Wal-Mart: Time To Get Going

Sep. 5.14 | About: Wal-Mart Stores, (WMT)

Summary

The company is taking correct measures to address competition and strengthen its position in the industry.

Growth investment will pressurize margins in the short term.

The company offers a decent dividend yield of 2.6%, and has been undertaking share repurchases.

I reiterate my bullish stance on Wal-Mart (NYSE:WMT). WMT is the leading retail company in the industry; the company has been facing intense competition in the industry, which has challenged its top line growth in the recent past. However, the company has been taking the correct measures to support its top line growth and address competition by making growth investments. It has been directing its investments towards expanding and improving its e-commerce business and increasing the numbers of small stores, as small retail stores are becoming popular among customers. The company's growth investments are likely to pressurize its margins in the near term, but will portend well for its performance in the long term. Furthermore, the company has been sharing its successes with shareholders through dividends and share repurchases, which makes it a good investment for dividend investors; WMT currently offers a solid dividend yield of 2.6%.

Small Format Stores = Need of The Time

WMT is the world's largest retailer and has operations around the world. The company has been operating through discount stores, neighborhood markets, Sam's club and supercenters. For the past few quarters, the decline in consumer spending in the U.S. has adversely affected customer traffic at WMT's supercentres. Also, the company's big stores (supercenters) are facing tough competition from small-store rivals, including Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR). In the recent past, small-store rivals have been successful in attracting low-income group traffic towards them. However, in order to address competition and increase store traffic, WMT has been focusing on increasing the number of small stores.

The company has been making the correct moves to capitalize on growth potential offered by small stores. In Q2FY15, with its small-format stores, consumer traffic at WMT's neighborhood markets increased 4.1% year-over-year, growing comparable sales at the company's 400 smaller-format stores by 5.6% year-over-year. Whereas customer traffic at its 3,288 supercentres was down 1.1% year-on-year in Q2FY15. The graph below shows the consumer traffic growth trend for WMT for the recent six quarters.

Source: Company's Quarterly Earnings Report

Going forward, the company plans on opening more smaller-format stores to tap the growth potential offered by small-format stores. WMT has committed $600 million for more small-store openings within the U.S., most of which will be opened in Q4FY15. The small-format stores will help the company offset the consumer traffic drop and address competition in the industry.

Strengthening E-Commerce Footing = Long-term Growth Path Carved

To keep up with changing consumer trends, retail companies including WMT, Target (NYSE:TGT) and Best Buy (NYSE:BBY) have increased their efforts to expand and improve the e-commerce business. WMT has also ramped up its investments to grow its e-commerce business. The growth investment by WMT in the e-commerce business has helped the company increase its online sales at a faster pace than traditional store sales. The company has recently reported healthy e-commerce sales growth of 24% for Q2FY15. TGT and BBY also reported e-commerce sales growth of 30% and 22% year-on-year, respectively, for the recent quarter. Also, to improve its online business, BBY has plans to spend $40-$50 million in 2H14.

Going forward, WMT has plans to further increase its e-commerce category sales by expanding its online sales channel around the globe. By the end of 2019, the company plans to open 50 retail stores in India (WMT currently has 20 retail stores in India), along with e-commerce services. Also, WMT now plans to capitalize on the potentials of the Chinese market by strengthening its e-commerce category footing. With its Chinese online arm named Yihaodian, the company will be increasing the number of products sold online, and will improve the mobile site and supply chain. I believe that with the growth in these online channels in high-potential markets like China and India, the company will boost its international segment's sales and also strengthen its global market presence.

Bottom Line

WMT has been actively looking for all the ways by which it could stay competitive in the long run. The company has been focusing on improving brand loyalty and store traffic. The company's growth initiatives will portend well for its performance in the long term; however, in the short term, the margins of the company will be adversely affected due to growth expenditures. In Q2FY15, WMT's operating income was down 2.4% year-over-year. Still the company managed to meet analysts' EPS expectations, as the Q2FY15 EPS was well in line with their expectations.

The company has lowered its FY15 EPS guidance from $5.10-$5.45 to $4.90-$5.15 due to the growth investments it has been undertaking. However, the growth investments will support the company's performance in the long term. Also, analysts have also anticipated a healthy next five years' growth rate of 7.07% for WMT, as shown in the chart.

Source: Nasdaq.com

Value Creation

The company has been sharing its successes with shareholders through share repurchases and dividends. In Q2FY15, WMT paid $1.5 billion cash as dividend. Moreover, it offers an attractive dividend yield of 2.60%, backed by its FCF yield of 4%. Furthermore, the company has spent approximately $307 million to repurchase shares in Q2FY15. Also, it remains committed to buying back an additional $600 million worth of shares in the coming quarters. I believe the share repurchases will fuel WMT's EPS growth and magnify its ROE in the future.

Conclusion

WMT is likely to deliver a healthy financial performance in the future. The company has been taking the correct measures to address competition and strengthen its position in the industry by focusing on small stores and growing its e-commerce business; however, in the short term, the company's growth investment will pressurize its margins. Also, the company offers a decent dividend yield of 2.6%, and has been undertaking share repurchases. Due to the aforementioned factors, I am bullish on WMT.

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.