By Ben Reynolds
Owning Wal-Mart Stores, Inc. (NYSE:WMT) stock has been very lucrative for long-term shareholders. Every $1 invested in Wal-Mart stock in August of 1972 is worth $1,763 today (including dividends). That comes to an annualized return of 18.6% a year.
Wal-Mart is a compounding machine with a shareholder friendly management. The company has increased its dividend payments for 43 consecutive years. This makes Wal-Mart 1 of 50 Dividend Aristocrats – S&P500 stocks with 25+ years of consecutive dividend increases.
Despite long-term success, the company has struggled in recent years. This article analyzes Wal-Mart stock in detail, including:
- Recent struggles
- Growth prospects
- Recession performance
- Competitive Advantage
- How to find Wal-Mart’s fair value
- 8 Rules of Dividend Investing rank
Wal-Mart generated earnings-per-share of $5.11 in its fiscal 2014. That is the company’s all time earnings-per-share high mark.
Earnings-per-share for the company from fiscal 2014 onward shown below:
- Fiscal 2014 earnings-per-share of $5.11
- Fiscal 2015 earnings-per-share of $5.07
- Fiscal 2016 earnings-per-share of $4.57
- Expected fiscal 2017 earnings-per-share of $4.27
- Expected fiscal 2018 earnings-per-share of $4.42
Source for expected earnings: Yahoo! Finance
Clearly, Wal-Mart has not delivered growth over the last several years. The company is not expected to eclipse former earnings-per-share highs until fiscal 2020.
What went wrong with Wal-Mart?
The company’s growth slowed dramatically in fiscal 2014. By Fiscal 2015, earnings-per-share were declining.
The problem is declines in both net margins and in sales.
Margins averaged around 3.5% for Wal-Mart from fiscal 2007 through fiscal 2015. Net profit margin declined to 3.0% in fiscal 2016, and is expected to be around 2.6% over the next 2 fiscal years.
The deep decline in margin is due to 2 factors:
- Significant increase in wages for non-executive employees
- Shift toward lower margin digital sales
These two factors are responsible for Wal-Mart’s decline in net profit margins. Both are strategic directions taken by the company’s management. The reasons why these initiatives were taken are discussed in the growth prospects section of this article.
Margin declines are the primary driver of Wal-Mart’s lower earnings-per-share. Revenue peaked for Wal-Mart at around $485 billion in fiscal 2015. We are in fiscal 2017 now, and annual revenues are around $482 billion.
Revenues have stagnated. Part of this is due to market saturation. Wal-Mart cannot expand much in the United States due to its past success… It simply has too many stores already.
Contrary to what many people think, online purchases are not the cause of Wal-Mart’s revenue stagnation:
Wal-Mart was still realizing solid growth in 2010 through 2013. Online sales make up just 1 percentage point more of total retail sales in 2016 than in 2013.
I believe Wal-Mart has struggled with revenue growth due to an unmotivated work force, stores that are not as clean as rival Target (TGT) and other retailers, and well noted stocking problems.
With Wal-Mart’s recent struggles, why should investors consider Wal-Mart?
The company still has solid total return potential – especially after the company’s recent investments.
Growth Prospects at Wal-Mart
Wal-Mart has shifted its focus over the next several years away from maximizing earnings-per-share and towards maximizing revenue growth.
To this end, Wal-Mart is investing $2.7 billion over the next 2 years into its employees in the form of higher wages and better training. The company has boosted all employee wages in the United States to $10 or more an hour.
Source: Wal-Mart 2016 Annual Report
Wal-Mart’s goal is to create a motivated work force that better serves its customers. The large investment in employees is the single largest reason why earnings-per-share have declined for Wal-Mart stockholders.
In addition to investing in employees, the company is also investing heavily in digital growth.
To this end, the company has acquired a slew of smaller tech companies. Wal-Mart Labs is the company’s tech hub based in San Bruno, California.
The company is currently the 3rd largest global online retailer, behind only Amazon and Apple.
Wal-Mart expects rapid growth in its e-commerce operations over the next several years. Investments in digital/e-commerce sales are a long-term commitment. Digital operations are expected to post operating losses through fiscal 2019 as they scale.
Wal-Mart is taking on unprofitable operations today to grow the business into the future. The company’s goal is to provide a seamless shopping experience, both on-line and in store.
In addition to its employee raises and digital investments, Wal-Mart is also rolling out more of its neighborhood market concept stores.
The neighborhood market store is Wal-Mart’s version of a tradtional grocery store. The stores are much smaller than Wal-Mart’s flagship Super Centers.
The company’s neighborhood market stores provide packaged grocery products, fresh (presumably) produce and meat, and pharmacy services.
Wal-Mart’s management has ‘reset’ the comapny. Wal-Mart is positioned for faster growth over the next several years than the previous 3 or 4.
The company is projecting revenue growth of between $45 and $60 billion over the next three years. This comes to revenue growth of between 3% and 4% a year.
In addition, Wal-Mart plans to repurchase $20 billion in shares over the next 2 years. This is ~9% of the company’s market cap at current price. Share repurchases should normalize at around 2% to 3% of shares outstanding a year over the long run.
Wal-Mart also has a 2.8% dividend yield. The company’s revenue growth, share repurchases, and dividend combine to give investors expected total returns of about 8% to 10% a year over the long-run. Returns could be a bit higher of margins improve over time (which is likely).
Total returns of 8% to 10% a year may not sound amazing, but they are around historical long-term S&P 500 averages – and higher than what the S&P 500 is expected to generate at current prices.
Return should never be considered outside of risk. Wal-Mart is one of the lowest risk, recession proof investments around.
Stellar Recession Performance
Wal-Mart is well-known to provide every day low prices. The company’s focus on price appeals to consumers of all income levels – but especially to those at the lower end of the United States’ economic spectrum.
Somewhere between 15% and 20% of all food stamp benefits in the Untied States are redeemed at Wal-Mart.
When money is tight, people tend to shop at Wal-Mart more than other stores. This makes Wal-Mart an ideal recession stock. Wal-Mart is one of the 10 most recession proof Dividend Aristocrats.
The Great Recession showed the strength of Wal-Mart in recessions. The company’s earnings-per-share through the Great recession are shown below
- 2007 earnings-per-share of $3.16
- 2008 earnings-per-share of $3.42
- 2009 earnings-per-share of $3.66
Take a look at the earnings-per-share of the S&P 500 over the same time period for comparison:
- 2007 earnings-per-share of $75.20
- 2008 earnings-per-share of $16.89 (ouch!)
- 2009 earnings-per-share of $56.33
In 2008, The S&P 500 fell 37% while Wal-Mart stock gained 21.6% thanks to higher earnings and an influx of new investors fleeing to one of the few businesses that was still seeing earnings-per-share growth.
Wal-Mart’s low-price business model rolled through the Great Recession as if it didn’t’ even happen. The average business in the S&P 500 suffered significant earnings declines.
Wal-Mart did well during the Great Recession because of its reputation for low prices.
The competitive advantage that insulates Wal-Mart from recessions is examined in the next section of this article.
Competitive Advantage Analysis
Wal-Mart has a strong scale based competitive advantage. The company has over 11,000 locations around the world – including ~5,000 Wal-Marts and Sam’s Clubs in the United States.
The company uses its unrivaled scale to force suppliers into lowest possible prices. Wal-Mart’s extensive distribution network efficiently distributes goods to its locations. Goods are sold to customers at ‘every day low prices’. The lower the company’s prices are, the more customers it gets, driving down prices further in a virtuous cycle.
Wal-Mart’s competitive advantage is its “Everyday Low Prices” strategy.
Wal-Mart’s competitive advantage is very easy to understand. The company’s business model is not overly complex. When a business is straightforward, there’s less chance for error as there are less ‘moving parts’.
Finding Wal-Mart Stock’s Fair Value
Wal-Mart’s dividend yield is near historical highs.
Wal-Mart stock’s yield has been rising as the company has slowly increased its payout ratio from around 25% to around 50% of earnings over the last decade.
The company’s price-to-earnings ratio has also declined, resulting in higher yields. The company currently has a 2.8% dividend yield which compares favorably to the company’s historical average.
Investing in high quality businesses when they are at or near their maximum historical dividend yield tends to produce excellent long-term results.
Wal-Mart stock is currently trading for a price-to-earnings ratio of 16.0. The company’s historical average price-to-earnings ratio over the last decade is 14.6.
For comparison, the S&P 500’s average price-to-earnings ratio over the last decade is 18.6 (excluding P/E ratio of ~70 in 2009 due to Great Recession). Wal-Mart stock has historically traded at around 80% of the S&P 500’s price-to-earnings multiple.
The S&P 500 is currently trading for a price-to-earnings multiple of 23.8. Applying Wal-Mart’s 10 year historical discount to the S&P 500, this implies a fair price-to-earnings ratio of around 19.0 for Wal-Mart stock. In today’s low interest rate, overvalued market, Wal-Mart looks undervalued relative to the market.
On an absolute historical basis, the S&P 500 has averaged total returns of around 9% a year. Wal-Mart’s expected total returns are in the same range.
The historical price-to-earnings ratio of the S&P 500 is 15.6. With Wal-Mart having about the same total return expectations (with much less risk than the average business), Wal-Mart’s fair price-to-earnings ratio on an absolute (not adjusted for current higher market prices) should be around 15 to 16 at a minimum.
Based on this, I believe Wal-Mart to be either slightly undervalued or trading around fair value on a long-term historical basis.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
– Quote from Warren Buffett
Final Thoughts & 8 Rules Rank
Wal-Mart is a favorite of The 8 Rules of Dividend Investing due to the financial metrics below:
- 43 consecutive years of dividend increases
- 2.8% dividend yield
- 43% payout ratio
- 19% 10 year stock price standard deviation
- Expected total returns of 8% to 10% a year
The company is the dominant player in its industry. It has a strong competitive advantage. It thrives during recessions. In short, Wal-Mart is a very high quality business.
The company is trading around fair value at current prices on a historical basis. I believe an investment in Wal-Mart at current prices is likely to outperform the market over the long-run because Wal-Mart is historically fairly valued (or slightly undervalued), while the overall market is overvalued.
Investors looking for dividend growth, safety, and a shareholder friendly management should consider Wal-Mart as a core holding in their portfolio.
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