The shares of many brick-and-mortar retailers have come under significant pressure over the last couple of years, as the market increasingly worries about the impact that online retailers such as Amazon (AMZN) will have on the business performance of more traditional retailers.
Not all brick-and-mortar retailers are impacted the same, though, as online competition is not an equal threat for all sub-segments of the large and diverse retail industry. Groceries, for example, are less impacted than book stores or retailers that focus on apparel sales.
We believe that the shares of some grocery companies are attractively priced right now, which is why we have compiled a list of the top 5 most attractive grocery stocks. Walmart (WMT, Financial), the largest retailer in the world, deserves to be examined in detail.
Company overview and growth outlook
Walmart is, by revenue generation as well as by customer transactions, the largest retailer in the world by far. The company generates annual revenues of more than $500 billion, serving several hundred million customers every single week. Walmart was founded in 1945, and is currently valued at more than $300 billion.
Walmart reported its first-quarter fiscal 2020 earnings results in May. The company had strong growth across its businesses, while operating efficiency moved in the right direction.
The company generated revenues of $123.9 billion during the first quarter, which was 1.0% more than Walmart’s revenues during the previous year’s first quarter. This was marginally less than what the analyst community had forecasted, but the revenue miss could be attributed to the adverse impact of currency rate movements.
Walmart’s most important business unit, the Walmart U.S. segment, performed very well during the quarter. Comparable store sales rose by 3.4% on the back of a higher transaction count and higher average spend. Rising ecommerce sales also were a tailwind for Walmart’s sales growth rate in its home market. On top of that, Walmart managed to grow its gross margins, while operating leverage, through higher sales at existing locations, allowed for a decline in the company’s operating expense rate. All in all, Walmart has been able to grow its operating profits at a mid-single-digit pace during the quarter, which is a very solid performance for a brick-and-mortar focused retailer.
Walmart should be able to continue to grow its profits over the coming years as well, through a combination of rising comparable store sales, some margin increases and share repurchases. Walmart is currently investing significant amounts of money into its online business, which leads to above-average capital expenditures and rising operating expenses. These investments into its online business will increasingly pay off in the future, though, and capex spending should decline over the coming years, which would boost free cash flows. These, in turn, will allow Walmart to accelerate its pace of share repurchases again.
Over the last decade, Walmart has bought back roughly one quarter of its shares. Thus, it is not unrealistic that it could get back to repurchasing 2-3% of the, annually in the future. This, coupled with the positive developments in its U.S. business and rising contributions from its ecommerce business, could allow for a mid-single-digit earnings-per-share growth rate.
Valuation and dividend analysis
Walmart’s shares have performed better than the shares of many other brick-and-mortar retailers over the last year, as Walmart’s share price has risen by 25% throughout the last 12 months, easily outperforming peers and the broad market. This has resulted in considerable valuation expansion, though, and Walmart’s shares currently look relatively expensive. At $105, they trade for roughly 22 times this year’s net profits, which is not a cheap valuation at all.
Walmart’s shares traded at earnings multiples in the low to mid-teens throughout the majority of the last decade, which means that they are not only looking expensive on an absolute basis, but also relative to the company’s historic valuation. Walmart should be able to grow its profits considerably going forward, but the forecasted earnings-per-share growth rate is not nearly high enough to justify an earnings multiple of more than 20. We therefore believe that Walmart’s valuation will decline towards 15 over the next five years, which would be more in-line with its historic valuation. This forecasted multiple compression will unfortunately result in a meaningful drag for total returns, and we forecast valuation compression headwinds of about 7% a year.
This is much more than the dividend yield of 2% that Walmart’s shares offer right now. Walmart has a consistent and long dividend growth track record, but its dividend yield is at the bottom of the range it has been at over the last decade, which suggests that right now is not a good time to buy Walmart’s shares for income investors at all. One should also note that Walmart’s dividend growth rate has slowed down considerably over the last couple of years, from more than 10% one decade ago, to just below 2% during the last couple of years.
Walmart’s shares will likely not generate meaningful total returns over the coming five years, as the forecasted earnings-per-share growth rate of 5-6% and the dividend yield of 2% will be mostly offset by the forecasted negative total return impact from multiple compression of 7%. According to our estimates, Walmart will thus generate total returns of 0-1% annually, which is not attractive.
Investor takeaway
Walmart is the largest retailer in the world, and the company continues to execute well, especially in its U.S. business. But its shares are trading at a historically high valuation, without having any good reason to trade for more than 20 times net earnings. This is why we do not believe that Walmart will produce strong returns going forward.
Despite the company not doing bad at all operationally, we rate Walmart’s stock a sell right now, due to valuation concerns. Other grocery stocks offer more attractive total returns.
Disclosure: No positions in any stock mentioned.
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