Wal-Mart (NYSE:WMT) is cheap. Regardless of how you value that dividend champion, the price should be very attractive. There is an illusion that Wal-Mart is doomed. Investors are terrified of holding the next Sears (NASDAQ:SHLD). I understand the concern. No one wants to hold the next Sears. However, there is little comparison between Wal-Mart and Sears beyond being large retailers. As Mark Twain would say, "The reports of my death are greatly exaggerated."
On a fundamental level, Wal-Mart remains strong and shares remain exceptionally cheap.
EV to EBITDA
I pulled up the chart of the last 10 years showing Wal-Mart's share price and the EV to EBITDA ratio. This chart helps investors break down the difference between price movements in the stock market and the ability of the company to generate EBITDA (earnings before interest taxes depreciation and amortization). It also allows investors to automatically incorporate the presence of debt in the valuation:
Wal-Mart trades at an exceptionally low multiple of EBITDA. The EV to EBITDA ratio is running about 7.27. Wal-Mart traded below that multiple for most of 2010 and dropped significantly below that multiple in late 2015. Both opportunities were followed by substantial growth in the share price. If the concern for Wal-Mart is a function of Amazon (NASDAQ:AMZN), it is well past due. Wal-Mart traded over $85 less than 2 years ago. Was Amazon not a threat back then? Is Wal-Mart suddenly falling apart?
Both suggestions sound absurd to me. Yes, Amazon is an incredibly strong competitor for some sales. However, they were already strong two years ago.
The next chart shows EBITDA across the entire company on the basis of the trailing 12 months. This method allows investors to have the new quarterly data replacing the oldest quarterly data rather than only using annual data. See the chart below:
EBITDA for Wal-Mart rose from slightly over $25 million to a peak of about $37 million before declining to the current level of $33.6 billion for the trailing 12 months. The headwinds Wal-Mart faces for growth in earnings and EBITDA are already included. The higher cost of wages is already seen. The one cost center that may still grow significantly is the investments in developing their online presence.
Acquisitions of smaller companies don't have to be expensed, but research and development costs are expensed as incurred. It is a quirk of accounting. Wal-Mart is emphasizing growth of their online presence over the next few years and expects to invest heavily in the area. The impact on earnings will depend on whether Wal-Mart invests internally or acquires smaller companies. From the perspective of a dividend investor, the impact is the same because it is cash leaving the company.
Since most investors are only interested in buying the stock rather than the entire company, some will want to discuss the metrics on the basis of their investment. Since the investor will have a given number of shares, the most logical place to start is looking at revenue per share. Rather than using revenue across the entire company, revenue per share emphasizes the amount of sales those shares represent.
When a company is using an aggressive buyback program, it is important to assess returns on a per share basis. Revenue per share has increased substantially since 10 years ago; it climbed from less than $85 per share to over $150 per share. For all the threat Amazon poses to Wal-Mart, revenue per share continues to grow. If investors want to look at the stock from a fundamental perspective, then it is a question of the revenue per share and the earnings produced from those revenues.
That brings us to the next chart which provides Wal-Mart's earnings per share on a rolling 12-month basis. Earnings per share rose from under $2.75 to greater than $5 before falling back to $4.66. The growth rate in earnings per share looked excellent up until the start of 2014.
What we are seeing as investors is substantial growth in earnings per share compared to only moderate growth in the share price. The fundamental operations of Wal-Mart continue to generate strong earnings for shareholders. Those earnings continue to easily cover a strong dividend and a massive share buyback program. The result of trading at low ratios is higher dividend income and faster compounding of metrics such as earnings per share and revenue per share.
Low multiples in the share price make buyback programs more effective. For an investor with a long-term focus and no need to harvest income immediately, reinvesting dividends leads to an even faster growth in the earnings per position and revenue per position.
To make that concept easier, think about the increase in revenues per share and adjust the value for the dividend yield. If you own a hundred shares at the start of the year and around 103 shares at the end of the year (due to dividend reinvestment), the revenues and earnings attributable to your position would grow 3% faster than the revenues and earnings per share.
Due to the rapid buyback by the company, EPS and RPS (revenue per share) grow faster than the revenues and earnings across the company. If Wal-Mart averages repurchasing 3% of their stock per year and carries a 3% dividend yield, then a 0% growth rate for earnings at the company level would still lead to 3% growth in EPS and 6% growth in the earnings per position. If the dividend payout ratio stayed flat, dividends could grow at 3% per share and by 6% for the shareholder choosing to reinvest for another year.
Wal-Mart is a dividend champion with a strong yield and an aggressive buyback program. They trade at low multiples of earnings and EBITDA. The company grew rapidly for years but the share price doesn't reflect the growth because the stock is priced at lower multiples. The low multiples are ideal for an investor with a long-term investment horizon. The company is facing a few headwinds to earnings, but these headwinds are already limiting the current values.
The company trades at attractive multiples of the already depressed earnings. The aggressive buyback program will consume a large amount of cash and numbers across the company may look weaker but the "per share" metrics should be just fine. In a year or two, when a new narrative takes hold, the company could see share prices jump higher. In the meantime, shares are available at bargain prices.
My rating = Buy
My portfolio includes some Wal-Mart. After an expensive summer, I see more opportunities developing for the investor seeking a solid source of income. It should be no surprise that the increasing treasury rates occur at the same time as weakness in several other strong income investments.
Disclosure: I am/we are 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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