Wal-Mart: The Best Play in This Market

Finding solid investing ideas in this market has not been the easiest thing. With the housing market and credit markets still unraveling, companies and consumers alike are finding themselves strapped for cash, as they try to reverse years of highly leveraged balance sheets and bad habits in dealing with their money. Volatile markets have scared off even some of the riskiest investors as 300 point swings in the Dow seem to be nearly a weekly occurrence.

One company that has stood the test of time and should continue to perform well is Wal-Mart (WMT). Most of you have probably shopped at Wal-Mart at one point or another, especially nowadays, as most consumers have had to cut down on discretionary spending. So why do I like Wal-Mart? Let’s find out.

Company Description

Wal-Mart is an operator of discount retail stores worldwide, providing household and consumer goods at the lowest prices. The firm is broken up into three units: Wal-Mart, Sam’s Club and International. As of the last quarter, sales were up 5.8% in their Wal-Mart division, 6.7% in Sam’s Club and an astounding 17% growth rate in international markets, which currently comprises about 25% of sales. The Wal-Mart division holds about a 20% market share in the competitive supermarket market and continues to be a one stop shop for the consumer looking for the lowest prices.

Strong International Growth

As of the second quarter of WMT’s fiscal 2009, it has recorded a 16.9% increase in international sales, a growth rate not very common in staples companies, especially ones as big as Wal-Mart. By opening up Trust-mart in China, after an acquisition a few quarters ago, and expanding in other emerging market territories like Brazil and India, Wal-Mart has positioned itself well in international markets and has realized some of its potential with recent strong international growth. While this may not be a good thing for most companies in what looks to be the beginning of a global slowdown, Wal-Mart is a company that people turn to during hard times, for their low prices. As management said during its last conference call:

Customers are counting on Wal-Mart for the lowest prices, and we remain committed to our mission to save people money so they can live better.

In fact one of the most interesting segments for Wal-Mart, its United Kingdom region, had same store sales growth of 5.5%. If you read my article on the current status of the British economy, it is starting to show eerily similar signs of the beginning of the housing crisis in the Untied States, so for WMT to provide stellar results in this area and increase market share by 60 basis points tells me that WMT should thrive if we truly are in a global slowdown. The strong international growth will only propel them forward, as struggling consumers in all countries will be looking for the lowest prices, and we all know Wal-Mart normally has the lowest prices. It is important to note that Wal-Mart has kept up with objectives by increasing operating income faster than sales in these areas. Here is just a summary of international growth rates as of the second quarter:

Mexico: 12.2%
Canada: 9.5%
Brazil: 16.6%
China: 32.2%

Bucking The Trend

Indicator	May	June	July	August
Wal-Mart Same Store Sales	3.9%	5.8%	3.0%	3.0%
Unemployment Rate	5.5%	5.5%	5.7%	6.1%
Retail Sales	3.5%	0.3%	-0.1%
Disposable Personal Income	5.2%	-2.6%	-1.7%
Consumer Spending	0.8%	0.6%	0.2%

The table above is a summary of some of the most important economic indicators along with Wal-Mart’s same store sales numbers during the past few months. It is important to note that Wal-Mart’s numbers are year-over-year, while the economic indicators are month-over-month. That being said, Wal-Mart has improved upon its numbers from last year, when the economic situation was much better, even while consumer spending, retail sales and disposable income have significantly deteriorated from already lower numbers in months past. Wal-Mart continues to put up solid same store sales even in the wake of skyrocketing unemployment.

On the other hand, its main competitor, Target (TGT), has struggled to maintain its same store sales number in the wake of the eco,nomic downturn. Let’s face it, when people are struggling they turn to Wal-Mart and I think if you look at the fact that other retailers have struggled while Wal-Mart has thrived, that should be some great evidence to show that WMT is going to come out of this global slowdown as the top discount retailer.

Strong Cash Flow and Value Creation for Shareholders

During a time when S&P 500 earnings are down 22% YoY, Wal-Mart posted a 14.7% increase in earnings YoY, which just further strengthens my point that Wal-Mart thrives regardless of the economic situation. This is not only a doing of Wal-Mart’s low prices, but also due to management's strong foreshadowing. Let me explain that a little more: In 2006 and 2007, WMT began to sense that its  consumer was being pressured, so it scaled back on the number of new stores it was going to open and instead focused on trying to get products on the shelves at even lower prices, while still maintaining solid margins (with its supremely efficient supply chain). With increased awareness in inventory management and forecasting the pressure of the consumer Wal-Mart has been able to maintain their earnings.

After the first six months of this year, WMT has free cash flow of $4.9 billion, compared with a deficit last year of $773 million. This is due to the work of the reduction in capex and the effective improvement in operations mentioned above. Target on the other hand has negative free cash flow through the first six months of the year. It has also consistently increased its dividend every year since 1974, which is something I always look for in a staples company.

It also repurchased about $845 million of stock during the 2nd quarter, in line with its $15 billion share repurchase program, which is about halfway complete. Wal-Mart clearly has a reputation of returning value to its shareholders through strong earnings, consistent dividends and share buybacks. The strong free cash flow situation just assures investors that it will be able to continue with these programs well into the future.

Risks

There are some risks involved with Wal-Mart, but I would say they have minimal impact on the business.

1. The first risk with Wal-Mart is its Sam’s Club segment. Operating income in this division decreased this quarter, mainly due to the lack of membership renewals with the tough economy and high fuel costs. This is primarily due to the extremely volatile oil prices, which affected its fuel business’ profits during the first half of the year. With the recent pullback in oil, I would expect this concern to be alleviated, but the membership renewal probably won’t be back at full force until the beginning of 2009.
2. Inefficiency in its supply chain or poor inventory management is a concern that WMT has always had and will continue to had as it is extremely important in order for them to manage these two properly in order to ensure strong earnings.
3. If WMT can not maintain its low prices and keep them lower than competitors on average, then Wal-Mart will run into a lot of trouble.

Valuation

P/E (ttm): 17.77x
Forward P/E: 15.74x
ROE (ttm): 20.7%
Price/Sales: 0.59x

I have highlighted some of the financial ratios above for WMT. At this point Wal-Mart, in my opinion, is slightly undervalued on a P/E basis. It is just a bit higher than Target, and lower than Costco (COST) (another main competitor). Wal-Mart is the biggest and has been the most successful of the three, which means, theoretically, it should be trading at the higher end of the P/E range for its industry. It has a strong balance sheet and great profitability, which should continue if the economic situation both in the US and abroad continues to worsen. With the strong cash flow situation mentioned above, possibility of even higher growth in international markets and the chance of a global slowdown positively affecting its business, WMT is one of the best plays in this market.

Disclosure: The author does not hold a position in any of the stocks mentioned.

Comments

[jerico:]

Great summary! Wal-Mart is ahead of the curve regarding preparing for and dealing with recession. They dance with the one who brought them to the dance. They work to serve the low to middle income customer. The number of low to middle income customers, or those who perceive themselves as such, have increased in the last couple of years. Therefore, the customer base they have designed their business around is growing.

2008 Sep 11 09:55 AM