Can you believe it?
Walmart (WMT, Financial) is becoming a battle stock. Gone are the days where Walmart was all about the dividend and same store sales.
This has introduced an interesting dilemma. There is now a fundamental shift from thinking of Walmart as the gold standard of long-term holds, to seeing short-term knee jerks.
It’s old news that analysts and the general investing public (myself included) are keen to see Walmart gain more ecommerce market share. So far that hasn’t happened.
Amazon.com (AMZN, Financial) is the clear leader and its advantage continues to grow.
Fourth-quarter market share numbers are not available yet, but even when you look at third-quarter market share, Amazon is destroying the competition.
Source: Internet Retailer estimate, U.S. Commerce Department
Now combine this third-quarter chart to the type of traffic and sales expected as fourth quarter rolls around. Think Thanksgiving, Christmas, end of year sales and promotions. The estimated number for Amazon’s total 2017 market share is at 44%.
But why am I talking about Amazon?
The point is to show that the Amazon wall is supremely high and difficult to penetrate. Amazon’s flywheel is in full motion and is spinning at breakneck speeds. Walmart is still trying to warm its engine.
Amazon Flywheel | Source: The Everything Store
Putting things into perspective and context is important.
Walmart is a small fry compared to Amazon’s online reach and competitive advantage. Walmart is a chimpanzee trying to overthrow King Kong at the moment. There’s a lot of training that this little monkey needs to work on before it makes up more ground. But the argument is the same vice versa.
However, on the online front, here’s a small list of Walmart disadvantages causing people to shop at Amazon.
- There is no fulfillment option like Fulfilled By Amazon (FBA) for sellers to deliver goods quickly -- no ecosystem to lock sellers in.
- Search functionality is dumber and far below Amazon’s algorithms.
- There is a lack of enticing features for third-party sellers like PPC advertising.
- Product pages are inferior with less information.
- There is less social proof.
Let’s get things straight. Walmart is far behind Amazon in the ecommerce space, and the expectation bar is set high with previous quarterly growth numbers exceeding 50%.
Walmart 2018 Q4 8-K
Based on various commentaries, the consensus concern is that online growth of 23% is too low. On the conference call, management said that it is expected to pick up again, but with the fourth quarter being the biggest sales period, it was disappointing to many shareholders.
Walmart dropped 10% and although it’s not the cheapest company to own (I’ll get to valuation later), a price drop of 10% is good news to my ears.
Compare the news to Wayfair (W) and how the stock price reacted.
Walmart vs. Wayfair Price Drop | source: Google Finance
If you believe markets are 100% efficient, a 10% drop signals a mild disappointment and not something to lose sleep over.
Of the 41 contrarian rules that David Dreman (Trades, Portfolio) wrote about, No. 11 sums up the reaction to Walmart.
Rule 11: Positive and negative surprises affect “best” and “worst” stocks in a diametrically opposite manner.
You see the difference in the “surprise” magnitude between Walmart and Wayfair. Goes to show that there are many strong holders of Walmart and that the market does not believe it is priced to perfection.
How much growth is the market expecting?
One of my favorite things to do is to simply look up what growth the market is expecting from the company -- a simple play from investing great Warren Buffett’s playbook.
"I only get into situations where I know the value. There are thousands of companies whose value I don’t know. But I know the ones I know. And incidentally you don’t pinpoint things. If someone walks in this door and they weigh between 300 and 350 pounds, I don’t need to say they weigh 327 to say that they’re fat." – Warren Buffett (Trades, Portfolio)
If you are trying to pinpoint valuation, you are either:
- New to investing.
- A Wall Street analyst.
Other than these two ends of the spectrum, the rest of the people in the middle understand that valuation is a range. By knowing the approximate market expectation, you can make an easy decision as to where a stock lies in the undervalued, fairly valued or expensive universe.
Here’s Walmart’s reverse DCF calculation based on fourth-quarter free cash flow of $18.3 billion.
Walmart Expected Growth Rate | source: Old School Value Reverse DCF
The important question to ask is whether you think Walmart can grow free cash flow at 6.4%.
2018’s free casn flow of $18.3 billion was a decline from the previous year's free cash flow of $20.9 billion. At first glance, the answer to the question is no.
But wait, there’s more.
Considering Walmart’s history, it’s better to zoom out and see the FCF growth rates over multiple different rolling periods.
Walmart’s FCF growth over multiple rolling periods | Source: Old School Value DCF
Lame question: Do you think Walmart can grow free cash flow at 6.4%?
My answer is yes.
Not over the next few months or next year, but over multiple periods – yes.
Is Walmart’s valuation overstretched?
Forget about price-earnings.
Using the same free cash flow concept, and applying it to a multistage DCF where growth is reduced by 10% every few years, I get a quick ballpark value range that looks like this.
WMT DCF Valuation Range | source: Old School Value DCF
I used the same inputs where:
- Starting free cash flow is $18.3 billion.
- Growth rate is 7.1% (not a short-term growth rate).
- Discount rate is 6.6% for retail industry.
By using a valuation sensitivity matrix, if Walmart grows between 3.1% to 7.1%, the fair value range is roughly $70 to $100.
WMT DCF Valuation Range | Source: Old School Value DCF
The current price of $93 is fairly valued at this time. This valuation also implies that Walmart isn’t priced to perfection -- hence the 10% drop compared to much sharper declines for the darling stocks that disappoint.
Walmart is much easier to value than most companies because of its consistency. If Walmart is valued from different angles, a price within that range results. It’s important that you don’t play with the numbers to match your assumptions.
With an earnings-based approach using $4.75 for 2019 guided earnings per share (lower end of the guidance), the Graham’s Formula gives a valuation of around $80.
WMT Graham’s Formula Valuation | Source: Old School Value Graham’s Formula
Rather than using price-earnings, I prefer EV/EBIT multiples. It’s not necessary to use this method for Walmart, but since its margins are going down as a byproduct of investing in ecommerce, you can see how it matches up.
WMT EBIT Valuation | Source: Old School Value EBIT Multiples
A normalized EV/EBIT of 11.2x can seem high, but the current price is a EV/EBIT of 14.4x with the lowest over the past five years being 10.2x.
An EV/EBIT of 11.2x is a fair multiple as the normalized figure which brings the fair value to $78. The aggressive multiple of 14.42x gives an upper fair value of $105.
Fair to say that the current fair value range is between $70 to $100.
Extra data
Summing up
Walmart is a stronghold in my portfolio and I am not worried about what it will do this quarter or next.
Once you get beyond the headlines that focus on click bait, short-term price movements and quarterly hurdles, you’ll see things from a different angle as you dig into the numbers and put things into perspective.
- Walmart does have issues with its website, but this can be fixed as it throws money and people at it.
- Walmart’s major business is still brick and mortar – it’s not dying. It’s thriving. It’s an internal funding machine for new ventures.
- Walmart is not overpriced or priced to perfection. It has plenty of room to grow and run.
Walmart is not perfect. So what?
Disclosure: Long WMT.
