Reading Between The Lines Of Wal-Mart's Accounts - Part III

Nov.21.13 | About: Wal-Mart Stores, (WMT)

Valuation of Wal-Mart (NYSE:WMT)

In this third and last part of our analysis (click here for Part I - Part II) we will try to figure out the fair value of Wal-Mart's shares and answer the remaining questions on the company's future and strategy.

Projection based on ROE

As we have found out in the first part of our analysis that Wal-Mart achieves a remarkably steady ROE, we could try a "quick and dirty" projection based on the following assumptions:

This year's equity x 22% = Next year's net income

Next year's equity = Next year's net income - Dividends paid out - Share repurchases + This year's equity

Wal-Mart should manage to buy back at least 3% of shares outstanding each year; the total amount spent on buybacks increases 5% every year; the dividend pay-out ratio increases by .5% every year.

The result is the following table:

2013

2014

2015

2016

2017

2018

CAGR

Equity ($m)

76,343

79,700

83,069

86,424

89,735

92,966

4.02%

Net Income ($m)

16,999

16,795

17,534

18,275

19,013

19,742

3.04%

Dividend pay-out ratio

32%

32.50%

33.00%

33.50%

34.00%

34.50%

1.81%

Dividends ($m)

5,361

5,459

5,786

6,122

6,464

6,811

4.90%

Buybacks ($m)

7,600

7,980

8,379

8,798

9,238

9,700

5.00%

Shares outstanding (M)

3,389

3,287

3,189

3,093

3,000

2,910

-3.00%

Dividend / share ($)

1.58

1.66

1.81

1.98

2.15

2.34

8.15%

GAAP-EPS ($)

5.02

5.11

5.50

5.91

6.34

6.78

6.21%

Click to enlarge

Of course there are a lot of "ifs": If buybacks reduce shares outstanding more or less, the results per share will change a lot (and buybacks depend mostly on volatile stock prices). If the dividend pay-out ratio is lower, more capital gets invested and thus net income grows faster. If ROE is lower or higher, a lot of figures would change, etc.

I would see the above projection as a cautious forecast. Investors at the current stock price of about $80 would get about $10 in dividends in 5 years and, assuming a stable PER of 16, a stock worth $108. All in all, they would make $38 on their investment of $80 in 4-5 years. That's a CAGR of about 8-10%. Not bad.

Projection based on Owner Earnings

These are the Owner Earnings for the past 6 years:

($ millions)

2008

2009

2010

2011

2012

2013

Operating cash flow as stated

20,642

23,147

26,249

23,643

24,255

25,591

Adjustments

Pre-opening costs (see Part I)

+ 358

+ 289

+ 227

+ 320

+ 308

+ 316

Tax gain on pre-opening costs

- 122

- 98

- 77

- 109

- 105

- 108

Adjusted operating cash flow

20,878

23,338

26,399

23,854

24,458

25,799

Maintenance Capex

- 3,500

- 4,600

- 5,500

- 5,700

- 6,000

- 6,000

Adjusted free cash flow (Owner Earnings)

17,378

18,738

20,899

18,154

18,458

19,799

Owner Earnings per share ($)

4.27

4.74

5.39

4.95

5.31

5.84

GAAP-EPS ($)

3.13

3.35

3.73

4.18

4.54

5.02

OE/GAAP-EPS

1,36

1,41

1,45

1,18

1,17

1,16

Click to enlarge

There seems to be the same growth trend of about 6-7%/year in Owner Earnings per share we have just projected above, which of course depends a lot on our maintenance capex estimates. The 6-year average of total capital expenditures is close to last years' figures, with comparatively more money allocated to growth investments in the early years of the period. All in all, I feel confident that these estimates are very close to represent Wal-Mart's maintenance capital expenditures correctly.

As a note aside, the table also shows that as growth investments slow down, Wal-Mart's Owner Earnings get closer to GAAP-earnings.

The questions that remained at the end of Part II

  • Why does Wal-Mart deliberately cannibalize sales of its own stores?
  • How much earnings growth can we expect in the years to come?

Too many investor focus on sales growth without looking at cost of sales. Profit margins are what matters in the end. If you think about some of the dynamics in a network of stores, it is not hard to see how a tighter knit network might compensate for a bit of sales cannibalization. My idea is that merchandise can get distributed to a tighter knit store network at a lower cost per merchandise, thus increasing margins and compensating for some sales lost to in-house competition.

As we have seen during this analysis, Wal-Mart's management has been incredibly efficient in maintaining stable margins and ROE. Wal-Mart just doesn't invest any money without getting a return of investment at the usual high level - otherwise the company pays it out as dividends or share repurchases.

Thus, I would not simply guess a number for future growth, extrapolating from historic trends. I just don't believe it's necessary: With Wal-Mart we can be as certain about the future as we can possibly be. If Wal-Mart stopped expanding right now, chances are very good that its shareholders would get a dividend of about $6/year. They could invest these dividends (i.e. the proceeds after taxes) and buy more Wal-Mart stock. This would roughly translate into a growth rate of their shareholdings of 5%/year. I don't need any guesstimate to know this for sure.

More tax efficient would be a buyback done directly by Wal-Mart. Assuming a steadily rising share price along with repurchases, EPS would increase by over 7% every year without any growth of Wal-Mart's business. These two alternatives should represent the minimum achievable (which is what actually happened during these recent years, as total Owner Earnings moved only little; on a per share basis they increased a bit more thanks to stock buybacks).

I still don't need any fancy growth forecasts; I just need Wal-Mart's business to remain stable. However, there is a great probability that in the future Wal-Mart will do a bit better. By investing part of its earnings back into its business and achieving the usual high returns on invested capital, Owner Earnings per share should definitely grow more than by a rate achievable through simple buybacks; I'd consider a growth rate of 8% per year to be a conservative assumption.

Valuation

Finally, how much is Wal-Mart worth? Let's see the price-earnings multiples Mr. Market considered appropriate for the company in the past:

2008

2009

2010

2011

2012

2013

Owner Earnings per share ($)

4,27

4,74

5,39

4,95

5,31

5,84

GAAP-EPS ($)

3,13

3,35

3,73

4,18

4,54

5,02

Price (high)

51,44

63,85

55,20

57,90

62,00

77,60

Price/OE (high)

12,05

13,47

10,24

11,70

11,68

13,29

Price/GAAP-EPS (high)

16,43

19,06

14,80

13,85

13,66

15,46

Price (LOW)

42,09

46,92

46,25

47,77

48,31

57,18

Price/OE

9,86

9,90

8,58

9,65

9,10

9,79

Price/GAAP-EPS

13,45

14,01

12,40

11,43

10,64

11,39

Click to enlarge

- Isn't it pleasing to recognize, at the end of all our hard work, that Mr. Market apparently seems to agree with us? Over the last 6 years there is a very clear pattern: The ratio of price to Owner Earnings rarely goes much below 10; on the high side it never goes above 14. Compare this to the very volatile ratio of price to GAAP-earnings: Almost certainly the usual EPS figures do not represent the best yardstick to measure the value of Wal-Mart's shares. Our Owner Earnings seem to be more useful.

Thus, with Owner Earnings of $5.84 per share, the current price level of almost $80 probably does not offer a lot of near-term upside.

And now?

We should keep in mind that this three-part analysis was intended to be just the starting point. And that it really is just a starting point. Until now we haven't looked at Wal-Mart's competitors, in the US and abroad, both traditional and online. We haven't read line by line the latest annual, quarterly reports and conference call transcripts, considered debt and shareholder structure. While we can feel confident to be on the right track with what we've found out so far, we should not let us fool by confirmation bias and correct our previous assumptions should the necessity arise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.