Global retail giant Wal-Mart (NYSE:WMT) is plagued by its fair share of problems from declining traffic in its U.S. stores to bad publicity surrounding wages and alleged corruption scandals . However, there are still some positives in Wal-Mart's future that merit the stock a position in your portfolio.
Endorsement from Warren Buffett's company
Perhaps the brightest spot of them all is the fact that the holding company of investing legend Warren Buffett, Berkshire Hathaway recently increased its stake in Wal-Mart shares increasing the total amount to 58.1 million shares. While it's unclear whether Buffett or his portfolio managers Todd Combs and Ted Weschler made the investment, Wal-Mart holds some of Warren Buffett's key characteristics for investment.
Wal-Mart exercises a certain amount of market power commanding a 30% market share in the U. S. grocery market. Also, the company commands a 66% North American share in mass merchant retailing according to the Bloomberg Industry Leaderboard. Unsurprisingly, Wal-Mart typically sits at the center of any given shopping center.
A ubiquitous presence will help the company overcome any shortcomings over the long term. Warren Buffett believes in investing in "toll bridges." Simply put, if you want general merchandise and groceries, Wal-Mart can deliver that more cheaply and profitably than anyone else. Not to mention, the stock trades cheaply at just 16 times earnings versus 19 for the S&P 500.
Responding to threats from online competitors, Wal-Mart devoted resources to its e-commerce platforms resulting in an online sales increase of 27% in its most recent quarter. Wal-Mart definitely possesses a leg up on its competitors in terms of distribution.
Some growing companies pour the vast majority of their cash flow into building a distribution infrastructure. However, Wal-Mart can effectively compete with them by backing their e-commerce initiatives with an established warehousing system, spending money only on the technology itself, and maybe some added space to mail its products directly to customers or leaning on stores to fill orders.
Smaller format stores
Realizing that Wal-Mart lacks a presence in smaller neighborhoods the company recently started building smaller format stores known specifically as Neighborhood Markets, Wal-Mart Express, Wal-Mart on Campus, Super Ahorros, Amigo, and Supermercado. In the most recent quarter, Wal-Mart's Neighborhood Markets expanded its same store sales a whopping 5% versus an even keel for Wal-Mart U.S when factoring in the impact of fuel. Serving customers low priced merchandise in closer proximity-- even on a limited basis--can provide incremental sales for Wal-Mart assuming it doesn't cannibalize its larger stores.
Over the past five years Wal-Mart expanded its annual revenue and net income 17% and 12% respectively. Its free cash flow is 28% lower than it was five years ago. However, that free cash flow registered at $10.9 billion last year, enough to purchase a mid-cap company outright.
Dividends while you wait
Investors can enjoy a decent dividend income while waiting for Wal-Mart's stock to rise. Last year, Wal-Mart paid out 57% of its free cash flow in dividends. Currently the company pays its shareholders $1.92 per share per year translating into a yield of 2.5%.
Wal-Mart is planning some interesting new initiatives that may help the company in the mid term including a money transfer service, a video game trade in program to compete with smaller video game retailers, and a Sam's Club Cash Rewards program. Over the long-term; however, Wal-Mart's capital gains and dividend potential will come from continued market dominance resulting in the ability to cheaply deliver general merchandise and groceries. If you doubt that, just ask Berkshire Hathaway.