Wal-Mart (NYSE:WMT) has done a fantastic job of raising its dividend year after year. The company operates its dividend growth schedule like clockwork. As fellow author FerdiS recently pointed out, the company has raised the dividend for 43 consecutive years.
Dividend Growth Forever?
The same article pulled out another great chart emphasizing the decades of increasing dividends. It's a dividend growth investor's dream. Any S&P 500 (NYSEARCA:SPY) company would love to repeat the results of Wal-Mart management. However, when I see something that works perfectly in an imperfect world, I start to wonder.
We all have heard the rumors of the buyback boom. We know the low-interest rates have had some effects on companies, one of which has been providing access to extraordinarily cheap capital. Cheap money makes it easier to raise earnings per share from many other sources than just "doing better." I put forward that Wal-Mart is no longer the operating king it once was, recent gains in EPS are from stock buybacks. Furthermore, Wal-Mart management is unable to continue providing a rising dividend - current trends do not justify it.
WMT data by YCharts
A 40-Year History
Looking back over a 40-year history of Wal-Mart shows an interesting story. Buybacks have been commonplace for a much longer period than ten years, with declining shares outstanding dating back to the late nineties. However, as we see above, in late 2014 we started to see a failure of the company to raise operating income. The competition began to heat up, and Wal-Marts strategy of crushing local opposition before jacking up prices has failed to continue to yield the incredible returns of the past. Now the buybacks carry on as the only way of raising, the number of shares outstanding continues to decline. This is perfect for investors for now, but it leads to the conclusion; what happens when the buybacks stop? If the company can't increase EPS through operational means, the dividend must cease to rise -- or the company risks the balance sheet.
WMT data by YCharts
Examining The Cash Flow Statement
Ray Merola is an author I find provides a bevy of directly applicable information. He recently wrote an article titled: How To Check A Cash Flow Statement And Why It's Important To You. In it, he provided some great rules of thumb for examining a cash flow statement. Before I go on, Mr. Merola hasn't endorsed this article, and I'm merely using it as a stepping stone for this analysis as a way of pointing investors towards his immediately relevant work. Here are the four main focuses, a few of what we have touched on.
- Operating cash flow and trend
- Free cash flow and trend
- Operating cash flow per share versus EPS
- Dividend coverage ratio as a function of free cash flow
Operating Cash Flow And Trend
Below, we take a look at cash from operations, and a pair of important connected variables -- income and operating margin. Wal-Mart has consistently gained revenue quarter on quarter, however, in the recent 3-4 years the company has had to forgo higher margins to do so. Thus, rising cash from operations as the lone wolf predictor doesn't give enough information. As margins get squeezed, and if revenue does ever drop, Wal-Mart could see rapid destruction in its slowly declining operating income (arguably a more important figure). This ties directly into the next point, free cash flow.
WMT Income from Continuing Operations (TTM) data by YCharts
Free Cash Flow
Free cash flow tells a different story than we see above. We need to pair it with EBITDA and depreciation and amortization to get to explain dropping earnings despite rising free cash flow. To deliver increasing free cash flow, Wal-Mart needed to increase revenue. The rising free cash flow numbers depend on an ever-growing number of stores.
As the numbers of stores increases, new markets are less lucrative than older markets. Using an analogy from oil and gas, Wal-Mart was high grading store locations. Older locations start to receive competition, and we start to see degrading margins. These items together make up my justification for poor future performance for Wal-Mart. Don't worry about calls for a $15/hr national minimum wage, Wal-Mart is running out of lucrative places to put stores while, at the same time, older stores receive tougher competition.
WMT EBITDA (Annual) data by YCharts
Operating Cash Flow Per Share Vs. EPS
Here is an area where I can't fault the company. Wal-Mart has a track record of converting cash from operations to EPS. A track record that has seen a dip in the most recent quarters and time will tell whether this is a trend -- or merely an outlier. The trend continues with what we have seen thus far in the analysis -- Wal-Mart is and always has been a well managed, however, they are running into a wall of diminishing returns and increased competition that will stymie growth.
WMT Cash from Operations (Annual) data by YCharts
Dividend Coverage As A Function Of FCF
For Wal-Mart, using dividend coverage as a function of FCF is wrong (not that Ray is, but using any metric requires adaptation to the circumstances). We already know that they are seeing declining margins and that Wal-Mart needs to continue to build new stores to increase revenues. What I am interested in is how dividend payments have been rising against EBITDA -- as a friend would say, earnings before you fudge the numbers (no comment on Wal-Mart).
Here lies the crux of the company's future growth prospects. Wal-Mart is facing declining EBITDA while it continues to increase its dividend (note the dividend payments are negative). Management is entering into a period of unsustainable dividend growth. At the moment, that is just an opinion, but if recent headwinds for the company continue or accelerate, it will become a fact. Wal-Mart will follow along with a bevy of other publicly listed companies that continued to increase the dividend in the hope of rising future earnings.
WMT Total Dividends Paid (Annual) data by YCharts
I see Wal-Mart as providing an interesting mix of management and value. While to date, I see good management care in the free cash flow numbers, and conversion of money to EPS; I fail to see tailwinds for the groups growth. Wal-Mart appears to be running into the laws of diminishing returns and stronger competition. Suffering margins will quickly deteriorate the dividend cover for the company, which is what we have seen for the last decades. The dividend cover for Wal-Mart continues to decline year on year.
WMT Dividend Cover (Annual) data by YCharts
I don't see good growth prospects for this company. When good management meets a company with a weak outlook, the company usually wins (to the sadness of its investors). As a last thought to investors, and with the recognition that with enough data, one can find a correlation between something, I leave you with this.
US Labor Force Participation Rate data by YCharts
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in WMT over the next 72 hours.
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.