Wal-Mart Remains Undervalued

The economy is slowing, but that is not a problem for retail giant Wal-Mart Stores (WMT). Wal-Mart is the world’s largest retailer and its economies of scale allow the company to offer lower prices than its competitors. So, as housing prices fall, gas prices rise, and the average consumer gets squeezed in between, Wal-Mart is a one-stop shopping destination for everything from groceries, to apparel, to DVD’s and video games.

So far this year, Wal- Mart stock has greatly outperformed that of its closest competitor Target (TGT). Their discount pricing strategy uniquely positions Wal-Mart to take advantage of the drawdown in consumer spending. Wal-Mart reported same store sales rose 2.6%--excluding fuel sales--in February which beat the consensus estimate of 1.1%. Sales growth has been an astounding 8.9%, much of that attributable to international sales growth which reached an incredible 19.8%. Furthermore, Wal-Mart boosted its annual dividend by 8% to $.95 from $.88, showing that the company is cash rich right now.

The increased dividend is not the only way that Wal-Mart is using excess cash reserves, as the world largest retailer continues to grow and open new stores. In fact, Wal-Mart plans to open 81 new stores this year which will employ 26,000 people, 16,500 of which represent new hires to Wal-Mart. While the company will be moderating growth plans for its “Supercenter” stores, they still intend to add locations. International growth continues to be quite strong as WMT will increase its stores in China by 30 locations, bringing the total there to 102. This will continue to help Wal-Mart’s bottom-line, as mentioned earlier; international revenue has grown by about 20%.

Ockham Research has been bullish on Wal-Mart for some time now, as the stock remains undervalued according to our methodology. Perhaps some of the bad press Wal-Mart seems to get on a regular basis has kept the stock unnaturally depressed. For example, WMT has a historical normal range for Price to Cash Flow of between 13.13 and 17.59 but that valuation metric is currently only 10.48. Similarly, the Price to Sales normal range is between .646 and .86, but it is only .505.

We have calculated these ranges based on what the market has historically been willing to pay for WMT and weighted the more recent years more heavily. So, given the undervalued nature of the stock price and a low price strategy that seems well positioned to ride out a rough patch in the economy, we can rationally expect Wal-Mart stock to attain a price of $63 when valuations reach more normal levels.

Disclosure: None

Comments

[clear1]

Great article! Agreed...the present valuation is a meaningful discount from its intrinsic value (and relative to its historical metrics of p/cf and p/s). Most importantly, it is finally trading to the upside in the face of bad news and poor performance among its peer group. We have owned the shares since the low and mid 40's...looking for your $60-65 target price. It is also worth noting that Berkshire Hathaway and Dodge & Cox now have large stakes...those folks don't make too many mistakes!

[Chungst]

Are we looking at the same company called Wal-Mart, with ticker being WMT???

"Wal-Mart boosted its annual dividend by 8% to $.95 from $.88, showing that the company is cash rich right now."

I am sorry to advise you that WMT's debt on its balance sheet has been increasing of late and that may help explain the strong cash balance. WMT's audited 2007 annual report revealed about $39 billion of funded debt on the balance sheet (WMT has considerable non-balance sheet as well, not to mentions commitments and contingencies) and WMT's unaudited 2008 balance sheet reveal about $44.7 billion of funded debt. That is to say, WMT's funded debt on its books continues to grow!

"The increased dividend is not the only way that Wal-Mart is using excess cash reserves, as the world largest retailer continues to grow and open new stores."

In Corporate Bond parlance, there is a term we used called Funds from Operations (net income plus primarily DDA and other non-cash adjustments before working capital account changes using the indirect method per FASB #95) was $18.7 billion based on audited 2007 numbers and that was insufficient to covered capex of $15.7 billion AND stock repurchase AND dividends. I don't see where this excess cash flow is. Based on the unaudited 2008 numbes, FFO increased to $20.1B and that again was insufficent to cover $14.9B in capex AND stock repurchases AND dividends. Perhaps what you meant to say per financial statement logic is that after WMT spent so much money on stock repurchase in fiscal year ended January 2008, it had to borrow money so it could continue to grow and open new stores. As you know, borrowing money for new stores is NOT the same as using retained earnings, respectively.

"In fact, Wal-Mart plans to open 81 new stores this year ..."

You failed to acknowledge that this number is a revised number, i.e. WMT had to rein in their growth from prior guidance in 2007. You never explained why WMT had to "moderate" its growth -- could it have been due to the fact that WMT's margins (i.e. EBIT margins) have been declining over time, that it's debt balances have been increasing over time, and that generic free cash flow (i.e. non-normalized CFFO less Capex) was about $4.5 billion based on audited 2007 statements and that number couldn't justify WMT's lofty valuations.

"For example, WMT has a historical normal range for Price to Cash Flow of between 13.13 and 17.59 but that valuation metric is currently only 10.48."

Based on my first two comments about your firm's understanding of basic cash flow analysis per financial statement logic, it makes me want to question your cash flow valuation metrics. Logic dictates that if you don't understand cash flow, then on what basis can you use cash flow metrics? Hmmm.

I would be very curious to understand how you treated the fact that WMT's EBIT margins now are so much smaller than say ten years ago, respectively. As you know from ROIC analytics, EBIT margins is one of the biggest drivers of NOPLAT margins.

Cheers.

[DeaverB]

ChungSt has a fabulous post above. Better than the original article, which is good itself. The only item I would add is Wal-Mart is "back" to being a discounter with lowering prices (not as much as they need to, but directionally correct) and not trying to be Target anymore. If they keep that up in the US, International growth will drive this company way up. See if they stick to the mission; as Peter Lynch says, "Sell when they change the strategy." They did some around 2000; seriously in 2004 Scott speech (we're going up to compete with Target, Kohls, etc); but of late he is firmly putting them back where they started. As McDonalds did with their $1 menu. If Wal-Mart really becomes Wal-Mart again, watch out.

[bluesmoke]

Good posts. WMT does seem to be doing a lot of things right lately. And seeing how many people shop there, it sure looks like a bellweather in this market.

[Gary Bushwacher]

WMT is the type of stock that will flourish in a recession; and yes we are in one.

They basically only sell staples and demand doesn't decline, for your basic necessary goods. In fact it goes up, because....

What does decline is "designer" goods. Abercrombe, GAP, Limited Too are already seeing same store declines and guess who's picking it up... WMT

[Ex15:26]

As a former very long time owner of WMT I can say that they need to continue focusing on being a low price seller and that's it.
My parents originally bought my first shares when I was in high school in 1985 and I sold my shares last year. My sell decision was based soley on how terrible my own personal experience was at the store over and over and over again.

I am a value shopper, so WMT is a perfect place for me to shop, however I repeatedly endured brutal customer service and very long wait times in their stores. It is no wonder that in my upper middle class neighborhood, I know am about the only person that shops there. My fellow church members all shop at Target and HEB (a local Texas grocery store) and have told me I am crazy for shopping there.
What I think WMT missed in their attempts to attract and retain shoppers in the middle & upper class is that they go for an overall client satisfaction experience, not just low prices on high-end goods.
Someone cited Peter Lynch above - Peter also went to malls and found places that people liked and enjoyed and were the rage. WMT may do better in this recession, but as soon as the economy turns, hurting middle class folks will be seeking better alternatives that deliver good product quality and customer satisfaction, with less emphasis on the lowest price.
Yes, I still shop there, but I felt that if I was this down on the customer service and experience the stock price long term was not going to provide the upside that I look for in my investments.

[Ray Lopez]

Everybody talks about low prices at WMT, but at least in California, there prices are not that low. I think it depends on the zip code.

[madmilker57]

well....if they have 95% China items in their China stores and China had a 63% drop in exports last month and a 33% increase in imports that company that has the star above the door is losing out big time.
Now.....for all the dipsticks that came from Princeton and Yale please red...oops! read between the lines.