Walmart (NYSE:WMT) is one of the few consumer reliant business models that tend to thrive during recessions as consumers seek out cheaper alternatives for the items that they need. Walmart has continued to expand their grocery offerings as well as the number of stores offering online grocery ordering and in-store pickup. In a world where everyone seems pressed for time, the ability to purchase everything you need at one store or to save time by ordering groceries online can free up an hour or two per week.
Walmart has also been expanding its e-commerce business both organically and through acquisitions such as with Jet.com and Flipkart. In 3Q FY 2019, ecommerce sales for the Walmart U.S. segment grew by 43% sequentially. Over the TTM, ecommerce revenues now represent over $15 B in revenues.
With 4Q and full year results due out this week, I wanted to re-examine this retailing giant to see whether it warrants some of my investment capital.
Via https://newsapi.org online business online marketing online business opportunitiesDividend History
When I started investing, the approach that I gravitated towards was dividend growth investing. The premise being focus on quality companies trading at fair valuations or cheaper and look to reap the dividends while letting the capital gains come over time. The idea behind that is that you can eat apples from an apple tree every year, but you can only harvest the wood once.
Image by author; data source Walmart Investor Relations. An interactive version of this chart can be foundhere.
Walmart has increased its dividend payment for 45 consecutive years giving it the title of Dividend Champion from the late David Fish. That’s nearly half a century of economic and geopolitical turmoils, inflation, stagflation and every other “catastrophe” that was going to forever change the economy as we knew it. Yet, every year, Walmart has been paying and increasing their dividend.
Up until 2013, Walmart had routinely given 10%+ annual dividend growth. However, starting in 2014, dividend growth has slowed to a crawl with just $0.01 per share increases being doled out, which works out to roughly 2% per year raises.
The 1-, 3-, 5- and 10-year rolling dividend growth rates since 1993 can be found in the table below.
|Year||Annual Dividend||1 Year||3 Year||5 Year||10 Year|
Table and calculations by author. Data source Walmart SEC filings. An interactive chart of the table is availablehere.
The slowing dividend growth has brought the payout ratio based off free cash flow down to more conservative levels. Over the last decade, the free cash flow payout ratio has averaged 39.3%, while the traditional net income payout ratio has averaged 37.5%. For the TTM period, the net income payout ratio is over 100%, although that’s due to accounting earnings taking a hit due to the tax law changes, which isn’t reflected in the free cash flow. Walmart’s dividend is still very safe and well covered by cash that the business generates.
Via https://newsapi.org online business online marketing online business opportunitiesHow Does Walmart Make Money?
Walmart is the world’s largest retailer with a variety of store formats from grocery only, membership stores and the most well-known Walmart Supercenter where you can buy just about anything that you can think of. Walmart is organized into 3 operating segments:
- Walmart U.S.
- Walmart International
- Sam’s Club
Walmart U.S. is by far the largest of the 3 in terms of both sales and operating profits with ~65% and 71% for 3Q of FY 2019, respectively. Walmart International is the second largest with 23% and 21%, respectively, with Sam’s Club generating 12% and 7%, respectively.
Walmart U.S. also leads the way in terms of operating profit margin at 4.9%, with Walmart International showing margins of 4.1% and Sam’s Club well behind at just 2.6%.
Approximately 77% of Walmart’s revenue and 79% of its operating profits during 3Q FY 2019 came domestically with the rest coming from outside the United States. While Walmart is highly exposed to the domestic market, they still have a significant exposure to the strength of the U.S. dollar.
A strong U.S. dollar hurts the International sales, by scale alone, it’s going to have an impact, when converted back to dollars for reporting purposes. However, it’s also important to remember that as a retailer Walmart has to buy goods to stock the shelves. With a large portion of consumer goods production coming from outside the United States, specifically in China and other Asian countries, the stronger U.S. dollar lets Walmart source the products for cheaper.
Via https://newsapi.org online business online marketing online business opportunitiesQuantitative Quality
The quality of a business model will show up in its numbers. Whether that’s consistent growth, improved operational efficiency, and most importantly, gobs of cash flow.
In spite of the “end of Walmart” being written many times, Walmart has still managed to grow sales by 23.4% over the last decade or roughly 2.4% per year. It’s actually pretty amazing to think that a company with over $400 B in annual sales in 2009 could push that up to $500 B in 10 years when the business is pretty much fully built out. Even more impressive is that revenue has only seen one year-over-year decline in that time as well.
Over that same time, operating cash flow has grown 22.4% or 2.3% annually with free cash flow climbing an absurd 57.0% in total or 5.1% annually. With operating cash flow keeping pace with revenue growth, that means operating cash flow margins have been flat over the decade while free cash flow margins have seen a marked improvement, albeit they still remain at very low levels.
My preference is for the companies I invest in to have 10%+ free cash flow margins. Walmart clearly fails this test with free cash flow margins averaging just 3.1% over the last decade. The 10% threshold is very industry-specific, and in the discount retailing space that Walmart operates, margins are notoriously tight compared to other industries.
Alternatively, I like to view the profitability of a business via its free cash flow return on invested capital. The FCF ROIC is the yearly return that one could generate from the business if you owned it outright under the current capital structure. I’ve also included the FCF ROIC “net” value, which nets out the cash held on the balance sheet from both equity and debt. Once again, I want to see a value over 10%.
Walmart hasn’t been above the 10% level every year over the last decade; however, they have routinely been above or just slightly below 10%. The average over the last decade has been 11.7% with the average FCF ROIC net coming in at 13.3%. Both of those are at healthy levels, and since 2014, the trend for both has been higher.
To understand how Walmart uses its free cash flow, I like to examine 3 variations on the metric, defined below:
- Free Cash Flow (FCF): The traditional calculation for free cash flow of operating cash flow less capital expenditures.
- Free Cash Flow after Dividend (FCFaD): FCF less total cash dividend payments.
- Free Cash Flow after Dividend and Buybacks (FCFaDB): FCFaD less total cash spent on share repurchases.
Ideal investment candidates will show positive FCFaDB the majority of the time. A positive FCFaDB would mean that the business generates enough cash through its operations to maintain and grow the business, as well as reward shareholders with dividends and share buybacks. If FCFaDB trends negative, then management will be forced to either use cash or assets on the balance sheet or seek out external funding via the capital markets.
Over the last decade, Walmart has grown its annual FCF by more than 50% and has averaged $14.17 B per year in FCF. Cumulatively, Walmart has generated $141.74 B in FCF, which is an astounding total.
That FCF has allowed Walmart to pay out $53.78 B to shareholders in dividends over the last decade and puts the FCFaD at $87.97 B for the entire period with an annual average of $8.80 B.
Walmart has also used $67.86 B in total on share repurchases over the last decade for an average of $6.79 B per year. That puts the FCFaDB for the last decade at a healthy $20.09 B.
Walmart has been truly exceptional at managing their free cash flow and not over allocating cash towards dividends or buybacks. The positive FCFaDB should allow management to continue with dividend increases as well as further pursue share repurchases through internally generated cash.
The $67.86 B spent on share repurchases over the last decade has reduced the diluted weighted shares outstanding by 23.8% over the last decade. That’s good for a 3.0% annual reduction.
Image by author; data source Walmart SEC filings
The following chart shows the ratio of the cash Walmart has used on dividends and buybacks. While I concede that share repurchases are more tax-efficient, I still prefer dividends to be a larger portion of the cash returned to shareholders. It takes a strong management to not force feed share repurchases if they aren’t a smart use of capital, and many managements do a poor job of buying $1 of earnings power for $0.50, let alone a 1:1.
The ratio of cash returned to shareholders has been quite variable over time; however, the ratio has typically hovered around a 60:40 or 50:50 split for dividends versus share buybacks.
With plenty of cash flow, Walmart has had no need to take on additional debt. That’s why the total debt to capitalization has been very consistent over the last decade with debt accounting for roughly 40% of the capital structure with equity making up roughly 60%. The debt that Walmart does carry is very manageable and would take just 2.1 years of free cash flow to pay off completely with free cash flow also covering interest at 8.3x. I would still prefer to see debt reduced; however, there are no concerns at this time regarding Walmart’s balance sheet.
Via https://newsapi.org online business online marketing online business opportunitiesRisks To An Investment
The elephant in the room is Amazon (AMZN). Amazon is one of the few retail companies that have the scale to be able to challenge Walmart as the low-cost provider for consumers on just about any product they want to buy. That being said, at least up until now, I think Mark Twain said it best with “the rumors of my death have been greatly exaggerated.”
In spite of Amazon’s growing presence, Walmart has still grown sales over the last decade with only 1 year-over-year decline. Also, Walmart has been building its e-commerce business and has made great strides in that department with revenues over $11 B for the last fiscal year. That’s still a long ways from truly competing with Amazon on e-commerce, but Walmart has made progress and should continue to do so.
Walmart has also been offering in-store grocery pickup which is a service I’ve yet to use, but that’s due to me preferring to grocery shop for myself. My time isn’t so pressed where I feel the need to save time with online grocery shopping although that very well could change with our second child due in April.
The other big risk is that there will be a continued push for higher wages. As one of the largest employers, increased wages will be felt by Walmart. I’m not too concerned about this either as Walmart has already pushed its starting wage up to $11/hr, and employees are likely to cycle at least a portion of the increased wages back into sales at Walmart. Also, increasing wages will eventually become less economical than automation which management is already pushing towards.
Via https://newsapi.org online business online marketing online business opportunitiesValuation
One of the methods that I use to determine the valuation of a business is the minimum acceptable rate of return, or “MARR”, analysis. A MARR analysis entails estimating future earnings and dividends, applying a valuation to the future earnings and then determining whether the expected return meets your threshold for investment.
On average, analysts expect Walmart to have earnings of $4.72 for FY 2019 and to see 6.0% annual earnings growth over the next 5 years. I then assumed that earnings growth would slow to 4.0% annually for the following 5 years. I’ve assumed that dividends will be targeted at 45% of annual earnings per share.
To determine a reasonable valuation, use the historic multiples that investors have valued Walmart’s earnings at. As you can see in the following chart, investors have typically valued Walmart’s earnings between ~10x and 20x. Using a modified Graham Number calculation pegs the fair P/E around 17x. For the MARR analysis, I’ll examine multiples in that range.
The following table shows the potential internal rates of return that an investment in Walmart could provide assuming a purchase price around $100 per share. Returns include estimated dividend payments and are run through the end of calendar year 2023, “5 Year”, and calendar year 2028, “10 Year”.
Alternatively, I want to determine price targets that would potentially generate 10% and 15% internal rates of return based on the varying P/E ratios. The same assumptions from above apply to the following calculations.
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Via https://newsapi.org online business online marketing online business opportunitiesConclusion
Walmart the business has proven itself over the last 57 years growing from a single store front in Arkansas to the world’s largest retailer. The retail sector is notorious for having very low profit margins; however, Walmart has consistently proven to have management that focuses on its free cash flow.
The problem right now with Walmart is not the business, rather it’s the stock price. At nearly $100 per share, the valuation appears too high based on the relatively meager growth prospects that Walmart has. If analyst estimates for $4.72 in EPS for FY 2020 play out, you’re paying over 21x forward earnings for a company expected to grow just 6% per year. That’s a hefty premium to pay even for a quality company.
Unless you expect growth to be materially higher than assumed in this analysis returns from the current price seem meager.
Even adding the perpetuity value of the dividend stream assuming no future growth after 2028 adds just $12.80 per share of value in the 10% discount rate price target and $5.47 per share of value to the 15% discount rate price target. That would still have shares of Walmart quite overvalued.
I believe there are better opportunities currently in the market and that better opportunities to purchase shares of Walmart will come in the future. Unfortunately, I can’t tell you when that will be. Given the current growth prospects of Walmart, I would begin to contemplate purchasing shares in the mid-$80s or roughly 15% lower than the current share price and likely wouldn’t add shares until an upper-$70s share price is seen.
I am not a financial professional. Please consult an investment advisor and do your own due diligence prior to investing. Investing involves risks. All thoughts/ideas presented in this article are the opinions of the author and should not be taken as investment advice.
Disclosure:I am/we are long WMT.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.