Don't Expect Much Of A Pullback From Wal-Mart

| About: Wal-Mart Stores, (WMT)

Summary

10-year fundamentals are very strong despite current weak operating margins due to elevated investment.

If retail spending continues to be sluggish, this would be bullish for Wal-Mart.

E-commerce initiatives and ShippingPass should increase Wal-Mart's online take. Furthermore, a recurring revenue model always brings higher margins in the long run.

Wal-Mart (NYSE:WMT), the dividend aristocrat, has raised its dividend for more than 40 years now, which is a feat in itself. In fact, if one had invested $10k 40 years ago in 1976 and re-invested all the dividends, that initial $10k would have ballooned into a substantial seven-figure sum by now. Nevertheless, some bears are doubting how long this dividend increasing streak can last. Operating margins have tumbled of late, and despite the most recent encouraging quarter, net income is still only at 2010 levels, which illustrates that there may be a long road ahead.

Before we even entertain the idea of investing in this stock, let's look at the company's important fundamental metrics over the last 10 years. Since we are in mid-year, we will use the trailing 12-month averages below:

Years Of Dividend Increases 43 Years - Pass
Free Cash Flow $17.653 billion (10-Year Trend Is Up) - Pass (Very Important For Dividend Investors - Dividend Currently Is 2.71%)
Revenues $483,208 billion (10-Year Trend Is Up) - Pass
Operating margin 4.9% - (10-Year Trend Is Down) - Fail
Price History of the stock Up 53% in the last 10 years excluding dividends - Pass
Healthy balance sheet Total assets = $198.7 billion (10-Year Trend Is Up) - Pass
Competitive Advantage
  • Cost Advantages
  • Economies Of Scale
  • Low Cost Brand - Pass
Resistant to recessions? Earnings Per Share actually rose during the recession of 2008 - Pass
Click to enlarge

So the metric sticking out like a sore thumb is the company's operating margins, which presently stand at 4.9% (average over the last four quarters). Furthermore, the company's 10-year average is 5.7%, so there is no doubt the retailer has a lot of ground to make up here. In fact, the $60 billion that management is touting will be added to the company's top line by 2020 may do very little for Wal-Mart's bottom line especially if a price war ensues between both online and offline competition. In saying this, dividend investors need not worry as the payout ratio is under 33%, which is really healthy despite the small increases we have seen of late. So how can this retailing behemoth get its operating margins back to where they belong? Here are a few things to watch:

  • Firstly Moody's came out recently and stated that it felt retail spending would drop in the US. On the surface, one may think that this is bearish, but not for Wal-Mart. Why? Well, we have already seen how impressively this company performed in the 2008 crisis when retail spending was on its knees. Earnings per share actually rose in the Great Recession as cash-strapped shoppers ditched "perceived" higher-priced goods and went for the "perceived" low-cost brand. Therefore, watch retail sales number. A contraction would be bullish for Wal-Mart as it would steal market share like it did in 2008/2009. Its huge store footprint in the US really becomes an advantage when the economy is in contraction mode.
  • E-commerce is the other area I feel Wal-Mart can make inroads especially through its third-party marketplace where it wants to add 1 million products per month to the website. This should increase sales and also margins despite e-commerce presently only making up 3% of total revenue. I have no doubt that bears would state this new volume would be nowhere near enough to affect the income statement in the near term, but all the market wants to see is a trend change which invariably results in the stock charging higher. We saw this last fall with McDonald's (NYSE:MCD) when the company stopped the rot of same-store sales in its US restaurants. Although we didn't see the trend change reflected in a huge spike in earnings at the time, the market knew bigger profits were coming and consequently priced the stock higher. Furthermore, its most recent Chinese offload states that the retailer will concentrate primarily on the US market for e-commerce and this makes sense in my view. It has a huge footprint and can position more supercenters around its fulfillment centers to provide an even better service.
  • Although Wal-Mart's e-commerce business only makes up 3% of its total sales ($15 billion of online goods sold last year), we can see from other retailers that there is an ample runway for growth in this area. Other retailers such as Nordstrom (NYSE:JWN) and Macy's (NYSE:M) for example have much better online divisions (as a percentage of their overall sales) and Wal-Mart knows it can do much better. Therefore WMT's plan is to build out its e-commerce network in an attempt to lower its delivery costs. Moreover, its ShippingPass program, which is currently offering a 30-day trial, is Wal-Mart's direct alternative to Amazon (NASDAQ:AMZN) Prime at $49 a year. If this initiative can gain traction, the recurring revenue model will be a big help to Wal-Mart, which should improve profit margins over time.

To sum up, we are holding Wal-Mart in our portfolio and will continue to hold despite its current operating margin issues. I'm going to be adding a few good dividend and growth stocks to the Elevation Portfolio over the next several weeks when I see value. In order to ensure that income is brought in every month, it's imperative that they are not correlated and all don't have similar valuations. You can follow along by pressing the"Follow" button above.

Disclosure: I am/we are long WMT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.