Wal-Mart's Hidden Source Of Value

| About: Wal-Mart Stores, (WMT)

This article is part of an ongoing series that highlights specific companies that are on sale. It helps me to document my thought processes when I add to my holdings or initiate new positions. Please provide your feedback in the comments section below.

Walmart (NYSE:WMT) is currently offering investors an opportunity to buy portions of the company at $78.50/share. The stock had been steadily declining for the month of December since reaching it's 52 week high and may now provide a good entry point. Right now, WMT is about four percent off the 52 week high, hit a month ago at about $81 per ownership interest. This brief pullback provides longterm investors with a good opportunity to initiate a position. Essentially, WMT has earned a whole month's worth of profit and repurchased an entire month's worth of shares, yet the price is a few percent lower than it was before that happened.

Walmart has a business model that is simple and sustainable. It manufactures or buys products and sells them through retail stores and warehouse clubs worldwide. Walmart has competitive advantages through it's scale, in that it can purchase goods to sell at steep discounts due to the large volume of it's purchases. About 75% of it's merchandise is sold before it even has to pay for it, which gives Walmart a financial float. Walmart is also able to increase its revenue at a rate that keeps up with inflation, passing along the devastating effects of inflation on to the consumer, not the owners. According to the 2013 Annual Report, sales growth was 5% year over year. Earnings per diluted share rose over 10%. Additionally, WMT is investing for future growth.

Despite the growth, I believe that Walmart trades at a discount to it's true valuation. WMT currently trades at 15 times ttm earnings and under 14 times projected next year earnings. EPS is expected to grow 9% next year and average about 9% for the next five years. WMT appears to be turning around now, and I am content to accumulate shares at this perceived discount.

Also, Walmart is a cannibal! WMT has been buying back it's own stock at a pace that affects the bottom line. Just one year ago, four short quarters, there were 3.38 billion shares outstanding of WMT. Today, there are under 3.27 billion diluted shares. In one year, Walmart has retired over three percent of its outstanding share volume! In three years, the company has retired 11% of it's outstanding shares. The company has indicated on many occasions that returning cash to shareholders via share buybacks is an important goal for management. They are using their free cash flow to buy out other shareholders, which further adds to the gains of the remaining shareholders.

With Walmart buying so much of their outstanding shares, let's look at how that will affect earnings. Analysts are expecting a consensus EPS of $1.65 for the next quarterly earnings release, with the lowest estimate coming in at $1.55. For reference, WMT reported EPS of $1.67 for the same quarter last year. It doesn't appear that analysts are expecting much, if anything, from Walmart. With WMT's large share buyback activity, it wouldn't have to make more in total earnings to affect the bottom-line EPS. Even if profits stagnate, EPS will increase due to the share buyback. I believe that Walmart will have a positive surprise, and this is the catalyst that will cause WMT to break out from it's recent downward trend and close substantially higher at the end of 2014.

Let's take a quick look at a couple of WMT's competitors, Target (NYSE:TGT) & Costco (NASDAQ:COST). WMT is trading at the lowest P/E of the bunch at 15. Target & Costco sport price-to-earnings ratios of over 17 and over 25, respectively. Walmart also has the highest ROE, ROA, and profit margin, by far. Walmart is the type of company that I want to own for the long haul, and this appears to be an opportune time to add to my position.

Walmart also has a solid yield for such a stable company. You literally get paid to wait. WMT has a current yield of over about 2.5%. Though this might not be as large a yield as many DGI are used to, Walmart is due to raise it's dividend soon, which drives price appreciation. During the financial crisis, Walmart did not cut its dividend. In fact, it raised the dividend! Walmart is a Dividend Champion and has raised it's dividend every year for 39 years. It's ten year dividend growth rate of 18% is a much faster pace than inflation. That means that if you are relying upon dividend income to sustain you, you would not lose purchasing power over time. In fact, it would grow. WMT is both a buyback king and a dividend king!

Combined with their earnings growth and share buyback activity, there is one other catalyst. It was recently announced that Walmart is opening a micro-store of under 4,000 square feet at the campus of the University of Missouri. Walmart already has "Walmart On Campus" locations at Arizona State University, Georgia Tech, and the University of Arkansas. Walmart has said that this format, which includes pharmacy & produce, meets student needs for budget and lifestyle. The new strategy focuses on strategic investments, lowering average location costs, and innovation. As the effects of these catalysts are combined with sales growth and increasing cash flow to buyback shares, Walmart will only become stronger.

As always, this article represents my opinions at the time of writing. You should do your own due diligence before making any decisions. However, I believe that Walmart represents a quality company that is trading hands at a discount.

Disclosure: I am 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.

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