Earlier this week, Tim Beyers argued that it made sense to short shares of the world's largest retailer. I couldn't disagree more. Betting against shares of Wal-Mart
My fellow Fool kicked off his commentary by singling out a troubling discussion board thread. Is Wal-Mart the next Kmart? He forgot to mention that the poll that kick-started the thread found most voters in disagreement with that notion.
Kmart had always been a tough sell. It couldn't underprice Wal-Mart, so it lost out on the thrifty. It couldn't outclass Target
Kmart failed because Wal-Mart was there as the more affordable alternative. What is the penny-pinching antidote to Wal-Mart? Tim argues that Target is well-positioned because its typical customer commands $20,000 more in annual household income. Then he spells out the recipe for Wal-Mart's decline as a faltering economy and its impact on Wal-Mart shoppers. Where will they go? More importantly, where will Target shoppers go when they are brought down a rung or two?
That's right: Wal-Mart. This is an all-weather retailer. The economy has had its shares of bumps and bruises over the years, but Wal-Mart's consistency has prevailed. Comps have risen every single year over the past decade because Wal-Mart provides the staples of sustenance. Between its flagship stores, warehouse clubs, and supermarket offerings, Wal-Mart gives its customers the best deal. Its operating prowess and economies of scale deny anyone else the change to beat Wal-Mart on price. In many ways, Wal-Mart is the Dell
Will higher prices at the pump derail Wal-Mart's growth strategy? I doubt it. We are consumers, by definition, and Wal-Mart thrives in providing dirt cheap basics. Besides, you do realize that more than half of the company's warehouse clubs sell gas, too, right? I'm not suggesting that Wal-Mart deserves a market premium just because it's a major provider of gasoline, but it's an interesting nugget nonetheless.
The company's consistency has also added to the pocket change of shareholders. Since 1974, Wal-Mart has increased its dividend every single year. With the last hike coming in May, investors will be receiving $0.60 per share this year in payouts, more than twice what Wal-Mart was distributing five years ago.
That's important because the company's quarterly distributions aren't the only things that have appreciated over the years. Yes, Wal-Mart's stock has been a dud. It recently pecked at a three-year low. However, the fundamentals haven't exactly followed suit.
|Sales (in billions)||$180.8||$204.0||$229.6||$256.3||$285.2|
|Earnings Per Share||$1.39||$1.47||$1.79||$2.07||$2.41|
|Dividends Per Share||$0.24||$0.28||$0.30||$0.36||$0.52|
So, let's see here. Five years ago, Wal-Mart shares were trading at roughly the same $45 price that they're fetching now. But back then, you were buying Wal-Mart at 32 times earnings, 1.1 times sales, and in line for a 0.5% yield. Buy Wal-Mart now, and you're looking at just 18 times trailing earnings, 0.6 times sales, and you're rewarded with a 1.3% dividend yield.
Vest in show
Tim then gets down to the nitty-gritty of valuation. Even if you agree with me that Wal-Mart is not the next Kmart, and that the company's historical consistency is commendable, it wouldn't amount to a hill of Sam's Choice coffee beans if the numbers didn't back me up.
Tim turns to the great discounted cash flow (DCF) calculator that is part of the Motley Fool Inside Value newsletter service. The application is flawless, but of course it's at the mercy of human input. That's where I don't necessarily agree with Tim's variables. For starters, he arrives at a "rosy scenario" of $4.4 billion in annual free cash flow (FCF). He's awarded relatively high growth rates as compensation and adjusted capex to reflect recent increases, but as investors, we'd be hard-pressed to know how much or how soon these investments will start to pay. FCF and associated growth might well be much higher.
Then we get to Tim's 10% discount rate. You don't get any bluer than this blue chip. It's a weatherproof, non-cyclical, large-cap company, and I can't think of any reason why we shouldn't go with a 9% discount rate instead.
I won't quibble over Tim using the current 4.18 billion shares outstanding, but I would like to point out that Wal-Mart has spent more than $13 billion over the past three years to buy back shares. This is the rare stock that has seen a drop in share count in recent years.
|Jan. 31, 2002||4.45 billion|
|Jan. 31, 2003||4.40 billion|
|Jan. 31, 2004||4.31 billion|
|Jan. 31, 2005||4.23 billion|
|July 31, 2005||4.18 billion|
So I'll stick with Tim's current number. It's accurate. But keep in mind that this figure is likely to keep shrinking every passing quarter. It's the thrifty Wal-Mart way.
My last bone of contention comes from the assumed earnings growth rates. Tim's middle set of possibilities finds Wal-Mart growing its bottom line at a 14% clip over the next five years, 9% over the five years that follow, and just 4% beyond that.
Fool value guru Philip Durell suggests not going beyond a 4% terminal growth rate when looking that far ahead, but I have to plead Wal-Mart's case here. This is a company that has been growing profits in the double-digits for more than four decades now. Its same-store sales growth has averaged a respectable 5.6% over the past 11 years. That's why a 4% terminal growth rate for Wal-Mart is insulting. Going by the company's historical performance, it's even lower than a zero-expansion policy. Under that kind of scenario, where Wal-Mart would stay pat on building new stores, FCF would come in closer to $15 billion a year!
But we all know that Wal-Mart keeps growing. Just 20% of the company's sales are currently rung up overseas, and the international segment was good for 18% top-line growth last year -- and a 26% surge in operating profits. There's a ton of real estate left to conquer.
That's why I'd argue that anything less than a 6% assumed earnings growth rate -- which is basically the company's unit-level performance -- is outrageous. Over the past five years (years 38 through 42 in Wal-Mart's corporate life), earnings have grown at an annualized clip of 14%. Why would someone box Wal-Mart into earning 4% a year in perpetuity 11 years from now?
That's why I think that 6% is still a slap in the face. Still, let's go with it. Just that change -- and adjusting the required rate of return from 10% to a more realistic 9% -- is enough to prop up the stock's intrinsic value from the $33 that Tim got to $55.
I won't even get into the three-digit sums that pop up if Wal-Mart were to take a more cautious expansion strategy, beefing up its FCF in the process.
The point is that Wal-Mart is worth far more than the market deems fair at the moment. There may be some recent operating hiccups in the ointment, but sales, earnings, and comps continue to grow. I know that Philip isn't afraid of retail stocks. He has recently recommended quality chains like Home Depot
Still think that Tim's the correct one? Fine. Be that way. Go ahead and short Wal-Mart if you must. You'll be betting against history, logic, and conservative valuation metrics.
If you crave other cheap stocks -- and want to have perpetual use of the nifty DCF calculator -- subscribe to Philip Durell's Inside Value research newsletter, or check it out as part of a free 30-day trial.
Longtime Fool contributor Rick Munarriz can squeeze a penny when he has to. He does not own shares in any of the companies in this story. Dell is a Motley Fool Stock Advisor pick. The Fool has adisclosure policy. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.