- Wal-Mart shares currently trade at a tempting discount of 13% to market.
- Updates and results from initiatives such as ecommerce development, adjustment of international operations, and expansion of small-format stores would narrow the valuation gap.
- Stock performance is expected to be buttressed by continued dividend growth and share buybacks.
Shares of Wal-Mart Stores (NYSE:WMT) now trade 8% off from their 52-week high of $81.37 achieved in December 2013. I believe the recent pullback has presented a great buying opportunity for this quality long-term investment as its valuation has become attractive and management's initiatives to tackle the challenging retail environment provides potential upside catalysts.
The stock now trades at a 13.4x 2015E P/E multiple, which is at a 13% discount to the same multiple for S&P 500 Index (see chart below).
I view the current valuation discount to be compelling as a narrower valuation gap can be justified by the following reasons:
- Wal-Mart's valuation discount to the market averaged at just 8% in the past 12 months;
- The company's consensus long-term earnings estimate of 8.6% is not far below the average estimate of 9.5% for S&P 500 companies;
- The stock now offers a 2.4% dividend yield, which exceeds S&P 500's average at 1.9%, and the dividend has grown by a CAGR of 15% since 2009, outperforming the growth for many large-cap dividend stocks;
- Management is committed to returning significant capital to shareholders as share repurchase in the past 5 fiscal years totaled at almost $48B, representing almost 20% of the current market capitalization; and
- Wal-Mart has a leading market position in the retail sector and its immense global presence should mean a below-average risk as reflected by the stock's 5-year beta of 0.32.
Looking forward, I believe the following key developments would drive a valuation upside:
- Wal-Mart's online business development has recently demonstrated success. Since the launch of Pangea search engine, the company has experienced a 20% increase in conversions from site search results. Revenue from Yihaodian, a Chinese ecommerce retail website that was acquired by the company in 2012, was up 40% in Q3 2013. Owing to the positive results, management recently raised its online revenue guidance from the prior estimate of $9B to $10B. Going forward, it is believed that Wal-Mart's resources allocated to the ecommerce development should continue to focus on improving the current technology platform and pursing strategic acquisitions and the online business would become a primary growth driver. Hence, I expect the stock price to benefit from future development updates.
- To cope with low-return performance from international operations, management announced in 2013 that it would slow down international expansion and shift its strategic focus to profitability improvement. In addition, management has also terminated some unsatisfied partnerships and stores in emerging markets (e.g. India, China and Mexico), reflecting their commitment to reshaping the international operations. Given that the international turnaround plan remains in its early implementation stage and the fact that the new CEO, Doug McMillon, used to be the chief of the international division, it is expected that new management would have a stronger focus on this issue and more measures to announce down the road.
- For the company's US operation, management's current strategy has been focusing on rolling out small-format stores. Given the recent solid performance (e.g. revenue for Wal-Mart Express grew at double digits the past few quarters), I believe the opening of the small-format stores would notably outpace traditional stores, which should buttress the top-line growth in the US market.
- As Doug McMillon recently took on the CEO role, it is expected that the company will announce some sort of detailed development plans for the initiatives I just mentioned and these announcements would likely improve market sentiment and support the valuation.
- Since 2009, the company has been raising dividends annually by a 15% CAGR. Looking forward, I expect the current pace of the dividend growth can be sustained by Wal-Mart's strong free cash flow generation, which significantly exceeded annual dividend payments in the past few years. Further, the share repurchase program has not only returned $48B to shareholders but also effectively reduced the share counts by 15% since fiscal 2010.
In summary, I believe Wal-Mart is well positioned to leverage its ample resources (e.g. global scale and vendor relationships) to achieve desired results from the improvement initiatives. As the stock valuation is now at a deeper discount to market, I believe a buy recommendation is warranted.
All charts are created by the author and data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.