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Walmart (WMT) Offers Downside Protection for Long-Term Investors

January 11, 2012 | About:
roydamico

roydamico

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Walmart is the largest retailer in the world with over $400 billion in annual revenues and fast approaching 10,000 stores across the globe. The company mainly operates supercenters, followed by wholesale warehouse clubs and also is testing a smaller store format for urban areas. Groceries account for roughly half of total sales with the other half in general merchandise that includes items in hardlines, apparel, health and wellness, entertainment, and home goods.

Shares are trading at $59 and its P/E ratio is 12.29. I find the current valuation very attractive.

WMT is a company that operates in a tough space. Its customer base includes low-income families. However, as the economy gets tougher, more consumers may make the move to WMT and its peers. In addition, WMT is increasing its customer base by keeping low prices and launching innovative web based sales schemes.

The company is also making a play for an increasingly tech savvy customer base. For such purpose it has launched its "Shopycat" offering, an application that promises to deliver gift ideas to Facebook users, targeting friends’ likes and favorites. The technology uses Facebook posts and profile updates to release targeted marketing at a potential customer base.

This overview shows that Walmart is in good standing. Indeed, the following information can show it. Today the company is capitalized at over $200 billion. Quarterly revenues increased by 8.9%, though earnings fell by 2.9% over the same period last year and operating margin of 5.94% produced a profit margin of 3.77%. Furthermore, the dividend yield is at 2.50%.

Of course this situation also involves a major risk: Sales are declining, thus bringing a drop in the operating margin driven by gross margin contraction.

In terms of last quarter results, WMT operating margins fell in the third quarter. Gross margins fell 48 basis points, but Wal-Mart was able to leverage expenses at all three business segments. A consequence of this situation, EBIT margins contracted about 20 basis points to 5.3% from 5.5% in the year-ago period.

Moreover, inflation in the 5%-7% range has been the main driver of the comp turnaround. Traffic trends remain negative and competitors are posting same-store sales growth in the positive mid-single-digit range. The company continues to lose share to some of its more formidable competitors.

In terms of future expectations, I think the stock has a low potential upside but it has a strong downside protection considering the historic low current P/E. Here we can see WMT FAST Graphs, a tool that I use to see how the price is acting in comparison to the valuation and the fair price that the stock should have according to the Company's earnings.



In the chart we can see that the stock price (black line) always traded above the earnings justified valuation line (orange) and the normalized P/E ratio (blue). That changed two years ago, when WMT started trading below its justified valuation. I think that shares could trade between the $60-70 range in 2012.

Speaking about sales, domestic stores remain the main driver of the business although it must be noticed that there is a disturbing trend of gross margin declines and negative comps.

It is expected that the company roll back prices to stabilize market share losses and that annual domestic comps return to the 1.5% and 2.0% range thus reflecting a more realistic GDP growth forecast.

Generally speaking, Walmart has been able to offset lower merchandise margins and negative comparable store sales through SG&A expense reductions to maintain essentially flat EBIT margins. Walmart will start to recover at a low pace.

“Profitable growth is the top priority for the team. We have plans in place to improve operating profit and returns in International and support a vibrant growth engine for our company,” said Mike Duke, president and CEO of Walmart Stores Inc.

Rating: 3.1/5 (18 votes)

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