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Using the Value Line Page: Wal-Mart August 6, 2010
Wal-Mart (WMT – Free Analyst Report) is the largest retailer in the world. The Business Description on the Value Line stock report outlines the specifics: 2,747 supercenters, 803 discount stores, 596 Sam’s Club outlets, and 158 Neighborhood Markets. And those are the stores in the United States… There are another 4,112 stores throughout the world, including in Latin America, the United Kingdom, fast-growing Asia, and financially solid Canada. (Click here for a free copy of the report that you can use to follow along while reading this article)
That’s a massive network of stores that can’t be easily replicated. In fact, it gives the company an enormous amount of pricing power with its suppliers, many of whom publicly complain that the company is squeezing their profit margins. It’s unlikely that customers are moved by such commentary, since Wal-Mart’s low prices and relentless drive to reduce costs are two of the company’s best known traits.
These low prices and management’s keen eye on margins is what allowed the company to have positive quarter-over-quarter earnings gains through the worst of the recent recession—a fact the can be easily seen by comparing the year over year quarterly earnings in the Earnings Per Share box on the lower left of the Value Line page. Clearly, those year-over-year quarterly improvements slowed as the recession took hold, but many companies, particularly those in the retailer sector, didn’t have such positive results. In fact, earnings at many retailers fell sharply into the red during the recession. Note, too, that Wal-Mart’s earnings have gone up every year since 1994, as the third column down in the Statistical Array shows. This is an impressive feat for a company as large as Wal-Mart. Indeed, it is often easier for small retail companies to show earnings growth, as they tend to have fewer moving parts, material geographic expansion prospects, and aren’t dealing with an already well-established brand—although this is often a positive for larger retailers, it can make it more difficult to maintain earnings trends.
The long-term earnings rise is even more impressive when put into percentages: Over the trailing 10 years through July, earnings advanced, on average, 13.0% a year; over the trailing five-year period, earnings advanced 10.5% a year. True, the rate slowed, but remember that just a few short years ago, the United States was in the middle of a long and painful recession—the impact of which continues to linger in the form of high unemployment and weak housing. You can find this information in the Annual Rates box on left hand side of the page.
These statistics, however, don’t seem to impress Wall Street. In fact, in the retail space, the market darlings are the dollar stores. Indeed, companies such as Family Dollar (FDO) and Dollar Tree (DLTR) have been successful at expanding their footprints and boosting sales. The weak property market, which allows for cheap rental space for new stores, and more frugal consumers have been the bright spots for these firms. In fact, some suggest that these companies, once viewed as an option only for less fortunate consumers, may pick up permanent market share, as new customers realize they carry more than just inexpensive knock offs of name brand goods.
Couple the success of these dollar stores with recently weak comparable store sales at Wal-Mart and it’s easy to see why the voting machine mentality of Wall Street is leaning away from the slow moving industry giant toward the faster gnats—a point highlighted in the Analyst Commentary. But the relative size here is important. Wal-Mart’s size not only affords it pricing power with its suppliers, but it required the company to build a world-class distribution system. That distribution system can’t be easily replicated and it is cutting edge, as the company is often at the forefront of technology here, including the use of such things as RFID tags to track merchandise. In fact, the company is currently trying to take over some of the trucking operations from its suppliers to increase efficiency even further.
It’s also important to note that the Wal-Mart generated about 50% of its sales from Groceries (as noted in the Business Description). Although the grocery business is low margined, consumers usually make at least weekly trips to the store to stock up on fresh food. So, while the smaller Dollar Stores may be nipping at Wal-Mart’s heels, there is a powerful pull to the local Wal-Mart. And, while at the store, customers can flow easily between the general merchandise and grocery isles. It’s the same idea as the large pharmacy chains, such as Walgreen (WAG), use—the pharmacy is the draw, but the general merchandise is there, just in case shoppers want to buy something else while they wait for a prescription to be filled.
That said, it’s important to note the full scope of Wal-Mart stores. They have pharmacies, banks, nail salons, hair spas, McDonald’s (MCD) (among other food offerings), and even game rooms for the kids. The stores offer a massive amount of convenience—all of which brings more people into the stores or allows those already there for other things to spend a little more. Wal-Mart is truly a hard act to follow and the controlling family, which still owns a massive stake in the company (insider ownership is 45%), has done a great job maintaining the company’s focus.
Perhaps the most impressive feat is that the company is as large as it is while maintaining an impressive amount of fiscal discipline. Very often retail stores grow store counts by taking on large amounts of debt. That debt often becomes unsustainable and the company’s crash and burn—or at least their stocks do. Wal-Mart, on the other hand, has just 35% of its capital structure tied up in debt (see the Capital Structure box in the middle of the left hand column on the Value Line Page). In fact, it earns top scores for both Financial Strength (A++, found on the bottom right of the page) and Safety (1, found in the Rankings box on the top left).
The Rankings box also shows that the company is pegged to just mirror the 1,700 stocks Value Line follows (Timeliness Rank of 3) in the year ahead. So, near-term prospects aren’t overly compelling. That doesn’t mean the company is sitting idly by as smaller fry eat its lunch. Indeed, as noted in the Analyst Comment, the company is working to reduce pricing by becoming even more efficient. It is also working on directly sourcing more of its private label brands—which are higher margined than outside brands. And, to keep its image up, it’s spending to spruce up domestic stores. Moreover, the company’s international division is set to grow faster than its U.S. counterpart (9% growth in retail space versus just 2% in the United States). Since a number of foreign markets are slated to grow more strongly than the United States, this is likely an appropriate strategy.
All of these steps lead us to believe the company’s top and bottom lines will continue to head higher, both projected to average 10% growth per year over the next three to five years. While those numbers may not be the kind of “knock your socks off” expectations that Wall Street prefers, if achieved, these results would likely translate to annual total returns of 14% to 20%, on average including dividend payments, over that time frame assuming a price to earnings multiple of around 15. That multiple is higher than today’s 12.6, but still relatively low compared to the company’s longer-term history, as seen in the Average Annual P/E Ratio row in the Statistical Array.
Looking one line lower on the Array at the Relative P/E Ratio also provides an interesting comparison. The company is priced historically low relative to the broader market. In fact, Wal-Mart’s current Relative P/E Ratio is just 0.79 (you can find this number at the top of the page to the right of the company’s name). This is a company that had been routinely afforded Relative P/E Ratios over 1.00 until 2005 (see the Array).
Note, too, Wal-Mart’s long-standing record of annual dividend increases. Although it’s current dividend yield is nothing to write home about, the dividend is projected to increase at an 11% per year clip out to the 2013-2015 time period. (These statistics can be found in the Annual Rates box on the left of the page.) That increase is well above recent inflation rates and adds to the appeal of the stock.
With the share count falling (again found in the Array), a strong business model, industry dominance, international growth potential, and admirable financial strength, it’s hard to believe that Wal-Mart will be out of favor for long. While it is true that it is hard to turn a ship as large as Wal-Mart, it’s also true that once the company gets a good head of steam behind it, it will be hard to stop.