Walmart (WMT, Financial), the world’s largest retailer, has dropped 20% since February when it was announced they were raising the minimum wage for their employees. Investors who are already worried about the razor-thin margins were concerned this would hurt the languishing retailer even more. However, recent developments may prove Walmart is still an attractive investment.
Recent developments
Internationally, Walmart is looking to expand quickly into the two biggest international growth markets. Walmart recently capitalized on China's newly reduced foreign investment restrictions by buying the leading online grocer, Yihaodian. The company also plans to open about 100 additional stores in the next few years, putting its Chinese store count at over 500. In India, Walmart shifted its focus onto a wholesale model similar to stores like Costco (COST, Financial), opening its first new store last week after having an almost four-year hiatus in the country. They plan to open 50 more stores in India under the Best Price Modern Wholesale brand name over the next few years.
Here in the U.S., Walmart hopes to take market share away from Whole Foods (WFM, Financial) and Trader Joe's by focusing on their more successful, smaller-concept Neighborhood Market stores. These stores offer better square feet/revenue and the prices of a Supercenter, but their easy-to-shop layout, focus on fresh produce, and convenient locations make them a true threat to the grocery store competition. In 2014, the initial success of these smaller stores led the company to double the number of stores it expected to open from 150 to 300. If completed, that would be close to 1,000 Neighborhood Markets across the U.S.
On top of that, Walmart.com recently ramped up with larger facilities and acquired key talent from eBay in order to compete with online mega retailer Amazon (AMZN, Financial), which currently offers members greater discounts and benefits through its Prime membership service. Walmart is also developing ecommerce tools. A local grocery pick up and delivery service is being tested in five U.S. cities as well as ShippingPass, an annual membership service that guarantees free thre-day shipping benefits similar to Amazon’s Prime but for half the price. It is unclear whether these ecommerce tools will significantly increase their success but the fact that they are determined to compete in every retail market is positive.
Ratio analysis
Wal-Mart is an expert discount retailer, selling goods quickly and cheaply and has done a fantastic job of maintain 20% Return on Equity for the last 15 years. The net margin remains small but consistent around 3-3.5% over the same period. This consistency and their simple business model explains why it’s a top holding in Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A & BRK.B) portfolio despite the recent decline in stock price.
The current valuation is cheap with a 14.5 TTM Price to Earnings Multiple, a 0.4 Price to Sales Multiple, and a Price to Book of 3, it is lower than most others in its category. Costco, for example, has similar margins but is trading at 27 times Earnings. Kroger (KR, Financial), the grocer has a Price to Earnings of 20, Price to Book of almost 7, and a Price to Sales 0.35. Walmart also pays a decent 2.7% dividend and an impressive five-year dividend growth at 12.9%. The stock is cheap from a ratio perspective and pays a consistently growing dividend.
Discounted cash flow calculator
This ratio analysis does not factor in future growth, however, so we must use the Gurufocus.com DCF calculator. Using the pre-filling setting of the DCF calculator, it would have you calculate that the Fair Value of Walmart is around $63 a share or 14% lower than the current price. The assumptions pre-entered are a bit optimistic in my opinion and need to be lowered. Expecting Walmart to grow at the 10-year average of 8% seems difficult to achieve. A terminal growth rate of 4% seems more realistic but still off. Finally a discount rate of 12% seems too high. A good discount rate should factor riskiness and the consistency of the firm warrants a lower discount rate.
If you estimate 4% future growth for the next 10 years and terminal growth of 3% for the terminal years, with a discount rate of 7% equal to weighted average cost of capital and do not add back tangible book value we would get a price right at the $72 the current price. If we add back the tangible book value which seems reasonable since Walmart has actual real estate and actual inventory, decrease growth to 3% and 2% for the terminal years, and increase the discount rate to 9%, it gives us a price of $74.5 a share. Under these two scenarios, we are not really pricing in the success of any new expansion initiatives that may make Walmart an even more undervalued stock.
Finally, while most investors are rightly concerned with increasing labor costs and reduced international sales figures due to the stronger U.S. dollar, the recent collapse of energy prices and drop in the Chinese yuan currency will make transportation costs and goods from China less expensive in the future. With new expansion initiatives in India and China, their focus on smaller, grocery-focused U.S. stores, and their drive to compete in the ecommerce market, Walmart is still appealing for the longer-term investor.
