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Throughout the past decade, shares of Wal-Mart (NYSE: WMT ) hovered in the $50 range, even as the retail giant more than doubled in its net income in that time. The explanation is fairly simple. Shares were overvalued at a P/E of more than 30 back in 2002 and needed some time to grow into that multiple. Here's what happened:
As you might expect based on its size and history, Wal-Mart appears to be one of the most stable stocks on the market. It has a beta of just 0.4, meaning its volatility is much lower than the broad market, and the company is a vaunted dividend aristocrat, having raised its quarterly distribution in at least each of the past 25 years. That's as sure sign of solid growth. In just the past 10 years, the company's dividend payment has quadrupled, as has the yield since the stock price has remained relatively unchanged.
Given that stability, it's surprising to see Wal-Mart shares going through the roof in recent months, reaching all-time highs in the process. Since it dipped in late April after news of a bribery scandal at its Mexican subsidiary broke, the stock has climbed almost 25% during a period when the broad market's lost ground. An earnings beat on May 17 helped propel shares to what was a new 52-week high at the time of $61.68, with highlights including a better-than-expected same-store sales increase at its U.S. locations. Shares continued to gain over the next few days, giving the retailer a 10% bump in just a week.
Later, news that wholesale inventories increased by more than expected in April sent shares up more than 3% on June 8, and finally this Tuesday, Wal-Mart bucked a trend showing that retail sales declined for the first time in nine weeks, while it gained 2%. One commentator argued at the time that a down economy favors the retailer, as consumers will trade down for its goods. But at near $71, Wal-Mart's share price is at an all-time high and is starting to seem unjustified. Let's look at some reasons shareholders may want to take some profits now.
As companies get bigger, growth tends to slow down. Wal-Mart is far and away the world's biggest retailer, and only ExxonMobil tops it in revenue out of American companies. The company has about 10,000 stores around the world and operates in 27 countries, and while it continues to expand, it's too big to do so at the pace of some of its competitors. Let's look at the expected growth rates in 2013 of Wal-Mart and some of its peers.
2013 Growth Rate
|Target (NYSE: TGT )||5.6%||$70 billion||13.3|
|Costco (Nasdaq: COST )||6.4%||$89 billion||26.4|
Source: Yahoo! Finance.
Target certainly looks like a better buy than Wal-Mart, with a faster growth rate and a cheaper multiple. Costco, meanwhile, receives a much higher P/E ratio because investors see its warehouse model as giving it a competitive advantage. Nevertheless, all three have relatively slow growth rates, although their earnings per share are expected to grow slightly faster.
The online threat
Perhaps the biggest threat to Wal-Mart comes from Amazon.com (Nasdaq: AMZN ) . The e-tailing leader has grown its top line 40%, in part by making inroads into digital media, but also through a canny strategy to establish a dominant retail position with Amazon Prime, and a large expansion effort building several new fulfillment centers.
With more than half of its sales from its grocery segment, Wal-Mart may not be as vulnerable to the online threat as retailers like Barnes & Noble or Best Buy, but the retail king has more money invested in bricks and mortar than any of its competitors and therefore more to lose as consumers move to Internet shopping. Wal-Mart's second-leading segment in its U.S. stores is entertainment, which accounted for 12% of its sales. Made up of electronics, toys, and books, among other items, that category looks to be the most vulnerable to Amazon.
Strangely enough, Wal-Mart's recent run-up in price came right after its bribery scandal in Mexico was exposed. Not only do those payoffs put Wal-Mart in hot water with the Foreign Corrupt Practices Act and Mexican laws, but it has also set the company in the crosshairs of its own shareholders, with lawsuits from, among others, the California State Teachers Retirement System, which owns 5.3 million shares, and New York City's own pension fund, holder of 5.6 million shares.
The scandal also serves as a reminder that the retailer has been anything but a beacon of corporate governance in its past. Another court case alleging gender discrimination reached the Supreme Court last year, and other suits involving forced overtime and the employment of illegal immigrants have forced settlements in the hundreds of millions of dollars. It wouldn't be surprising to see more legal trouble in the company's future.
Foolish bottom line
With only a positive earnings report and mixed economic news driving Wal-Mart's recent gains, the retailer looks overbought after rising 25%. Wall Street adjusted its average EPS estimate up $0.06 for this year and next, but at current P/E levels those gains should account for only about a $1.50 increase in share price. Even if that increase in estimates is drawn out for a few more years, it still wouldn't justify the $13 appreciation in share price.
At today's prices, it looks due for a pullback, so I've placed an underperform CAPSCall on the retailer. I think the current gain is undeserved, and I wouldn't be surprised to see a drop of 10% or more.
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