In part two of my investment activity review for October, I look at my decision to open a position in the world's largest retailer.
Opened position in Wal-Mart Stores Inc (Ticker: WMT)
I owned Walmart almost 7 years ago and managed to make a decent return. I sold at the $60 level and it proceeded to keep rising up to $90. In the last few months it has been pulling back meaningfully and is now back in the high $50’s. I decided to take a look again at the company and see if there is still opportunity there. Again I evaluated the company using my 8 questions.
Q1: What do they sell?
Unless you’ve been living in Bora Bora the last 50 years, I’m thinking you already know what they sell…pretty much everything. It may not be necessarily the best quality, but they will sell it. For those who have been living in Bora Bora, here is the clinical description, per Reuters,
“Wal-Mart Stores, Inc. is engaged in the operation of retail, wholesale and other units in various formats around the world. The Company offers an assortment of merchandise and services at everyday low prices (EDLP). The Company's operations are conducted in three segments: Walmart U.S., Walmart International and Sam's Club. The Walmart U.S. segment operates retail stores in all 50 states in the United States, Washington D.C. and Puerto Rico, with three primary store formats, as well as digital retail. The Walmart International segment consists of operations in 26 countries outside of the United States and includes numerous formats divided into three main categories: retail, wholesale and other. The Sam's Club consists of membership-only warehouse clubs and operates in 48 states in the United States and in Puerto Rico, as well as digital retail.”
Q2: Who do they compete with?
Walmart main competitors (if you want to call them that as their market capitalization is 3 times bigger than their next closest competitor) are other discounted retailers such as Costco, Target, Sears Holdings, and extreme discount retailers such as Ross Stores and Dollar General in the US and Dollarama and Giant Tiger in Canada. In the cyberworld of online retailing, Amazon is considered its closest foe.
Q3: Who buys their products and services?
Walmart gets slammed a lot by upper income people. You hear a lot of, “I wouldn’t be caught dead in a Walmart” yet if you goto a typical Walmart parking lot you will your fair share of BMW’s, Audi’s and Mercedes. The official demographic might be low income but the reality is everyone shops there, even if they won’t admit it.
Q4: Will they buy their product over and over again?
Just by my unscientific eyeballing of their parking lots and the lines inside (some of which are internally generated), I’m going to go out on a limb and say they get a lot of repeat business.
Q5: Do they make money?
Walmart is one of the most profitable companies on the planet. They make more money than some countries. It truly is a money printing machine. If we look into their numbers, the company is generating healthy Returns on Invested Capital in the 13 to 17 percent rage which is much higher than it’s cost of capital level of 9 percent. For 2015 they are tracking on generating about $6.5 billion in Economic Profit on almost half a TRILLION in sales. Without looking at the company through an analysts filter, the numbers are truly stunning but for Wall Street analysts who are obsessed with growth, half a trillion dollars in sales is pretty tame. I disagree.
Q6: What do they own and who do they owe money to?
Walmart’s balance sheet is pretty solid and pretty straight forward for a company of this size. Walmart is a company that is not going away anytime soon. In terms of what the largest company in the planet owns, you would expect them to own quite a bit and they do. They are the largest owners of…trucks, employees, retail stores, guns (one of the largest gun retailers), and bananas (number one selling item). Its debt levels are manageable (Debt/Equity of 0.5). Its assets are pretty high quality with very minimal intangible assets. From a liquidity perspective, the company is posting a Current Ratio of less than 1 which is not ideal, but given the company’s ability to generate extremely rich free cash flows, it is not a threat to the company.
Q7: How risky is their business?
The sheer scale and size of Walmart and how much it is embedded in the retail and supply chain landscape makes it very difficult for it to get taken down. Its ability to shake down suppliers is epic. That doesn’t mean it isn’t susceptible especially in the cyberspace domain. Amazon is quietly closing on Walmart in online sales and recently surpassed Walmart in market capitalization. Size can also be an impediment as it makes it much more difficult to adapt and adjust. Walmart though has the capital and resources and a culture of cost management to address the challenges. It recently announced that it will be making significant investments in its electronic commerce infrastructure.
Q8: Is the stock cheap?
On a relative basis, Walmart’s stock is cheaper than some of its main competitors like Target, and Costco, trading at about 16 times earnings. On a discounted basis, the stock using a discounted cash flow approach values the stock at around $70 which is at discount from its current level of $58. At one point earlier this year the stock was trading at the $90 level. It has fallen from grace as a result of recent “lackluster” earnings in the eyes of analysts and the decision of company to engage in heavy capital spending to make its online services more competitive with Amazon and at some point these investments will bring long term benefits for the company.
The company has its challenges including staffing, customer service, inventory management, and ongoing battles with its suppliers and NIMBY neighbourhoods that have been documented ad nausem. Other companies are no different but it seems Walmart because of its size and visibility are more magnified. At the end of the day, this company creates a lot of tangible wealth and ultimately the goal for us is to invest in high quality companies that are profitable and create tangible wealth. Walmart does this in spades and in my mind I think the stock is on sale and so I decided to open a small position and build it slowly. It is still the most dominant retailer on the planet and will be among the most dominant for the foreseeable future. The stock is out of favour right now by Wall Street and because it is out of favour right now, the stock price may have even more room to fall, so I can slowly build up a position at attractive price points.