Seeking Alpha
Long/short equity, value, research analyst, deep value
Profile| Send Message|
( followers)  

If you are look­ing for a good, safe stock in this volatile mar­ket, Wal-Mart (NYSE:WMT) is one of the best. After strong gains in the 1980s and 1990s, Wal-Mart's stock price is lower now than it was in Octo­ber 1999.

The stock has gone nowhere in the last decade while rev­enues have grown 9% com­pounded annu­ally and after-tax cash flow (NOPAT) has grown 10% com­pounded annu­ally since 2000.

Com­ing into the last decade, Wal-Mart's busi­ness needed to grow into its stock price. Fig­ure 1 shows how, until 2009, Wal-Mart's stock price was well above its eco­nomic book value, which equals the value of Wal-Mart's exist­ing cash flows. The basic for­mula (more details here) for eco­nomic book value is NOPAT divided by the firm's weighted aver­age cost of cap­i­tal (WACC).

I think of the eco­nomic book value as the no-growth value of the busi­ness or the value of the busi­ness if exist­ing prof­its stay flat for­ever. WMT's eco­nomic book value is $82 per share today. Its cur­rent stock price of ~$52 per share implies a per­ma­nent 35% decline in the company's profits.

Fig­ure 1: Stock Trades At Steep Dis­count to Eco­nomic Book Value


(Click to enlarge)

Sources: New Con­structs, LLC and com­pany filings

For most of the first decade of this cen­tury, I con­sid­ered Wal-Mart a good com­pany, but not a good stock. Not anymore.

Now that the stock trades at a 35% dis­count to its no-growth value, WMT is both a good com­pany and a good stock.

Even if Wal-Mart may be approach­ing its max­i­mum size, I think the worst-case sce­nario is that WMT's prof­its plateau, which, per above, implies a stock price of $82/share.

I believe prof­its will not drop off a cliff as the mar­ket sug­gests because Wal-Mart's man­age­ment has proven to be excel­lent cap­i­tal allo­ca­tors. Indeed, over the years, there has been lit­tle doubt about the qual­ity of Wal-Mart man­age­ment or the effi­ciency of its operations.

Lately, growth con­cerns have weighed on the stock. As Wal-Mart's growth decel­er­ated, it became a less pop­u­lar stock in a mar­ket that all-too-often seems obsessed with growth at all costs.

The momen­tum investors that seem to dom­i­nate the mar­ket these days do not appre­ci­ate or under­stand the value in Wal-Mart's busi­ness now that it is no longer a “growth story”. In their obses­sion with growth, these investors tend to over­hype stocks on the upside and overkill on the down­side with lit­tle regard to the under­ly­ing eco­nom­ics of businesses.

They miss the fact that Wal-Mart gen­er­ates huge prof­its with rel­a­tively lit­tle growth because of its large size.

They also miss the fact that Wal-Mart's busi­ness has been a remark­ably steady per­former in tur­bu­lent times that have derailed many lesser companies.

Even while grow­ing NOPAT at 10% per year, Wal-Mart's return on invested cap­i­tal (ROIC) has remained admirably steady. See Fig­ure 2. Most com­pa­nies that grow as much and as steadily suf­fer steep declines in ROIC as they deploy large amounts of cap­i­tal with only hopes of future profits.

Not Wal-Mart, its ROIC has held steady as man­age­ment has intel­li­gently invested in stores, busi­nesses and acqui­si­tions that have earned impres­sive returns. This achieve­ment puts Wal-Mart in rare company.

Over the past 5 years, Wal-Mart has had the second-least volatile ROIC of all Rus­sell 3000 com­pa­nies with returns greater than 10%, next to little-known National Bank­shares (NASDAQ:NKSH), which gets our “attrac­tive” rating.

Fig­ure 2: A Drop In Prof­its Would Be a Major Aberration


(Click to enlarge)

Sources: New Con­structs, LLC and com­pany filings

As is often the case in equity mar­kets, stocks over­shoot to the upside and to the down­side. WMT is an excellent exam­ple of a stock whose val­u­a­tion had over­shot to the upside when sen­ti­ment was pos­i­tive. Now, it is an exam­ple of a stock that has over­shot to the down­side as sen­ti­ment has turned decid­edly neg­a­tive. You know the script: the more exu­ber­ant the pos­i­tive sen­ti­ment, the more ruth­less the neg­a­tive sentiment.

This excess neg­a­tive sen­ti­ment pro­vides investors an excel­lent oppor­tu­nity to buy a great busi­ness at a great price.

Though WMT's growth is decel­er­at­ing and may decline, it is not likely that the com­pany will incur a per­ma­nent 35% reduc­tion in prof­its as implied by the market's cur­rent val­u­a­tion of the stock. Accord­ingly, down­side risk to the stock is low.

Upside reward poten­tial is strong as the stock has to go over $82/share to trade at a value that implies the company's prof­its will expe­ri­ence a 0% decline, a no-growth sce­nario. If the com­pany does any­thing bet­ter than a 35% decline in prof­its, the stock has upside.

I also rec­om­mend the fol­low­ing ETFs because of their “attrac­tive” rat­ing and expo­sure to WMT.

  1. Con­sumer Sta­ples Select Sec­tor SPDR (NYSEARCA:XLP)
  2. Van­guard Con­sumer Sta­ples ETF – DNQ (NYSEARCA:VDC)
  3. Focus Morn­ingstar Con­sumer Defen­sive Index ETF (NYSE:FCD)
  4. Pow­er­Shares Buy­back Achiev­ers (NYSEARCA:PKW)
Source: Blue Light Special on Wal-Mart's Stock