- Leader in retail with sustainable pricing power and opportunities in other product categories.
- History of cash returns to shareholders with very consistent operating performance.
- Opportunity for better valuation on shareholder discontent in the near-term.
Shares of Wal-Mart (NYSE:WMT) are up just 2.8% over the last year, underperforming the 20% gain in the S&P 500 as investors contend with a bribery investigation in the company's international operations and only moderate sales growth. Shareholder dissatisfaction, especially around the company's annual meeting on Friday may push the shares lower in the near-term. The company is in no danger of losing its scale advantage and any further weakness in the shares could be a good opportunity for value investors. Add a buy alert between $71 and $72 per share for value on expected earnings and a strong dividend yield.
The company that needs no introduction
Wal-Mart is the largest retailer in the world with a massive $475 billion in annual global sales and is able to demand high price discounts from suppliers. While the company passes some of the discount to customers and is the clear price leader in retail, its 25% gross margin is still above peers.
Beyond its traditional product categories, the company is facing a huge opportunity in its pharmacy segment against Rite Aid (NYSE:RAD) and Walgreen (NYSE:WAG). Wal-Mart has yet to leverage its size to attract growth in pharmacy sales as it has with groceries. The company is also rolling out the smaller store format for express needs in the city centers. Because of the large footprint needed for supercenters, the company has historically been under-represented in urban areas. While the small-store format may help increase sales in high-density areas, it also presents a risk of lower operating margins.
Sales have grown at a fairly consistent rate of 3.3% over the last five years with operating expenses growing slightly faster at an annualized 3.6% pace. Recently, spending on e-commerce has increased which has hurt margins but should pay off in the future with a stronger digital presence. While expenses have grown slightly faster, the company has maintained an operating margin of 5.6% or higher over the last decade.
The draw here for investors is clearly consistency in performance and cash return. Return on assets has varied by less than one percent from the 8.5% average over the last ten years and margins are incredibly consistent. As more markets reach maturity growth, the company has been increasing its cash return to shareholders. Wal-Mart bought back $6.7 billion in shares last year, more than 2.5% of the company and has averaged $8.5 billion in annual repurchases over the last five years. In total, the company returned $13.5 billion in cash to shareholders last year.
The per share dividend amount has been increased by an annualized 13.9% over the last ten years on a combination of a higher payout and an aggressive share buyback program. The company pays out 39% of its income as dividends and the shares offer a 2.5% yield. Free cash flow has come in consistently between $10 billion and $13 billion over the last four years, even as the company spends around $13 billion in capital investments.
The shares are currently trading for 16.0 times trailing earnings, slightly above its five-year average of 14.3 times earnings but still below the industry average of 17.3 times. The higher price multiple seems largely a function of higher multiples across the market. While there is downside to a broader market sell-off, the shares are a classic defensive play and should hold up well.
Given strong sales and its cash position, the company should be able to maintain dividend growth of 13.5% over the near-term. I have used a 10% growth rate for the second stage in the discounted cash flow model below and a conservative 4% rate for terminal growth. These last two estimates are probably overly conservative given the company's already mature business.
The company has announced legal fees and other costs related to an ongoing federal investigation into bribery in its international operations. The investigation has cost the company $400 million so far and could cost another $200 to $240 million this year before adding in any eventual fines.
The bribery allegations and the stock's performance over the last year have driven some shareholder antagonism and put a measure on the ballot for greater information into pay clawbacks for executives. The company already discloses compensation clawbacks for six executives but shareholders want that number extended to others. Also on the proxy for Friday's annual meeting is a move for an independent chairman and an annual report on lobbying.
As most proxy votes go, these shareholder measures will likely get struck down in favor of management. The Walton family itself still owns more than 50% of the company and others will vote along with management. I am not expecting this to escalate into large-scale shareholder satisfaction but it could mean a short-term sell-off in the shares.
With a price multiple of 15.0 times expected earnings for this year and 8% earnings growth expected next year, any sell-off in the shares could be an attractive opportunity to buy. I would put a buy order in between $71 and $72 per share. This would improve the dividend yield to 2.7% and would be a price just under 14.0 times this year's expected earnings. The lower price would also represent a discount of nearly 13% to fair value and a significant gain once the shares recover.