Wal-Mart's Future: Growth Or Decline?

| About: Walmart Inc. (WMT)
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In just 50 years, Wal-Mart (NYSE:WMT) has gone from Sam Walton's vision of putting large discount stores in underserved smaller communities to operating more than 10,000 retail outlets in all 50 states and 27 countries. Today, it's not only the world's number-one retailer, it's the world's largest company in terms of annual revenue, having generated $469 billion in its last fiscal year. Wal-Mart became an international company in 1991 when it opened its first Sam's Club near Mexico City. In 1999, it became the world's largest private employer, a title it still holds today with more than two million associates.

Wal-Mart shares have generated a 25% return for investors in the last year and about 11% year to date. Shares have traded between $57 and $77.60 in the last year, with a current price of $76. The company is valued at a price-to-earnings ratio of 15.

The question for investors and would-be shareholders: can Wal-Mart continue to grow substantially enough to generate future returns on investment?

The Case for Growth

The company's net sales have increased every year since 1998. Other than a minuscule decline in net income between 2011 and 2012, the company's net income has risen every since 1998 as well. Sales growth percentages have fluctuated over the past decade, in the 12-20% range from 1998 to 2001, and closer to 10% annually from 2004 to 2009.

For the fourth quarter of its fiscal 2013, which ended on January 31, 2013, total revenue was $127.9 billion, an increase of 3.9% from the previous year's fourth quarter. Income for the quarter was $5.6 billion, up 7.9%.

For the full-fiscal year, Wal-Mart reported revenue of $469.2 billion, an increase of 5% over fiscal 2012. It booked income of $17 billion, up 7.8% from the year before.

Wal-Mart recently raised its dividend about 18%, from $1.59 a share annually to $1.88, with a current yield of 2.5%.

Wal-Mart ended the year with free cash flow of $12.7 billion, compared to $10.7 billion in the prior year.

Wal-Mart decreased its long-term debt 13% to $38 billion over the past year. Its long-term debt-to-equity ratio stands at 47% down from 58% the same time last year.

Nobody can match Wal-Mart's size and scope. It has one of the largest private distribution operations in the world with more than 40 Regional Distribution Centers. Each one is over 1 million square feet in size and operates 24/7. Inside each center, more than five miles of conveyor belts move over 9,000 different lines of merchandise. Each center supports between 75 and 100 stores within a 250-mile radius. There are also distribution centers for specific product categories such as grocery, jewelry, pharmacy, apparel/shoes, and for Sam's Club. The Dotcom Distribution Centers, which support the Walmart.com online operation and the Site-to-Store program, is the fastest growing segment of the company's distribution network.

Wal-Mart is considered one of the world leaders in logistics. Four of every five items Wal-Mart sells in its stores goes through its distribution centers and is delivered by its own trucks, the highest proportion in the discount retail industry. Trucks are even more than half full on backhauls. Wal-Mart was an early adopter of cross-docking, a system in which items arriving on inbound trucks are immediately reloaded on outbound trucks headed to stores. The company has also adopted radio frequency identification, however slow adoption by suppliers has kept Wal-Mart from fully replacing bar coding with this new technology.

Because of its reputation for offering low prices, Wal-Mart has been able to build its brand with a much lower advertising/sales ratio than most of its rivals. Though it spends $2 billion annually on advertising, its advertising/sales ratio was 0.55% during the most recent financial years, whereas its chief competitors had ratios of 1.5% to 3%.

In addition to its innovation on the distribution side, Wal-Mart has stayed on top of trends in retailing. Over the years, Wal-Mart has introduced several formats. In 1983, the company opened its first Sam's Club membership warehouse modeled after Price Club. Five years later, it opened the first supercenter - a concept based on European hypermarkets - which is now the company's dominant format. In 1998, the company introduced its Neighborhood Market concept and two years later caught up with the Internet craze by launching Walmart.com. Just last year, the company started testing its Wal-Mart Express with two 15,000-square-foot stores in northwest Arkansas. Fuel has become a staple at many of its stores, and the company is testing the concept of installing lockers in certain stores to allow online customers a more efficient method of receiving the items they purchase.

Wal-Mart's economy of scale can be seen in its margins and returns, especially when compared with the industry average. Its average annual net profit margin over the last five years, 3.7%, is more than triple the industry average of 1.1%. Its average return on assets has been 8.7%, compared with the industry average of 1.8%, while Wal-Mart's return on investments has averaged 14.3% annually over the last five years, compared with 3.1% for the industry.

The Case for Decline

Looking at the whole of Wal-Mart's financials, competitive advantages and capabilities, it would seem there is little worry about the company losing its dominant position in the retail market anytime soon. Of course, many people thought the same thing about Sears many years ago, and that company is creeping toward extinction.

Wal-Mart's large size makes it more difficult to manage and create growth than a smaller company. It's difficult to grow physically in the U.S. when about two-thirds of the American population already lives within five miles of a Wal-Mart.

For fiscal year 2012, sales growth for Wal-Mart U.S. was only 1.5%, while Wal-Mart International experienced more than 15% growth. The gap was a little closer in the last fiscal year, with Wal-Mart U.S. achieving 3.9% growth against 7.4% internationally. The international division has accounted for similar growth in operating income for the past three years as compared with its U.S. counterpart.

One possible warning sign in the company's financials is the decrease in growth in same-store sales for its U.S. division, from a high of 9% in 1999 to a low of 1.6% in 2008. During the last fiscal year, the company's U.S. same-store sales, which includes Sam's Club, was about 2.2%. This could mean the company has saturated the U.S. market and is spending more to make the same amount of revenue because of store cannibalization.

Growth or Decline?

Even the analyst community is mixed on whether Wal-Mart can sustain growth. Currently, seven analysts are rating the company as a 'strong buy,' four a 'buy' while another 10 have the company as a 'hold.' But overall, the case for growth looks to be stronger than the case for decline. In the end, it may come down to whether you think Wal-Mark can manage its size and growth and continue to successfully innovate and scale its business even further.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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