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Published: June 16, 2010
During the past decade, investing in
housing, the stock market, or gold has been an eye opener for
U.S. consumers. The value of houses soared and then crashed.
Gold slumped and then surged ahead. Oil prices rose to
unimaginable peaks and then fell by more than -75%. All the
while, shares of Wal-Mart (NYSE: WMT) just sat there.
Despite hundreds of upgrades and downgrades by analysts over the
last ten years, shares of Wal-Mart are right where they were
when Bill Clinton was still in office. To understand why shares
haven't moved before and why they may start moving upward now,
you need to break this story into three Acts.
The first act involves an unknown retailer from Arkansas that
was founded in 1962, came public in 1972, and went on a
never-ending winning streak that made it the world’s largest
retailer by the late 1990s. By then, the retailer had grown so
large that it became harder and harder to keep growing at a
double-digit rate. Yet investors mistakenly assumed that
Wal-Mart would never slow down, and awarded the stock very rich
valuations.
And then began Act Two. Over the ensuing decade, Wal-Mart kept
growing, but at an increasingly slower pace. Management pulled
out every trick in the retailer’s handbook, not always to good
effect, and large mutual funds began to look elsewhere for new
opportunities, figuring the stock did not deserve an especially
high
price-to-earnings ratio (P/E). So the
P/E ratio on its shares kept shrinking, even as profits were
slowly rising. Rising profits plus a lower P/E spells a flat
stock price.
Yet a case can be made that Wal-Mart is moving into Act Three.
Its new strategies are showing real promise, and could set the
stage for a moderate rebound in sales and profit growth rates.
Lessons learned
In the last several years, Wal-Mart moved away from its image as
the lowest-cost provider and tried to move its image upmarket.
Meanwhile rivals such as Target (NYSE: TGT) managed to
lower prices and maintain a fashionable reputation. Wal-Mart was
at risk of catering to neither value nor fashion shoppers.
Lesson learned. Starting in March, Wal-Mart began to
aggressively roll back prices, an effort that has really picked
up steam over the last few weeks. The company just provided a
comprehensive update to investors, and management finally
appears to have pulled the right levers this time.
The main goal of the price rollback is to drive store traffic.
But if lower prices simply quash profit margins, then it’s a
Pyrrhic victory. Wal-Mart managed to find a range of
efficiencies that led to lower operating costs. As a result,
management notes that the low-pricing strategy is boosting sales
while keeping margins flat. For example, the company’s grocery
segment has begun to buy a lot more local produce, which can be
bought for much less than it would cost to have it shipped in
from across the country or across the world. The net result:
Wal-Mart’s produce prices have been steadily dropping as savings
are passed on to customers. And that’s boosting produce sales
and driving more traffic to the rest of the store.
Wal-Mart no longer
reports monthly
sales, and investors
remain focused on
the fact that
same-store sales in
the most recent
quarter fell -1.4%.
Yet management was
pretty clear that
the current quarter
is going quite well.
If their body
language is being
correctly read,
same-store sales
should show nice
gains this quarter.
Right now, investors
think that Wal-Mart
will boost sales
around +5% this year
and next, due solely
to robust growth in
its international
division. Management
noted last week that
sales in Brazil and
China are trending
very well, and sales
in Mexico and Canada
are also above plan.
The company is
improving its global
sourcing for all of
those regions, and
thinks it can
improve its
inventory turns and
cash flow in the
international
business.
But if the
international
business is doing
well, and the U.S.
business is picking
up, it’s fair to
wonder if analysts
are being too
conservative,
forecasting sales to
rise +5% each year
and per-share
profits to rise
around +10%.
Analysts at Smith
Barney think so.
They think consensus
forecasts are too
low, and Wal-Mart
should earn around
$5.40 a share next
year, well above the
$4.86 consensus.
Shares trade for
less than ten times
that street-high
estimate. The
consensus estimate
is likely too low,
as it doesn’t
account for a new
$15 billion stock
buyback program that
represents about 7%
of shares
outstanding,
So what is a fair
way to value this
stock? If sales and
profit growth are
weak, then you could
assess the stock by
its free cash flow
yield (which is free
cash flow divided by
the market cap).
Free cash flow
should hit around
$11 billion this
year, implying a
5.8% free cash flow
yield. ($11
billion/$189
billion). If you
assume that
Wal-Mart’s cash flow
won’t sink, then
that yield looks a
lot more attractive
than the
fixed-income yields
you get from bonds
and
CDs these days.
But if sales and
profit growth are
indeed picking up,
reversing the
declining growth
rate trend, then a
P/E ratio is
suitable. As noted
above, shares trade
for a little less
than 10 times next
year’s projected
profits (according
to Smith Barney
estimates), even
though per-share
profits could start
rising at a +15%
pace (assuming a
sales growth rate at
half that level). If
the multiple finally
starts to move up to
12 or 13, then
investors are
looking at +20% to
+30% upside.
Action to Take
-->
After a decade of
moving sideways, it
may seem foolhardy
to predict a big run
for shares of
Wal-Mart at this
point. But a
combination of
rising sales,
improved sourcing,
tighter expense
control and a
reduced share count
make this
mega-retailer poised
to surprise on the
upside.
-- David Sterman
Staff Writer
StreetAuthority |
