by Larry Gellar
While a possible bribery scandal at Wal-Mart (WMT) has many investors calling for top management to be removed from their positions, the California State Teachers' Retirement System is not quite ready for these step to be taken. Indeed, that was one of the main issues arising during a recent conference call with the second-largest public pension fund in the U.S. Specifically, CEO of the California State Teachers' Retirement System, Jack Ehnes, said that "the leadership question is on the table" -- and the organization owns over 5.3 million shares of Wal-Mart. This comes after The New York Times reported last month that Wal-Mart de Mexico (a business that Wal-Mart has a 69% stake in) used numerous acts of bribery over the past decade to achieve market dominance. Additionally, Wal-Mart CEO Mike Duke has come under fire in particular, since he was the head of the company's international business during part of this time period.
While this news certainly calls into question the integrity of one of America's largest companies, Wal-Mart is still a great stock to hold right now. The stock has a price-to-earnings ratio of 12.92 at the time of this writing, which is lower than a number of other similar companies such as Target (TGT) at 12.98, Costco (COST) at 24.29, Fred's (FRED) at 15.91, and Dollar General (DG) at 21.40. Wal-Mart's price-to-book ratio (2.83) and price-to-sales ratio (0.45) are also relatively low. Meanwhile, Wal-Mart's margins (3.68% net profit, 25.02% gross, 7.76% EBITD, and 5.94% operating) are closer to the middle of the pack but still good enough to sustain future profitability.
Of course Wal-Mart can generate profits, but the real question is how much of a shakeup will be caused by the California State Teachers' Retirement System. While the comments mentioned above would be enough to stir things up, the pension fund is also formally suing Wal-Mart. Here's why the California State Teachers' Retirement System is suing, as mentioned in the actual lawsuit:
The Board's prolonged failure to address detailed and credible allegations of criminal activity undertaken with the tacit or express consent of current and former senior corporate officials, and the complicity of the Company's highest level executives in shutting down any investigation into those allegations, is causing and will continue to cause the Company substantial harm.
That's a pretty damning statement, but it's true: Wal-Mart's actions (and lack thereof) could have violated the U.S. Foreign Corrupt Practices Act as well as rules put in place by Sarbanes-Oxley. In many ways, the issue is twofold: Wal-Mart may have used bribery in Mexico, but it may also have been working to cover up the details.
Wal-Mart's low prices and massive presence throughout the world are what make this company so valuable. Still, I would be remiss not to detail a couple of interesting issues that the company is dealing with. For instance, Wal-Mart has had to release employees that labeled regular pork as organic pork in China. Due to additional previous violations, however, the city of Chongqing decided to close the company's stores for two weeks. Hopefully Wal-Mart will be able to get back on the good side of authorities in that region, but I can't imagine this news affecting the stock price going forward.
This is not the only controversy outside of the bribery scandal, however. Wal-Mart also violated overtime laws for a number of employees at its vision centers, Discount Stores, Supercenters, Neighborhood Markets, and warehouses for Sam's Club. The issue was that Wal-Mart incorrectly considered some employees to be exempt from overtime, and the company will now pay $4.8 million to rectify the issue. Wal-Mart will also have to pay $464,000 in civil penalties. This is yet again another unfortunate situation, but probably not something that will affect this company's fundamentals.
What will affect this company's fundamentals is its ability to gain traction in the small-store business. Indeed, the market for urban shoppers is estimated to be about $80 billion per year, and Wal-Mart will need to find a way to serve these consumers in order to keep growing. In fact, this is one area where I think Wal-Mart is firmly on the right path. While net margin for the smaller Neighborhood Markets was 1% when it first started, that number is now up to 3%. Reduced expenses for decorations and expenses have played a large role in that, and I'm confident that Wal-Mart will continue to find ways to make these stores more profitable. For example, Wal-Mart plans to do more research on the best balance between food and non-food items, and this could be an important adjustment. At the very least, Wal-Mart's urban locations should slow down the ability of competitors to build up their image.
Wal-Mart is also embarking on a strategy to allow consumers who don't use banking services to still buy items online. These customers will be able to pay for their transactions at a Wal-Mart store with cash. I don't really view this as a groundbreaking development, but it could help Wal-Mart get any last niche of consumers it has not tapped into yet. In fact, approximately only 15% of Wal-Mart's transactions are made via credit card. Additionally, there is at least some research that estimates between 18% and 24% of the U.S. population does not use traditional banks.
Overall, I see Wal-Mart as a sprawling giant with more than enough resources to keep up its 2.7% dividend yield. For the fiscal year ending in January, Wal-Mart had $24.25 billion of operating cash inflow. With a mix of capital expenditures, stock repurchases, and dividends paid out, this company is clearly creating value for its shareholders. By continuing to grow globally, Wal-Mart should be able to overcome any obstacles created by its occasionally deviant business policies.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
