sam's Clubs, and various retail websites that operate outside the US. The Sam's Club business segment consists of membership warehouse clubs operating in 47 states in the US and Puerto Rico, as well as the segment's online retail operations onsamsclub.com. The Sam's Club segment accounted for approximately 12% of Wal-Mart's fiscal 2013 net sales.
Over the last four years the company's net sales grew at a CAGR of 4.75%. Net sales for the fiscal 2013 increased 5% to $469 billion from $447 billion in fiscal 2012. Sales from its Wal-Mart US segment increased 4% to $274.5 billion in fiscal 2013 compared to $264.2 billion in fiscal 2012.The Wal-Mart International segment's net sales of $135.2 billion for fiscal 2013 increased from $125.9 billion in fiscal 2012. The Sam's Club segment had net sales of $56.4 billion and $53.8 billion for fiscal years 2013 and 2012, an increase of 4.8% on a year-on-year basis.
Besides sales growth, another important metric for retail stores is "sales per square foot." Sales per square foot measures how successful the company is at making money off of this key asset. Companies with low sales per square foot have fewer cushions to cover their expenses, and their business model may not make the best possible use of their retail space.
Source: annual report Fiscal Year 2013
In order to assess the company's upside potential I used a modified dividend discount model because the company is already mature and has a stable payout ratio.
The table above shows the assumptions and projections of the company's dividend discount model that has been modified and adjusted to incorporate the effect of stock repurchases. In order to do so, a modified payout ratio has been calculated. The expected growth in earnings has been kept constant at 8%, lower than the historic earnings growth of 11%, because the company is at a mature stage. The average modified payout ratio of the past five years has been used to project future payout proportions in order to reduce the effect of spiked values in a single year. Terminal growth has been assumed to be 1%.
The table above indicates the cost of equity assumptions and the fair value calculations. Using a market rate of return of 12.3% (S&P 500 post financial crisis return) and a risk free rate of 2.8% (10 year treasury yield). The required rate of return of5.9% is used to discount future dividends. This yields a price target of $101.47 and a share with an upside potential of 35.93%.
In order to make this model more flexible I applied a sensitivity analysis to incorporate any variations in the assumptions associated with growth rates and required rate of return.
The table above shows the sensitivity analysis with respect to the company's long term growth rate and its required rate of return. This table shows the different scenarios with respect to expected growth rate and required rate return. In the worst case scenario, where the expected growth rate dropped to 4% and required rate of return increased to 6.9%, the stock price would drop to $76.66 or drop by 5.35%. In the best case scenario, where the expected growth rate increased to 12% and required rate of return decreased to 4.9%, the stock price would increase to $152.11 or 104%.
The table above indicates that the company is currently undervalued on its multiples, compared to industry and S&P 500. Regardless of it being undervalued on its multiples, the company is paying higher yield than the industry and the S&P 500 index because it has reached a mature stage where growth for expansion slows and it returns higher profit to its shareholders.
Today technology has blurred the lines of shopping experiences and shaped a retail industry open for business that suits the customer's shopping preference. There is no doubt that the advancement in technology brings excitement and anticipation of a brighter future for the retail industry but it also intensifies the competition. However, with its immense network of stores, low price business model and attractive deals Wal-Mart Inc. is still able to attract customers and this is clearly reflected in its sales growth. Furthermore, company multiples and assessment based on the dividend discount model signifies that the company is undervalued. This means that its stock has the potential to grow in the near future. My recommendation for this stock is buy.