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Shares of Wal-Mart (WMT) hardly moved following the release of its third quarter earnings report on Thursday before the market open.

The release was a mixed bag. Combined with the increased valuation, and the gradual built up in leverage, I remain on the sidelines. It is time to take some profits.

Third Quarter Results

Wal-Mart generated third quarter revenues of $115.7 billion, up 1.6% on the year before. The company faced some currency headwinds, totaling $1.6 billion. In constant currencies, revenues would have been up by 2.7%. Analysts were looking for revenues of $116.8 billion.

Consolidated earnings rose by 2.8% to $3.7 billion. On the back of share repurchases, earnings per share growth was higher at 6.5%. Earnings per share rose by seven cents to $1.14 per share, beating consensus estimates by a penny.

Looking Into The Results..

The modest revenue growth was indeed caused by currency headwinds. As Costco (COST) has introduced a very successful membership model, Wal-Mart is now trying similar things, resulting in a 12.3% increase in membership and other income. Membership and other income totaled $823 million, or 0.7% of total sales.

US comparable sales fell by 0.3% compared to last year, despite a strong 3.4% sales increase of the Neighborhood Market format. Sam's Club comparable sales rose by 1.1%. As such total US comparable sales fell by 0.1% excluding fuel, as they fell by 0.2% including fuel sales. The international activities reported total sales growth of 4.1% in constant currencies.

Gross margins rose by 18 basis points to 25.1% of total sales. Operating expenses were up by 7 basis points to 19.6% of total sales, limited operating earnings growth. Net earnings growth was furthermore limited by higher effective tax rates.

Repurchase programs, which reduced the number of outstanding shares, resulted in a boost to earnings per share.

In 2011, Wal-Mart has committed itself to reduce operating expenses by a 100 basis points by the fiscal year of 2017. Given the continued progress, Wal-Mart remains committed to that goal.

... And Looking Ahead

Fourth quarter earnings per share are seen between $1.50 and $1.60 per share. Note that the guidance includes charges totaling $0.10 per share related to the closure of 50 underperforming stores in China and Brazil. The company will furthermore end the franchise agreement with Bharti Retail in India. On top of this, Wal-Mart agreed to sell its Vips restaurants in Mexico.

Note that adjusted fourth quarter earnings are seen between $1.60 and $1.70 per share, with full year adjusted earnings seen between $5.11 and $5.21 per share. Analysts were looking for adjusted earnings of $1.69 per share for the fourth quarter.

Valuation

Wal-Mart ended its third quarter with $8.74 billion in cash and equivalents. Total debt, including capital lease obligations, stood at $61.82 billion, for a net debt position of $53.08 billion.

Sales for the first nine months of the year came in at $346.6 billion, up by 1.7% on the year before. Net earnings rose by a similar percentage to $11.6 billion in the meantime. At this pace annual revenues of around $475-$480 billion are attainable as adjusted earnings are seen around $17 billion.

Trading around $79 per share, the market values Wal-Mart at $256 billion. This values equity in the firm at 0.5 times annual revenues and 15 times annual earnings.

Wal-Mart currently pays a quarterly dividend of $0.47 per share for an annual dividend yield of 2.4%.

Some Historical Perspective

Shares of Wal-Mart have stagnated in a $40-$60 trading range between the year 2000 and 2010. In 2012 shares broke upwards out of this range to trade in a $70-$80 range in 2013. Shares are currently trading around the high end of this range.

Between the calendar year of 2009 and 2012, Wal-Mart has grown its annual revenues by a cumulative 15% to $469 billion. Earnings rose by 17% to $17 billion. Note that the company repurchased some 15% of its shares outstanding over the time period, providing a boost to earnings per share growth.

Investment Thesis

Wal-Mart delivered a mixed bag. The modest fall in US same store sales is disappointing as analysts were looking for flat sales. Notably lower television prices and poor sales of toys and packaged foods provided a drag. Despite these headwinds, Wal-Mart guided for flat comparable sales in the so important holiday quarter.

With Wal-Mart being focused on low-income consumers, those being strapped by payroll taxes the most, not much growth had been expected this year. Wal-Mart did notice that its smaller stores performed well, reporting comparable growth of 3.4% as it plans to open another 100 stores to end the year with 400 stores under the format.

Online sales are going fine as well, up 40% on the year as they are expected to total $10 billion this year, little over 2% of total revenues.

Wal-Mart continues to work on the re-introduction of its everyday low pricing strategy in China and Brazil, which is leading to quite some store closures now. Other continued issues are the allegations of the bribery of Mexican governmental officials.

Despite the flat comparable store sales growth, Wal-Mart remains committed to its 3-5% sales growth target for the fiscal year of 2015, starting in February.

To offset the modest operating performance, Wal-Mart continues to pay out cash to shareholders. The company pays $1.5 billion in dividends over the quarter, accompanied by repurchases of $1.7 billion. Combined, these payouts provide investors with a total "yield" of 5.0%.

Back in August of this year, I last took a look at Wal-Mart's prospects following the second quarter results. Trading around $74 per share, I concluded that shares offered long-term appeal despite a softer period ahead.

With fierce competition resulting in slower growth, shares have still risen some 15% year to date. This is partially to thank to increasing payouts to shareholders, as the company continues to aggressively return cash to shareholders. These returns combined with a modest expansion pace of its empire have pushed up the valuation to 15 times earnings at the moment. Combined with the steady built up in leverage, I am a bit more cautious now.

It is time to take some profits, and remain on the sidelines.

Source: Wal-Mart: Mixed Bag Into Earnings Season