Despite the well known problems Wal-Mart (NYSE:WMT) is facing, the company today raised its dividend more than 20%, giving the stock a respectable 2.75% yield. Some of the problems it is facing:
- Ongoing public relations struggles as the company moves into a new community and puts local business owners out of business.
- Accusations of mistreatment from current and former employees.
- Loss of local market share to smaller competitors with stores in neighborhoods where their customers live.
These problems are real, and Wal-Mart will have to work hard at shedding some perceptions of it as an 'evil empire.'
That said, Wal-Mart is an investment that should probably show up in most conservative, income driven investors' portfolios. In response to losing market share to local competitors like Dollar Tree (NASDAQ:DLTR), Family Dollar (NYSE:FDO), and Dollar General (NYSE:DG), Wal-Mart has stated it will begin to unleash its "Everyday-Low-Prices" strategy that it had gotten away from to counter the loss of business. Also, Wal-Mart is planning to build much smaller stores that will be closer to the neighborhoods where customers live, directly competing with these other three stores on their home turf.
While the loss of market share in the US is concerning, my fears are alleviated by the fact that international growth is more than making up for the local loss as the company's business grows in the low double digits overseas. Who would ever have thought of Wal-Mart as an exciting international/emerging market story? The company has more than 4200 stores in 14 countries and it's adding more every month. In the BRIC countries alone, it has almost 750 stores, and India is just getting going while Russia is not in the mix yet. Growth in these regions has the potential to put Wal-Mart back in hyper growth mode over the next few years.
That said, has Wal-Mart actually fallen out of growth mode? If one were to look at the share price alone, it would seem like it has done nothing but lose money. On Dec 31, 1999, Wal-Mart shares closed at $69.12. On Dec 31, 2010, they closed at $53.93 and paid $6.89 in dividends over that time, for a net 12% loss (not including taxes on dividends). Does this mean Wal-Mart has done a terrible job over this time frame? On the contrary, the only terrible job done in this story is the analysis work investors did back in 1999. We as investors like to blame companies when their stock price goes nowhere while we own them, never wanting to shoulder the blame for our own greed. Were investors greedy back in 1999? Yes.
Take a look at the numbers. Today Wal-Mart sports a market cap of $185 billion dollars and generated $13.45 billion in owner free cash flow the last 4 quarters. This is the money you can use as take home pay if you decided to buy the entire company. It's where returns are generated, as dividends, debt pay down, and stock buybacks come from this number. Over the past 4 quarters, Wal-Mart decided to use $4.4 billion of this $13.45 billion to pay in the form of a dividend. That left the company with a little more than $9 billion that it could have used to pay dividends with, but used instead to buy back stock.
I think this is a great idea.
First, if the companyy paid me the cash, I would probably use it to buy more shares through dividend reinvestment. Doing that, I would have a tax liability of 15% for taking the cash first, to end up doing with it what they are doing and buy more shares. Much better for me.
Next, they are borrowing money and buying back more shares than cash flow alone could over the past 4 quarters. With the free cash flow yield sitting at 7.2% per share currently, if they can borrow money for less than that, it makes sense to borrow and buy back shares. Since 1999, Wal-Mart has retired about 20% of its shares, meaning that anyone who owns a share in 2011, owns something that is 20% more rare than in 1999 when it was trading much higher. As I have stated in other articles, when something becomes more rare, it becomes more valuable.
Third, in 1999 a minimum wage Wal-Mart employee would have to work 13.42 hours in order to buy one share at the minimum wage rate of $5.15 an hour. Today, the minimum wage earner only needs to work 7.18 hours. That is 46.5% less. Even though the net loss is 12%, shares are actually 46.5% more affordable today than they were back then for the minimum wage earner. Maybe Wal-Mart should market the stock in its stores as an "everyday-low-price" bargain. What does this tell us? It says to me that even though the price has gone down since 1999, the value of the company has skyrocketed.
We can go back and forth arguing about if the company has done a good job creating shareholder value over the past 11 years, but the numbers don't lie. The problem with the stock price going nowhere over this time is not that the company did not perform, it is because investors were too greedy back in 1999 and over paid by quite a bit. Back then the 10 year treasury yielded 6.5%, while Wal-Mart showed a free cash flow yield of only 1.41%. Investors paying $69.12 back then would have to see the business performance increase 360% just to match the potential risk free yield of a government bond. Was it wise to own WMT back then? Sure doesn't seem like it.
Today, with the company yielding 7.2% on a free cash flow basis and the 10 year treasury sitting at only 3.51%, it is clear that on a relative basis, Wal-Mart is MUCH more valuable. It can yield over 100% more in the form of dividends than the 10 year treasury if the company chose to pay everyting out in the form of a dividend. The company is growing like a weed in emerging markets, it is fixing the issues it faces in the US, and it just gave its owners a 20% pay raise. Over the past 10 years, it has raised its dividend annually at a rate of 19.5%. Let's pretend that slows to only 15% a year. Any money invested today would see a 11.12% yield per year in 10 years on this original investment. This coming from one of the safest business models in existence. What's not to like today?
Disclosure: I am long WMT.
Additional disclosure: I have no other positions in any stock mentioned. Our clients hold WMT in their accounts.