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Summary

  • Walmart, the emperor of retail, is finding it difficult to bring growth to its top line. The top line grew at a CAGR of 3% in the last five years.
  • A large increase in dividends is not a sustainable way to support the share price. Margins are stable but Walmart desperately needs to bring growth to its top line.
  • Walmart’s focus on online retail is expected to payoff. Target price estimates show upward potential. These improvements along with dividend make Walmart a good investment.

Emperor of the Retail Business

Wal-Mart (NYSE:WMT) has been a very proactive enterprise that has worked tirelessly to bring efficiency to its business. The company came up with ingenious ideas to cut down prices in order to offer better value products to its customers at unseen low prices. With its dynamics strategy and business model, WMT gained the title of largest retailer in the world. Most shoppers in the US have no option but to shop at WMT for the rock-bottom prices.

Declining Top-line Growth

(click to enlarge)

Source: Morningstar.com

Looking at the revenue growth trend in the last ten years, it is important to note that WMT's top line has slowed down considerably from 2009 onwards. From 2005 to 2009 the top line grew at a CAGR of 9%. From 2009 to 2014 the top line showed a meager growth at a CAGR of 3%. In financial year 2013-2014 revenue grew by only 1.5%. This is a large decline and creates worry. There is no material decline in the gross and operating margins indicating that WMT has no big issue with the operating efficiency of the business.

High Dividend Payout Only Works in the Short Term

The figure above shows that WMT has increased its dividend payout ratio in the last two years from 31.7% in FY2013 to 49.3% in TTM. WMT seems to have increased its dividend in order to support the share price. However, this is not a sustainable way to support the share price. WMT needs to bring growth to its top line that can flow down to the bottom line to boost EPS.

An Urgent Need for Growth

Wal-Mart is working to expand in the emerging markets like China and India to bring growth to its top and bottom lines. The company is evolving further in the pursuit of growth. WMT desperately needs to bring growth to its business and it cannot afford to lose its shoppers to online retailers. Although presently, online sales make up a tiny fraction of Wal-Mart's total sales (about $10 billion online sales compared to $476 billion total sales in financial year ended 31 Jan, 2014) it is extremely important in a strategic sense for the future growth given the changing dynamics of retail industry.

Strengthening its Position in the Online Arena

WMT has intensified its efforts to gain space in online retail and this is one of the many steps taken towards increasing its online presence. It is rebuilding its website, Wal-Mart.com, to enhance the personalization feature for a better shopping experience. By adding new features to its website WMT is taking a step forward in the online retail market dominated by Amazon.com (NASDAQ:AMZN). WMT is flexing its muscles to become bigger competition to online retailer king Amazon.com.

This is a very important time in the history of the retail industry and WMT urgently needs to work on its e-commerce strategy to capitalize on the growth potential presented. This is the time when brick-and-mortar retailers are unable to produce meaningful growth. On the other side, e-commerce is growing at a staggering 25% to 30% per year. In the last fiscal year ended Jan 31 2014, WMT reported a 30% increase in e-commerce sales that reached $10 billion. On the other hand WMT's US store sales have fallen in the last five quarters.

Time is Ticking Away

It's very important for WMT to strengthening its position in the online retail space because it is already a little too late to realize the strategic importance of online retail for future growth. WMT needs to focus on its e-commerce strategy and it can't afford to make many mistakes. The company has no time to waste as the e-commerce space is becoming increasingly competitive. Many retailers such as Home Depot (NYSE:HD) are already working tirelessly to capture the growth opportunity offered by e-commerce. They are also focusing to capture market share in the m-commerce space. This trend denotes the fact that in the coming years there will be more retailers focusing on improving their online retail operations.

WMT has an efficient supply chain and infrastructure that would back its online retail strategy. WMT produced $477 billion sales compared to the $81.8 billion revenue it reported in trailing twelve months. WMT already has a huge customer base. If WMT shoppers begin to shop online instead of coming to the stores then WMT should not lose out to AMZN or any other online retailer.

Target Price

Consensus target price shows that WMT's stock is under-appreciated by the market and upward potential exists. The mean target price is $80.39 with an upside of about 10%. The median target price is $83with an upward potential of about 13%. The highest target estimate is a price gain of 23% and the most conservative price estimate expects a downside of -20%.

Source: Yahoo Finance

Relative Valuation

WMT's stock is trading at about 14 times its earnings. It is cheaper compared to the sector average but it is expansive compared to the industry and the S&P 500. After scaling the P/E ratio with expected growth, the PEG ratio of 1.75 shows that WMT's stock is undervalued compared to the sector and S&P 500.

Source: Yahoo Finance

Conclusion

Wal-Mart rules the retail industry but it needs to focus on online retail which is a rapidly growing phenomena. Mammoth revenue of $477 billion is stagnating and needs fuel from multiple sources along with online retail. Wal-Mart's efforts to enhance its online retail operations will pay off. Valuation has upward potential and along with the current dividend yield of 3.2% makes Wal-Mart a good investment at its current price level.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Wal-Mart: E-Commerce Can Be The Next Catalyst