Founded in 1945, Wal-Mart Stores, Inc. (NYSE:WMT) is the world’s largest retailer, operating more than 11,000 stores across across 27 countries that serve more than 250 million customers weekly.They operate through supercenters, wholesale clubs, and Neighborhood Markets, in addition to e-commerce.
The company is the largest publicly traded company in the world by revenue and also the world’s largest private employer.
There are three reportable segments: Walmart U.S. (60% of fiscal year 2015 sales), Walmart International (28%), and Sam’s Club (12%).
Wal-Mart operates in superlatives. They are “the world’s largest” in a number of different categories. As such, due to the law of large numbers, a company this large isn’t really expected to grow very quickly. Yet they’re actually holding their own.
From FY 2006 to FY 2015, revenue increased from $315.654 billion to $485.651 billion. Huge numbers here. Revenue grew at a compound annual rate of 4.90% over that period, which is pretty impressive when we’re talking about coming off of a base of over $300 billion.
Meanwhile, earnings per share increased from $2.68 to $5.05 over the last decade, which is a CAGR of 7.29%. I think long-term EPS growth over 7% for a company this large is really rather incredible. However, EPS growth over the last three fiscal years has slowed markedly.
Substantial share repurchases helped the bottom line, and will likely continue to do so. Over the aforementioned time frame, WMT bought back over 900 million shares and reduced the outstanding share count by approximately 22%. This activity will likely continue for the foreseeable future: As of January 31, 2015, $10.3 billion remained on the current $15 billion share repurchase program.
S&P Capital IQ is calling for 7% compound annual growth in EPS over the next three years, which is in line with what we see above.
Now, where WMT shines extremely bright is in regards to their dividend history. Serving millions of customers every day and registering sales of almost $500 billion is all fine and dandy, but, as a part owner and business partner, I want my fair share of profit via a growing dividend.
Well, WMT doesn’t disappoint here.
They’ve increased their dividend for the past 42 consecutive years. That period, by the way, stretches from the Vietnam War to the Great Recession and on through today. Not too shabby.
Over the last decade alone, the dividend has grown at an annual clip of 14.8%. That’s twice the rate of EPS growth, which is obviously unsustainable. In addition, the last two dividend increases have been substantially smaller, likely because profit growth over that period has been disappointing.
However, a payout ratio of just 39.5% indicates the dividend is sustainable and in no immediate danger. In fact, I’d consider it extremely likely that the dividend will continue growing at a rather attractive rate moving forward.
The stock yields 2.70% right now, which compares incredibly favorably to the five-year average yield for this stock of just 2.3%.
Looking at their financial situation, the balance sheet is solid and stable. Long-term debt seems quite imposing at over $41 billion, though that’s mostly unchanged over the last five years and is very manageable for the company. The long-term debt/equity ratio is 0.51 and the interest coverage ratio is north of 11. These numbers are in line for the industry.
Profitability doesn’t immediately impress, and that’s because the retail industry is fraught with razor-thin margins. WMT does pretty well here, though the margin is still thin. Over the last five years, the company has averaged net margin of 3.49% and return on equity of 21.97%. Both metrics compare favorably to peers.
The company enjoys immense competitive advantages, which leads to the growth we see above.
First, WMT’s sheer size confers massive economies of scale. In addition, the firm has unrivaled pricing power and negotiating power over suppliers. They’re able to leverage this by securing low prices on merchandise, which they’re then able to pass down to consumers. This puts them in an enviable position where they’re able to beat the competition on both price and total selection, in most cases.
While this model works incredibly well in their supercenter format, they’ve been facing fierce and increasing competition from the smaller dollar stores that are able to provide convenience by fitting into spaces that Wal-Mart’s large stores do not.
As such, the company has responded by rolling out their smaller format stores, called Neighborhood Markets. And these smaller format stores are leading the way for growth – while the company registered 0.5% comparable store sales growth for FY 2015, Neighborhood Markets registered 6% growth.
Retail continues to change, though. One major change over the last decade or so has been the rising prominence of e-commerce. Now that people can buy almost anything they want/need online, this eats away at WMT’s economic moat and clout a bit. However, the company is responding to that challenge fairly well through the leverage of their own e-commerce platform.
The company reported 22% growth in their global e-commerce sales (totaling $12.2 billion), which is really incredible. WMT also notes that 75% of sales on their website – where eight million items are available – come from non-store inventory, which limits the cannibalization of in-store sales.
The company is also opening four new e-commerce fulfillment centers in the US in FY 2016, at an average size of 1.2 million sq. feet. I believe this will only add to the company’s ability to leverage multiple channels, and their massive footprint across the country gives them a unique advantage in e-commerce.
Future growth will likely come from a number of different avenues. There’s comparable store sales growth, which WMT generally delivers. There’s also the increase in the number of stores/retail square footage – the company expects to add approximately 16 million total net retail square feet in FY 2016. And then, of course, there is the growth in other channels, like e-commerce.
International growth opportunities also remain incredibly exciting – the company’s Chinese e-commerce arm, Yihaodian, saw 60% traffic growth last fiscal year. In addition, the company is experimenting with new channels, like Click & Collect, as well as other ways to add convenience/automation to the shopping experience.
The company’s stores are ubiquitous in many parts of the world, but certainly here in the US. And while retailing changes over time – it’s certainly changing incredibly quickly right now – the fact of the matter is that people need stuff like food, bathroom tissue, toothpaste, and cleaning products every single day. And WMT is highly likely to continue selling these products in high volume at the best possible overall prices for years to come. What’s really wonderful is that, due to their position in providing goods that people need, regardless of the economy, the business performed exceptionally well during the financial crisis – they grew EPS (and the dividend) straight through from 2007 to 2009.
The retail industry is incredibly competitive. There is essentially no switching costs, which limits stickiness and loyalty to any one retailer.
Margins are thin in retail, which means any excessive/unreasonable competition on price could further limit WMT’s ability to generate attractive profitability and growth.
As an international company, they face currency and geopolitical risks.
Lastly, e-commerce could cannibalize sales from physical stores, putting the company at a cost disadvantage relative to smaller peers due to their large and costly store footprint.
The stock trades hands for a P/E ratio of 14.58. That’s significantly lower than the broader market, but more or less in line with the stock’s five-year average. Most other valuation metrics, like price-to-book, are in line with the five-year average as well.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7% long-term dividend growth rate. This growth rate appears fair to me. It’s below that of the rate EPS has grown at over the last decade, while also much lower than the dividend growth rate over that period as well. In addition, the company has a moderate payout ratio. Moreover, it’s in line with the forecast for EPS growth moving forward. However, I’m also factoring in the fact that the last two dividend increases have been incredibly modest. The DDM analysis gives me a fair value of $69.91.
The company is high quality across the board. Really solid fundamentals, and I love the business’s performance during the financial crisis. It’s incredible that even though they’re generating almost $500 billion in annual sales and $16 billion free cash flow (the company’s FCF has quintupled over the last decade), they’re still growing at a rather attractive rate. And with continued opening of new stores, additional sales in e-commerce, international opportunities, and comparable store sales growth, the company should continue to post EPS growth in the mid single digits.
The stock appears roughly fairly valued here. This is the first time I’ve added to my WMT position since May 2011, so this has been a long time coming. But the stock is down more than 15% YTD, and I think now’s a pretty good time to initiate or add to an existing position. The yield is far higher than its historical norm and the company is producing more FCF than ever before. I view it as a defensive, low-risk investment, which is why I felt comfortable paying full price here. The riskier I feel a stock is, the larger the margin of safety I want. But WMT isn’t going anywhere and I can’t see any reason why the company’s profit and dividend won’t be much higher in 10 years.
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