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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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Wal-Mart Stores (WMT) |
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Selected Analyst Coverage (Target): Wachovia - Outperform ($51-55) William Blair - Outperform Oppenheimer - Buy |
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WMT Closed at $43.74 on 8-24-07 |
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Released 8-26-07 |
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Wal-Mart (ticker: WMT), with sales of $363 billion in the last year, is the world’s largest retailer. It operates traditional discount stores, “supercenters” that combine discount stores with grocery stores, and Sam’s Club membership warehouses. · Wal-Mart’s dominant position in the retail business is a testament to the business model of leveraging economies of scale to achieve the lowest possible cost for goods, which it can then pass on to consumers. With the enormous scope and scale the company has achieved, it is difficult for competitors - even other big box retailers - to compete with Wal-Mart on efficiency metrics. · WMT had a 22% increase in the short position in the last month as the stock fell to its 52-week low following the company missing quarterly earnings and softened forward guidance below expectations. Shares are now at an eight-year low, and at 14.5x earnings, are the cheapest they have been in more than a decade, trading at a discount not only to the industry average (16.6x) but also to the S&P 500 (20.4x). The 5-year average multiple for WMT is 25.1x earnings. · Because Wal-Mart has high capital expenditures associated with new store openings, free cash flow is not the most accurate trailing metric to use with the stock. Management is now favoring a deceleration in new store openings (I view this as an admission of market saturation) and this will have a positive effect on FCF in the future, but for a company dependent on store expansions I favor operating cash flow as a valuation proxy. On this basis ($18.2 billion in trailing annual operating cash flow) the stock trades for just 11.84x cash flows on an EV/Op. CF basis. · While Wal-Mart undoubtedly surprised the investment community with its failure to meet/beat expectations, one should put the quarterly results into the proper context. The company continues to generate an average return on equity in excess of 20%, as it has for the last decade, and overall margins continue to come in in the middle or high end of long-term averages. The cash conversion cycle continues to move in the right direction, and inventory carried as a percentage of sales is falling, meaning Wal-Mart is operating an even leaner business model. Similarly, inventory turn is at its highest rate ever, so that while same-store comps growth has been sluggish, it has not yet had any real adverse impact on financials. · While many outsiders criticize the company for sacrificing profits for the sake of revenues, the fundamental model of Wal-Mart has always been ruthlessly leveraging efficiencies and making up the low margins on volume. Buyers of WMT can be assured that they have an extremely competent and frugal management team that, while perhaps not being renowned for popular products, can underprice/outsell just about any other company on the planet. Surely, this counts for something. Keep in mind that Wal-Mart just trails Exxon Mobil (XOM) for having the greatest sales revenue of any company, despite the fact that Wal-Mart does not make one thing it sells on its shelves. Consider, for a second, that the company sells $363 billion of other company's goods, and keeps $12.5 billion of that for itself. Core competence? I think the management team at Wal-Mart is well aware of what their's is and how they need to execute upon it. · Given Wal-Mart’s anticipated earnings growth, its balance sheet position, cash flows, and business risk, the fair value target for WMT is $58.50, putting WMT shares as being undervalued by approximately 33.7% based off Friday’s closing price of $43.74.
Disclosure: The analyst has no position in WMT or its derivatives. |
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