"We are in the real estate business, not the hamburger business."
- Ray Kroc, founder of McDonald's (NYSE:MCD)
The scale of Wal-Mart's (NYSE:WMT) operations is staggering. The company will sell $1 trillion worth of goods over the next two years. It employs 2.3 million people. The company owns over 1 billion square feet of real estate - more than enough to cover the island of Manhattan and the entire city of Berkeley, CA, combined. Since the numbers are so overwhelming, I think it is a productive exercise to try to break the business down into more understandable chunks and value them separately. The most logical way to break down the company is into component parts and compare those to other publicly traded companies. You could do this in any number of ways; I chose to break it into real estate, e-commerce, supermarket/pharmacy, international, and the legacy business. Today, I will look at Wal-Mart's real estate business.
As of the last annual report through January 31, 2016, Wal-Mart owned and operated 6,738 out its total 11,865 stores and distribution centers. Based on the average sq.ft. of unit by type (Supercenter, Sam's Club, etc.) and the number of each type owned and operated, I came to a total of approximately 990 million sq.ft. of real estate WMT owns. It has added tens of millions more sq.ft. in the last year, but we can't approximate those numbers until the annual report is released in March, so I will conservatively estimate 1 billion sq.ft.
In my last article I estimated the real estate value at $230 billion using a Commercial Real Estate Index and the amount Wal-Mart had spent each year going back 25 years. Since Wal-Mart does lease roughly 20% of its US locations, we can also value the owned real estate by looking at comparable sales of real estate it is currently leasing. Commercial real estate is valued in two ways: by Capitalization Rate (cap rate), which equals the percent return you get each year from rent minus expenses before debt payments, and by price per sq.ft. These are the first 4 results where cap rate and square footage are given when you Google "Wal-Mart NNN lease for sale." NNN, or Triple Net lease, just means the tenant pays all insurance, taxes, and maintenance. They are spread across the country and include a Neighborhood Market, Sam's Club, and Supercenters, so they should represent a cross-section of the real estate assets. The average price per sq.ft. is $243, and the average cap rate is 4.84%. Three of these are asking prices and not sold, so I discounted them by 5% to $231/sq.ft. and a cap rate of 5.1%. If those numbers held across the real estate portfolio, it would value them at just over the $230 billion I had estimated earlier.
What would the market value Wal-Mart's real estate business at if it stood on its own? I contend that the business would look a lot like Realty Income Corp. (NYSE:O), so we can value it in relation. O owns 4944 retail properties across 49 states that have long-term triple net leases to national brands. The top 10 tenants, which make up 37% of revenue, include Walgreens (NASDAQ:WBA), Dollar General (NYSE:DG), BJ's Wholesale, CVS Health Corp. (NYSE:CVS), Dollar Tree (NASDAQ:DLTR), Family Dollar (NYSE:FDO), AMC Entertainment (NYSE:AMC), and FedEx (NYSE:FDX). O is trading at a 31% premium to where this article had estimated the underlying real estate (Net Asset Value, or NAV) was worth in August and at a cap rate of 4.50%. It trades at a dividend yield of 3.84%. I calculated the company borrows 29.5% of the value of the real estate at a weighted average interest rate of 4.3% as of the last annual report.
If Wal-Mart spun off all the owned real estate to a Real Estate Investment Trust (REIT) on the following assumptions:
- It traded at underlying Net Asset Value (not a 31% premium like O).
- Wal-Mart paid the 5.1% cap rate in rent on NNN leases ($11.7 billion in rent/year).
- It took on the same debt structure and terms as O (29.5% ltv at 4.3% interest).
- Running the REIT cost 3% of rents (seems high for one-tenant long-term NNN leases).
- It paid the remaining cash flow as dividends.
- The underlying real estate's value is $230 billion.
Then each share of Wal-Mart would receive $22 in cash (from loan proceeds) and a share of the REIT trading at $52.7 that would be paying a dividend yield of 5.2%. The total of $74.7 is $4 more than Wal-Mart is currently trading at.
Wal-Mart could easily pay this extra $11.7 billion in rent out of its Cash Flow of Operations of $31.5 billion and Free Cash Flow of $21 billion in the last 12 months.
It is my understanding that because the Walton Family Trust owns almost half of Wal-Mart and such a spin-off would cause a tax problem for them, it is unlikely to ever happen. Also, Sam Walton was burned on a lease for his very first store. This caused the company to greatly prefer owning rather than leasing - a preference that lasts to this day. So I believe management would be against such a spin-off as well. This analysis is just to show that the value is there.
I can think of no reason to invest in any retail REIT - O, National Retail Properties (NYSE:NNN), Agree Realty Corp. (NYSE:ADC), Brixmor Property Group (NYSE:BRX), VEREIT (NYSE:VER), STORE Capital (NYSE:STOR), Equity One (NYSE:EQY), GGP Inc. (NYSE:GGP), Simon Property Group (NYSE:SPG), DDR Corp. (NYSE:DDR), Federal Realty (NYSE:FRT), Macerich (NYSE:MAC), Regency Centers (NYSE:REG), Taubman Centers (NYSE:TCO), Kimco Realty (NYSE:KIM), Weingarten Realty (NYSE:WRI) - over investing in WMT. If WMT trades 50% higher from here or the retail REITs trade 35% lower from today's levels, only then could a rational investor start to make a case for the relative value of the REITs on a diversification basis. On a pure intrinsic value basis, I think it would take a doubling of Wal-Mart's shares to bring the values into line.
In future articles, I will show the value in the other parts of Wal-Mart's business after accounting for the rent paid in this article.
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.
Additional disclosure: I also own WMT long-dated call options, and am short a smaller amount of O as a hedge.