Published by Nick McCullum on November 16, 2017
Wal-Mart (WMT) is one of the most well-known retailers in the world thanks to its global presence and every day low prices.
It is also a very popular dividend growth stock. With 44 years of consecutive dividend increases, Wal-Mart is a member of the exclusive Dividend Aristocrats index – an exclusive group of dividend stocks with 25+ years of consecutive dividend increases.
Wal-Mart is a large, well-established company, but make no mistake – its growth days are far from over. In the company’s third-quarter earnings report (which was released on November 16), the company reported online sales growth of 50%, silencing questions about whether it can compete with Amazon in the eCommerce space. Wal-Mart’s stock surged to an all-time high following the announcement.
This article will analyze Wal-Mart’s third-quarter earnings release in detail and determine whether the company merits investment at current prices.
Wal-Mart is the world’s largest retail corporation, founded in 1962 by legendary entrepreneur Sam Walton. The company is arguably one of the biggest success stories in the history of American business.
The original Wal-Mart locations had one goal in mind: to provide the lowest possible prices to consumers, every day. This mission has helped Wal-Mart to deliver fantastic growth.
Today’s Wal-Mart is one of the world’s largest companies, serving more than 260 million weekly customers through 11,600 stores in 28 countries. Wal-Mart generated revenue of $485.9 billion in fiscal 2017 and currently employs about 2.3 million associates.
Wal-Mart reports business performance under three operating umbrellas:
- Wal-Mart U.S.: $77.7 billion in quarterly revenue
- Wal-Mart International: $29.5 billion in quarterly revenue
- Sam’s Club: $14.9 billion in quarterly revenue
The next section will discuss Wal-Mart’s third quarter financial performance in detail.
Third Quarter Financial Performance Summary
On November 16, Wal-Mart reported financial results for the third quarter of its fiscal 2018. Wal-Mart’s unusual financial calendar means that fiscal 2018 will conclude at the end of January 2018.
The company’s quarterly performance was far better than the markets expected. In response, the company’s stock was bid up by about 8% on the day following the announcement. Let’s turn to the numbers to understand why the markets were so happy with Wal-Mart’s earnings release.
The company reported total revenue of $123.2 billion, an increase of 4.2% (or $5.0 billion) from the same period a year ago. As a global company, Wal-Mart’s reported financial figures are significantly impacted by currency fluctuations. On a constant-currency basis, Wal-Mart’s revenue increased by $4.5 billion, or 3.8%. In either case, low-to-mid single-digit revenue growth is within our expectations for a global retail giant like Wal-Mart.
Much of the company’s solid top-line performance was due to strength in its domestic U.S. segment. Wal-Mart U.S. comparable store sales increased by 2.7% and comparable stores traffic increased by 1.5%. More importantly, the company’s domestic eCommerce sales increased by 50% from last year’s third quarter.
Unfortunately, Wal-Mart’s top-line strength did not convert well to bottom-line expansion. Wal-Mart’s reported earnings-per-share were impacted for three major items:
- A charge or $0.29 for loss on the extinguishment of debt associated with a recently-completed tender offer
- A charge of $0.09 related to discussions with the government related to international bribery claims
- A $0.04 charge related to the sale of certain international properties.
Because of these notable one-time accounting charges, it is most meaningful to analyze Wal-Mart’s adjusted earnings-per-share (which excludes these items). Wal-Mart reported adjusted earnings-per-share of $1.00 in the quarter, representing growth of ~2% from last year’s period. This is lower than our long-term expectation for the company, but markets were still happy with the resutls due to the company’s expoding eCommerce sales.
Here’s what the company’s President and Chief Executive Officer, Doug McMillon, had to say about the company’s performance in the quarter:
“We are pleased with the strong results in the quarter across each of our business segments, and I want to thank our associates for their commitment and great work to make it happen. We have momentum, and it’s encouraging to see customers responding to our store and eCommerce initiatives. We are leveraging our unique assets to save customers time and money and serve them in ways that are easy, fast, friendly and fun.”
Wal-Mart also increased its full-year earnings guidance when it released third-quarter earnings. The company now expects adjusted earnings-per-share of $4.38 to $4.46, up from $4.30 to $4.40 previously. At the midpoint ($4.42), Wal-Mart’s new guidance represents a 1.6% increase from its previous guidance.
With that said, the difference between Wal-Mart’s current guidance and its previous guidance is not the meaningful metric here. As long as it is an upwards revision, we’re happy. What really matters is how much Wal-Mart’s fiscal 2018 earnings are expected to grow versus fiscal 2017’s.
Wal-Mart’s reported adjusted earnings-per-share of $4.32 in fiscal 2017. The new midpoint of Wal-Mart’s guidance band ($4.42) represents paltry growth of 2.3% over last year’s figure.
2018 is not expected to be a blockbuster year of earnings growth for Wal-Mart. With that said, we remain confident that this is a temporary anomaly. Wal-Mart is likely to deliver mid-single-digit earnings growth over full economic cycles.
Valuation & Expected Total Returns
With the rapid growth in Wal-Mart’s eCommerce sector over the last several quarters, investors are beginning to realize that the company can truly compete with Amazon (and other large players) in the online retail space. This has led to more demand for Wal-Mart shares, and a correspondingly higher stock price and valuation.
In fact, Wal-Mart’s valuation is high enough now to prevent it from earning a buy recommendation from us, despite the underlying business being the obvious leader in the retail industry.
Here’s what the numbers look like. Wal-Mart’s revised fiscal 2018 earnings guidance calls for adjusted earnings-per-share of $4.42 (at the midpoint), while the company’s stock is trading at $97.63. This implies a price-to-earnings ratio of 22.1.
The following diagram compares Wal-Mart’s current valuation multiple to the company’s long-term historical average:
Source: Value Line
Wal-Mart’s current price-to-earnings ratio is 22.1 and the company’s 10-year average price-to-earnings ratio is 14.6. Using this important valuation metric, the company is trading at a significant 51% premium to its normal stock price.
One could argue that Wal-Mart’s premium business model deserves a premium valuation metric. We do not agree. Investors who buy Wal-Mart stock right now are exposing themselves to the very real risk that the company’s earnings multiple reverts to more historically normal levels.
Consider the following: if Wal-Mart’s price-to-earnings ratio reverts to 16 (still above its 10-year average) over the next five years, this will provide a 6% per year drag on shareholder returns. The number jumps to 9% per year if a P/E of 15 is realized over four years.
Clearly, now is not the time to buy Wal-Mart. Despite the fact that the company’s performance in the most recent quarter beat expectations, we recommend that investors hold off and wait for a more reasonable buying opportunity.
Wal-Mart has many of the characteristics of a high-quality business:
- A multi-decade-long streak of consecutive dividend increases
- A brand that is instantly recognizable for millions of consumers across the globe
- A very recession-resistant business model
These factors combined with the company’s performance in the most recent quarter clearly make it appealing for fundamental, bottom-up investors.
The only negative aspect of an investment in Wal-Mart is its current valuation. We can’t stomach the company’s current price-to-earnings ratio, and so the company does not earn a buy recommendation at this time. Wal-Mart remains a strong hold, particularly for investors that are carrying their shares at a cost basis well below current market prices.