The press likes to say that Warren Buffett is a hold-forever investor, but in his 2016 letter, Buffett specifically addresses this misinterpretation.
Sometimes the comments of shareholders or media imply that we will own certain stocks “forever.” It is true that we own some stocks that I have no intention of selling for as far as the eye can see (and we’re talking 20/20 vision). But we have made no commitment that Berkshire (BRK.A, Financial)(BRK.B, Financial) will hold any of its marketable securities forever.
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Confusion about this point may have resulted from a too-casual reading of Economic Principle 11 on pages 110-111, which has been included in our annual reports since 1983. That principle covers controlled businesses, not marketable securities. This year I’ve added a final sentence to No. 11 to ensure that our owners understand that we regard any marketable security as available for sale, however unlikely such a sale now seems. – BerKshire 2016 letter
You’re seeing this with Walmart (WMT, Financial).
Buffett has clearly fallen out of love with Walmart with his ownership now at 1.4 million shares – just 0.04% of his portfolio.
You don’t allocate 0.04% of your portfolio to your best idea.
Buffett Walmart Holding Size
Why is Buffett selling and are you wasting money on Walmart?
Retail is brutal
On the surface, retail is easy to understand.
- Buy or manufacture a product.
- Open a store.
- Sell it.
Between steps 1 and 3 there are a gazillion things to be done, then another zillion things after step 3 we don’t think about.
When you realize there are hundreds of thousands of stores doing the same thing, it is a competitive nightmare for the weak, slow or inexperienced.
In 2005, Buffett was asked about Eddie Lampert, K-Mart and Sears (SHLD, Financial).
A classic Buffett response (emphasis added).
Eddie is a very smart guy but putting Kmart and Sears together is a tough hand.
Turning around a retailer that has been slipping for a long time would be very difficult. Can you think of an example of a retailer that was successfully turned around? Broadcasting is easy; retailing is the other extreme. If you had a network television station 50 years ago, you didn’t really have to invent or be a good salesman. The network paid you; car dealers paid you, and you made money.
But in retail you have to be smarter than Walmart. Every day retailers are constantly thinking about ways to get ahead of what they were doing the previous day.
Retailing is like shooting at a moving target.
In the past, people didn’t like to go excessive distances from the street cars to buy things. People would flock to those retailers that were nearby. In 1966 we bought the Hochschild Kohn department store in Baltimore. We learned quickly that it wasn’t going to be a winner, long term, in a very short period of time. We had an antiquated distribution system. We did everything else right. We put in escalators. We gave people more credit. We had a great guy running it, and we still couldn’t win. So we sold it around 1970. That store isn’t there anymore. It isn’t good enough that there were smart people running it.
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How many retailers have really sunk and then come back? Not many. I can’t think of any. Don’t bet against the best. Costco (COST, Financial) is working on a 10% to 11% gross margin that is better than the Walmart's and Sam's. In comparison, department stores have 35% gross margins. It’s tough to compete against the best deal for customers. Department stores will keep their old customers that have a habit of shopping there, but they won’t pick up new ones. Walmart is also a tough competitor because others can’t compete at their margins. It’s very efficient.
In other words, investing in retail is hard.
I know.
I’ve lost plenty of money on what I considered to be good bets.
Would Buffett use Walmart in this example today?
If Buffett is asked this question today, would he replace Walmart with Amazon (AMZN, Financial)?
Yes.
Buffett made it clear that he admires what Jeff Bezos has done.
We haven’t seen many businessmen like him. Overwhelmingly, he’s taken things you and I’ve been buying, and he’s figured out a way to make us happier buying those products, either by fast delivery or prices or whatever it may be, and that’s remarkable. – Warren Buffett
If you consider the retail environment as brick-and-mortar stores only, Walmart is still on top of the list.
However, with the ubiquitous shopping experience needed to compete and grow in today’s environment, Amazon is hands down the favorite, despite Walmart’s revenue of $485 billion.
Maybe the following charts explain why Buffett divorced Walmart.
Don’t bet against Walmart just yet
Walmart has been left in the dust in terms of innovation (and stock price), but its core competency of low prices and efficiency is what keeps it on top of the ladder despite the falling dominoes of retail companies.
Its fourth-quarter results show why Walmart is king of retail (brick and mortar).
- Walmart's U.S. comp sales increased 1.8%, driven by a traffic increase of 1.4%. Neighborhood Market comps increased approximately 5.3%.
- E-commerce growth at Walmart U.S. was strong as sales and GMV increased 29.0% and 36.1%, respectively, including Jet.com and online grocer
- Net sales at Walmart International were $31.0 billion, a decrease of 5.1%. Excluding currency, net sales were $33.7 billion, an increase of 3.0%
- Free cash flow increased 39.5% due to improved working capital management.
The segment that everyone will continue to monitor closely will be on e-commerce.
Will Jet.com and ShoeBuy make a dent in Amazon?
No.
Doesn’t move the needle for Walmart revenues.
According to Prosper Insights & Analytics, 81% of U.S. consumers have never heard of Jet.com.
What it does show is Walmart’s willingness to make acquisitions and start to build a portfolio of e-commerce stores.
Don’t expect a huge, cash-gushing portfolio overnight or within a few years. Amazon didn’t get to where it is in a few short years.
But here’s a data-driven and bottoms-up approach for why you shouldn’t give up on Walmart.
Walmart fundamentals
One of my recent rules of thumb is to stay clear of failing retailers that are supposed to be in turnaround mode.
To make sure signs aren’t pointing toward a slow and painful death, here are some quality indicators I look at.
Walmart’s Piotroski score
The Piotroski F-score is made up of nine fundamental accounting checks.
Here’s the link to view the full details of how the Piotroski score works and a Piotroski screener using the best criteria of the nine scoring factors.
I use the Piotroski Score extensively because it has been proven. It cuts down a lot of time and makes it easy to analyze a stock.
The current Piotroski Score of 7 is good. Return on assets (ROA) and current ratio dropped, but other fundamentals are going strong.
Walmart Piotroski F Score Trend | source: old school value
Walmart’s DuPont analysis
Not all ROE is created equal.
The DuPont analysis breaks down the components of return on equity (ROE) so that you get a clear picture of how the company is driving its profits.
It helps you answer the following questions:
- Is the company increasing margins?
- Is the inventory turnover increasing?
- Is leverage being used?
Take a look at Walmart and Target (TGT, Financial).
Walmart’s ROE is consistent, has been consistent and even during the recession it didn’t register a blip.
Walmart 5 Step DuPont Analysis | source: old school value analyzer spreadsheet
The decrease in operating income is the main driver behind the dip in ROE. There’s no breakdown in the fundamentals unless operating income falls further.
Compare this to Target’s DuPont analysis.
Target DuPont Analysis | source: oldschoolvalue analyzer spreadsheet
Target is a well-run company but has difficulties and its recent jump in ROE is due to improving operating income and increased leverage.
Despite Target’s latest achievements in ROE and Walmart’s slight dip, I’m giving it to Walmart for consistency.
Walmart’s cash conversion cycle
Cash flow is the lifeblood of a retailer.
- Can the business get good terms from vendors?
- How quickly can it turn over inventory?
- How many days does it take to turn its assets into cash?
The quicker this process happens, the better. You don’t want to be in Sears' situation.
Walmart Cash Conversion Cycle Comparison
To see it up close, here’s a detailed breakdown of the Cash Conversion Cycle.
Walmart Cash Conversion Cycle Performance
You see that Walmart has fantastic buying power, currently paying its bills 43 days after being billed.
For the heck of it, here’s Amazon.
Amazon Cash Conversion Cycle Performance
This includes the AWS segment, so it’s not an exact comparison, but it goes to show the muscle that Amazon flexes.
Think of a negative cash conversion cycle like an interest-free loan from their suppliers. Suppliers are paying Amazon 35 days before Amazon has to pay anything off. Amazon can use this cash like float to finance its operations.
For a brick-and-mortar operation, Walmart is still elite. Stellar fundamentals with no concern of deterioration.
Now it comes down to what price makes sense.
Walmart ballpark valuation
Ben Graham said that the price you pay will determine the result of the investment.
A great company can be a bad investment if the price is too high. Conversely, a horrific company can be a superb investment if the price is cheap enough.
The question to answer is whether the current price offers a margin of safety.
Walmart Valuation Ratio Trends
Rather than focus on a single method to value stocks, I cover my bases and look at different views.
Valuation multiples gives you a comp view much as you value home prices.
DCF tells you that the value of a company is the sum of its future cash flows.
Earnings is also used in valuation because stock prices track earnings.
With Walmart, its EV/EBIT is 11 which is at the upper range of my preferred range.
I like to look for companies trading below EV/EBIT of 11.
You see a different picture with FCF and owner earnings. FCF and Owner Earnings is growing year over year, and Walmart is cheap with this metric. Anything under P/FCF or P/OwnerEarnings of 15 is value.
Walmart stock value (ballpark DCF)
Before getting deeper into the numbers, valuation is more art than science.
Depending on your narrative of the company, the valuation will change.
If you believe Walmart’s business will see a revival, your growth rates will be different to mine.
On the flip side, if your narrative is that Walmart is going down the drain, your valuation is going to be lower.
This is why I go for a valuation range.
Fair value is a moving target.
Using a FCF starting value of $20.9 billion, growth rate of 5.9%, discount rate of 6.8% using professor Damodaran’s industry specific rates and then applying a multistage DCF where the growth rate decays, the fair value comes out to $98.
Walmart DCF using FCF
Take note of the reverse growth rate.
The reverse growth rate signifies that Walmart’s current stock price is pricing in a growth rate of 1.6% when compared to Free Cash Flow.
The question for you is, will Walmart's fair value based on FCF grow faster than 1.6%?
That’s an easy yes.
So I know that $98 is a possibility.
Let’s look at it from another angle though.
Walmart Earnings-based DCF Stock Value
If I use an earnings-based valuation where the starting value is $13.6 billion, Walmart has to grow earnings faster than 8.37%.
Is this possible?
Not as likely.
Putting together the two DCFs and the valuation ratios, the fair value range looks like it is between $60 and $98.
That’s a big spread, and the current price of $72 sits in the middle.
If Walmart shot up to the 80s I’d be a seller. Current price is a hold for me and I’d be a buyer if the stock price was in the lower $60s unless you want a bigger margin of safety.
Buffett may be selling, but it’s not the end for Walmart.
Patient investors will receive value, but make sure the price is right.
Summary
- Buffett knows that retail is a tough industry. Turnarounds rarely happen. Go for a leader.
- Is Walmart a bad investment? No, but don’t expect huge returns. Fundamentals are strong and will let you sleep at night without worrying.
- A successful investment comes down to the price you pay, and your price will be based on your narrative of the company.
- An uphill battle for e-commerce, but Jet.com and ShoeBuy acquisitions are a step in the right direction.
Disclosure:Ă‚ Long Walmart at the time of writing.
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