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Vitaliy Katsenelson
Vitaliy Katsenelson

Wal-Mart So Far So Wrong

November 30, 2006 | About:

My thesis for buying Wal-Mart (WMT) was very simple: once it improves its store appearance and merchandise, existing customers will spend more money and new customers will start spending new money on higher margin merchandise. Same store sales will go up and everybody will be happy (except competitors like Bed Bath and Beyond (BBY), Linens and Things (LIN), etc.). Then, international growth will keep the giant growing for years to come.

So far so wrong. Same store sales dipped into negative territory - not so good. International growth?  Well, exiting Germany and South Korea was not part of my plan but it actually made sense, Wal-Mart could focus on the countries where it has a competitive advantage and labor laws are less… well, socialistic.

As I’ll say many times in my upcoming book (it is never too early to promote a book), in today’s market you should keep your stocks on shorter leash - sell sooner, don’t let the problems escalate into big losses. Wal-Mart is no exception, I have no intention of making excuses for the company; it is not my job, my job is to analyze. Putting my analytical hat on (which rarely comes off anyway), should I be worried about the stock at this point? I should if negative same store sales are an indication of a longer-term trend, therefore violating my thesis for owning the stock. So far I am not convinced that the subpar performance I observed over the last two months is an indication of a long-term trend for several reasons:

  1. Wal-Mart is remodeling more than half of its US stores, remodeling of existing stores could have caused - in part - a decline in same store sales.
  2. It terminated its layaway program. I don’t know what percent of sales layaways represented (the company doesn’t disclose it), its probably not very significant but on the margin contributed to same store sales going negative.

Wal-Mart’s offensive PR move on $4 generic drugs was an indication that this company is still run by smart and agile management. The stock is not very expensive, trading at about 16x earnings not discounting high growth. That is in part why it was only down 2.5% on negative news and a bad market. Its free cash flows are about to balloon as it will slow the opening of new stores in the US. This will spill into higher share repurchase and possibly higher dividend. Wal-Mart’s management has executed in the past, but it is famous for taking the wrong steps first, regrouping and making great ones.

Wal-Mart has found its place on my double secret probation group – I’ll be watching company’s operating performance like a hawk and if over next couple of quarters it fails to produce positive mid single digit same store sales, it will find itself in my recycle bin.

About the author:

Vitaliy Katsenelson
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 2.0/5 (2 votes)


Vooch - 10 years ago    Report SPAM

> in my upcoming book (it is never too early to promote a book)

I didn't know you were writing a book. That's cool. I've been writing one the past five years. Perhaps we can collaborate on one, together. In any event, I would enjoy a telephone conversation with you sometime if you're up to it.


Anyways, the reason for writing this, is... your current dismay with WMT. I've added onto my WMT position 32 days ago, 29 days ago, 22 days ago, 4 days ago, and it's funny you wrote this today... I bought more WMT today.

I heard today Michigan Sediment (not sure on the actual name at the moment) numbers were below 50. Apparently, it's a manufacturing number where below 50 means economic contraction. While no one number, is a signal, collectively, data points can add up to give a signal.

So... perhaps... we take the negative Michigan Sediment number (which signals a contraction)...

We couple that... with... the inverted yield curve that's been going on for awhile. I've learned (maybe you have too) it might take 9-12 months (or longer) for a high-probability recession after the inverted yield curve begins.

We then... couple that with America's largest retailer (WMT) who's experiencing flat sales.

Then, we.... couple that with the declining dollar.

Folks... we're heading into a recession, imo.

Now... perhaps the USA is optimistic because of the upcoming Vista (and supposed technological sales boost associated with it) release. I dunno.

But... let's look at the facts:

(1) If we're really going into a recession, almost all stocks will decline for a lengthy period of time, and;

(2) The U.S. deficit is a major problem. At a time when the USA should be preparing for an aging generation, they've opted for the heroin-like quick fix (spend more money now so the politician can get re-elected). Nobody want to talk about the elephant (the national debt problem) in the room (nationally), and;

(3) In my opinion, a further dollar decline almost seems guaranteed in the future (the long-run). Lengthy deficits do not help a currency, and;

(4) I believe the reason for flat WMT sales is because the economy sucks right now. I'm not a believer in growth-all-the-time-economies like our country likes to do. Instead, I'd rather see healthy growth and healthy declines. Otherwise... if we, as Americans, keep propping up the economy long enough, we're gonna suffer a depression in our lifetime. Keep in mind, it won't be the first for our country - it'll only be just another. Some people make money in depressions.

WMT's strengths don't seem to be comprimised any time soon. TGT might chip away at it, but WMT has the better fundamentals (the better margin of safety) today, imo.

All of this leaves me feeling uneasy. It makes me want to go to 100% cash and forego any profit-making opportunities. However...

Q: What is the value of cash when there's inflation?

A: Less.

Q: What is the value of cash when there's a recession?

A: Less.

Q: What is the value of cash vs. holding an index if the economy grows and the market (as a whole) grows?

A: Less.

Q: What is the value of cash vs. a stock index when earnings continue to rise?

A: Less.

As far as my buying more WMT today.... perhaps I'm making the wrong decision because down-the-road I could be screwed later, by either: (1) a very depressed Mr. Market, or; (2) a recesssion.

I cannot foretell the future, but it seems to me, that WMT is worth buying.

A recession will knock almost every stock on it's ass, but it'll probably be better to own a WMT than a GOOG when the dark storms arrive.

Perhaps cash (or bonds) would do even better, but I'd rather stray away from such proven lackluster long-term result opportunities.

The bottom line... Is it sensible to own a value stock as one thinks the economy heads into recesssion? I dunno, but I'm about to find out, eventually.

- Vooch
Jasonfrey33 premium member - 10 years ago
I originally purchased WMT shares on this reasoning:

* Large safety moat and competitive advantage resulting from location, large volume

orders and established distribution network.

* Limited LT debt that could be repaid with Operator Earnings in <2 years.

* Intelligent management that I understand and trust.

* Wise allocation of capital and resources AEB ROE of 21.

* Negative skepticism of market that has created a buying opportunity d/t slowed sales,

negative press, and renovation of stores.

* Company is well positioned in an industry that sells products individuals purchase on a

daily basis, which = steady sales and a cushion in a down market.

* International exposure accounting for 20% of sales in 2006.

WMT is a company that I feel is receiving too much negative skepticism for the amount of difficulty that it is experiencing. For this reason, I have been adding steadily to my position over the last year and a half. The fundamentals of this company are solid. Debt is managed well, capital is allocated appropriately, and they sell everyday products that will be purchased again and again. The same growth potential may not be there for WMT, but at current valuations I don't believe that it's necessary to continue growth at previous rates. The effects of decreased store construction in the U.S. on free cash-flow should also not be ignored. Think back to the effect this had on Mc Donald's during early 2000's. I believe WMT is in a similar position to decrease expansion of U.S. stores, increase emphasis on international growth, and upgrade existing store locations. When this occurs the share value will reflect the significant increases in earnings, dividend growth and free cash flow.

Until that time I wait patiently and continue to add when the price is right.

Sgeranpa - 10 years ago    Report SPAM
Question 1: If WMT stops opening new stores (at least in the US), its free cash flow will improve drastically, but growth will slow drastically too. Investors are looking for a slow down in expansion to improve free cash flow but, with A ROE of 20%, isn't it better to continue using any free cash to open new stores (as long as there is room for growth of course)?

Question 2: Its not that easy to evaluate wmt. Based on P/E, specially given its wide moat and quality of business is very cheap. But its not clear how much of their cap-ex is for opening new stores (good cap-ex) and how much for maintaining the existing operation (bad cap-ex). So how can you value wmt based on its free-cash-flow. Any comments?

Comment regarding recession: I for one think its very hard to base investing decisions on economic forecasts. If I'm buying a stock for the long run, especially one with a wide moat such as WMT, then the likelihood of an economic downturn shouldn't enter the equation. Besides, for all we know much of the downturn may already be reflected in the stock prices.

Vitaliy premium member - 10 years ago
Thank you for your comments.

It is hard to find a company that is completely recession proof. Government contractors are to some degree. Maybe pharmaceutical companies, though to lower degree now since lifestyles drugs are becoming a more significant part of their product line. Wal-Mart is not recession proof either, However, as I wrote in my article for FT ( http://contrarianedge.com/2006/08/06/fall-in-love-again-with-a-bellwether-friend/ )awhile back, it customer base is likely to grow during tough times as consumers will be shopping for bargains.

On the question of capex (capital expenditures). A very large portion of Wal-Mart capex (I estimate around 75-80%) goes into for-growth type of capital expenditures. Since its announced its plans to slow down opening of new stores, its capital expenditures will go down. The math here is simple, however, Wal-Mart still a large store renovation program underway as it is renovating half of its US stores. Therefore we will not see the benefit of lower for-growth capex this year.



Sgeranpa - 10 years ago    Report SPAM
Thanks for the response Vitaliy,

One further question: I would expect wmt to have a long term organic growth of inflation + GDP growth (roughly 5%). Given its current earnings yield of 6%, that’s a total of 11% long term return, which I think given their potential for expansion in emerging countries is a conservative estimate. Do you agree with that analysis?


Sgeranpa - 10 years ago    Report SPAM
There is no comparison whatsoever between gap and wal-mart. I personally consider Gap to have a very narrow moat if any. It is very hard to establish a brand in apparel retailing. People don’t really care where they buy their clothes as long as they like the look of it and the price is right. I don’t think Buffett bought that much Gap shares and in any case it may have been Lou Simpson who bought the shares. Walmart has a huge moat. Its moat has nothing to do with its name. Iif anything its name right now is a liability. Its competitive advantages arise from its humongous size which allows it to strike better deals with suppliers and to have a lower cost of distribution. The staying power and growth of walmarts business in the coming decades is virtually guaranteed. Gap may be around 15 years from now but it will still be struggling. Also, walmart only distributes the goods. It doesn’t care how cheap it sells its merchandise as long as it buys them from its suppliers even cheaper. Gap however needs to sell its merchandise at a high enough price to make its business and margins worthwhile. Competition in apparel retailing is huge. I personally would never own gap, specially at the current p/e of 17.
Freehling - 10 years ago    Report SPAM
Is it really true that 48 percent of Joel Greenblat's company's portfolio is in WMT? And it appears that he bought the stock at about the current price. When an investor of this magnitude makes this kind of massive investment in a stock that appears historically undervalued, it's difficult to not buy the stock. Further, practically every other top value investor (Buffett, Dodge and Cox, Tweedy Browne, Muhlenkamp, Oakmark, etc.) has bought it. Responses?
Gurufocus premium member - 10 years ago
Joel Greenblatt does have some Calls which are not included in the holding list. Other than those, every commom stock is included in the list.

Vitaliy premium member - 10 years ago
On Wal-Mart’s growth. I look at it from a bit different angle. Here is what I said in the article (http://tinyurl.com/y3kz2c) wrote about my expectations of Wal-Mart’s future growth:

Wal-Mart can deliver 10-14 per cent earnings growth, depending on the degree of success of its new initiatives. The Street expects 14 per cent. Of this, 5-8 per cent would come from opening new stores domestically and internationally, 3-6 per cent from same-store sales and another 1-2 per cent from share buybacks. In addition Wal-Mart pays a 1.5 per cent dividend yield, which has been on the rise in line with earnings growth.

Best, Vitaliy

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