Walmart: Unlike Its Merchandise, The Stock Is Overpriced

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I first recommended Walmart Inc. (NYSE:WMT) in an Editor’s Pick Seeking Alpha article on June 27, 2017. Since then, the stock has outperformed the S&P 500 by 4,723 basis points, or 47.23 percentage points during this holding period.

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In this updated research report on Walmart, I put the company and its common shares through my market-beating, data-driven investment research checklist of the value proposition, shareholder yields, fundamentals, valuation multiples, and downside risk.

The resulting investment thesis:

Although Walmart remains a most recognizable and crowded storefront, with solid fundamentals and low downside risk, fierce competition from Amazon Prime (NASDAQ:AMZN) and Costco Wholesale (NASDAQ:COST) is evident. Nevertheless, valuation multiples need to be marked down for investors seeking a more reasonable current stock price to initiate a new position or add to an existing one. Current view on WMT: Hold.

Unless noted, all data presented is sourced from Seeking Alpha Premium and YCharts as of the market close on May 3, 2022; and intended for illustration only.

Value Proposition: An American Institution

Walmart is a dividend-paying large-cap stock in the consumer staples sector’s hypermarkets and supercenters industry. The company engages in retail, wholesale, and other units worldwide through Walmart U.S., Walmart International, and Sam’s Club. It operates supercenters, supermarkets, hypermarkets, warehouse clubs, cash and carry stores, discount stores, membership-only warehouse clubs, e-commerce websites, and mobile commerce applications. Founded in 1945, Walmart is based in Bentonville, Arkansas, USA.

The chart below illustrates the WMT outperformance since June 2017 against the Consumer Staples Select Sector SPDR Fund ETF (NYSE:XLP) and the SPDR S&P 500 ETF Trust (NYSE:SPY). Ultimately, investing in individual common stocks should aim to beat the benchmark indices over time. For example, WMT’s total return has near doubled its sector and outperformed its market benchmark, particularly spiking during the coronavirus pandemic and now YTD as investors flee to defensive non-cyclical stocks.

My value proposition elevator pitch for Walmart:

Love it or hate it, Walmart is an American institution.

My value proposition rating for WMT: Bullish.

Data by YCharts

Shareholder Yields Are Underperforming

As part of my due diligence, I average the total shareholder yields on earnings, free cash flow, and dividends to measure how a targeted stock compares to the prevailing yield on the 10-Year Treasury benchmark note.

In other words, what is the equity bond rate of the common shares?

I target an earnings yield greater than 6 percent or the equivalent price to earnings multiple below 17 times. As demonstrated in the chart below, at 3.20%, WMT was under the floor.

I screen for a free cash flow yield of 7 percent and higher or the equivalent of fewer than 15 times the inverted price-to-free cash flow multiple. At 2.59%, WMT underperformed the threshold.

Although not a dividend investor by definition, I prefer dividend-paying stocks for compensation in the short term while waiting for capital gains to compound over time. Walmart had a modest dividend yield of 1.45%, supported by a conservative payout ratio of 34.11%, below my 60% ceiling. This indicates a safe, well-covered dividend with room for rate increases.

As an investor who takes the long view, I am not a fan of high yield dividend investing unless it’s coming from the yield on a share cost basis. With an adjusted stock price cost basis of $69.38 on June 27, 2017, and an annual dividend payout of $2.24 a share, WMT yielded 3.23% on cost.

Next, I take the average of the three shareholder yields to measure how the stock compares to the prevailing yield of 2.98% on the 10-Year Treasury benchmark note. The average shareholder yield for WMT was 2.41% or 57 basis points below the 10-Year. Arguably, equities are deemed riskier than U.S. bonds. Thus, securities that reward shareholders at lower yields than the government benchmark, such as WMT, question the relative safety of the stock versus the bond.

Remember that earnings and free cash flow yields are inverses of valuation multiples and suggest WMT is an overvalued stock. I’ll further explore valuation later in this report.

My shareholder yields rating for WMT: Bearish.

Data by YCharts

Fundamentals Remain Compelling

Next, I’ll explore the fundamentals of Walmart, uncovering the performance strength of its senior management.

When analyzing a business, I am biased toward established growth instead of executive guidance and sell-side analyst projections. For example, per the chart below, Walmart had three-year trailing revenue growth of 0.52%, below the consumer staples sector median of 9.97%. Other than spikes during the pandemic, the company’s topline growth is flat.

Walmart had a trailing three-year pre-tax net profit margin of 2.39%, half the sector’s 5.26% median margin, but in line with the low margins of its supercenter peers. I screen for profitable companies to avoid unnecessary speculation, as witnessed in the money-losing disruptive growth stocks.

Return on equity or ROE reveals how much profit a company generates from shareholder investment in the stock. I target an ROE of 15 percent or higher to discover shareholder-friendly management. At 16.87%, Walmart outperformed the trailing three-year median returns on equity of 13.57% for the sector.

I target a return on invested capital or ROIC above 12%. Walmart’s three-year trailing ROIC of 10.53% was below the threshold but above the sector median of 7.14%, indicating that its senior executives are efficient, if not superior, capital allocators. Return on invested capital measures how well a company invests its resources to generate excess returns. On the contrary, ROIC stock market-wide appeared challenged during the pandemic.

ROIC needs to exceed the weighted average cost of capital or WACC by a comfortable margin, affirming management’s ability to outperform its capital costs. For example, Walmart had a trailing WACC of 5.62% (Source: GuruFocus). The spreads between ROIC and WACC combined with competitive net profit margins and adequate equity and capital returns for a retailer indicate competent management performance.

My weighted return on management rating for Walmart: Bullish.

Data by YCharts

Unlike Its Merchandise, Shares Are Overpriced

I rely on four valuation multiples to estimate the intrinsic value of a targeted quality enterprise’s stock price. The model reflects market sentiment proximate to the financial vertical of trailing sales, earnings, cash flow, and enterprise value.

The price-to-sales ratio or P/S measures the stock price relative to revenues. I target fewer than 2.0 times, and WMT was trading at 0.75. Moreover, the trailing median P/S ratio was 1.28 for the consumer staples sector and 3.04 for the S&P 500. Thus, the weighting of the sector and market ratios suggests that WMT is undervalued relative to the company’s topline.

Although often a hit or miss multiple, I target price-to-trailing earnings or P/E multiples fewer than 17 times or below the target stock’s sector averages. WMT had a price-to-earnings multiple of 31.24 against a sector median P/E of 21.75. Further, the stock traded in a higher range than the S&P 500’s recent overall P/E of 24.14, indicating that investor sentiment overvalues the stock price to the sector and market relative to Walmart’s earnings per share. (Source of S&P 500 P/E: Barron’s)

I target single-digit price-to-operating cash flow multiples for the best value. At 17.68 times, WMT traded above my ceiling and the sector median of 14.51, indicating the market awards a premium to the stock price relative to current cash flows.

Enterprise value to operating earnings or EV/EBIT measures whether a stock is overbought, a bearish signal, or oversold, a bullish signal, by the market. I target an EV/EBIT of fewer than 15 times. Walmart was trading at 21.76 times enterprise value to operating earnings. Based on the broader sector median of 17.73, WMT appears undersold by the market, a bearish signal.

The weighting of my preferred valuation multiples suggests that the market continues to reasonably value, if not overvalue, Walmart’s stock price. Therefore, based on the fundamentals and valuation metrics uncovered in this report, risks and potential catalysts notwithstanding, I would call WMT the fully-priced stock of a well-run super retailer. Note that the low price to sales ratio prevents a bearish rating on the valuation.

My weighted valuation multiples rating for WMT: Neutral.

Data by YCharts

“Always Low” Downside Risk

When assessing the downside risks of a company and its common shares, I focus on five metrics that, in my experience as an individual investor and market observer, often predict the potential risk/reward of the investment. Hence, I assign a downside risk-weighted rating of above average, average, below average, or low, biased toward below average and low-risk profiles.

Alpha-rich investors target companies with clear competitive advantages from their products or services. An investor or analyst can streamline the value proposition of an enterprise with an economic moat assignment of wide, narrow, or none.

Morningstar assigns Walmart a moat rating of wide.

We contend that Walmart’s standing as the dominant traditional retailer (and the number-one grocer) in the United States has allowed it to develop intangible assets and a durable cost advantage that justify a wide moat rating. While the retail sector has been roiled by digitization and under constant pressure as Amazon builds scale, we believe Walmart is uniquely positioned to compete with the digital juggernaut head-on.

Zain Akbari, CFA, Equity Analyst, December 15, 2021

A favorite of the legendary value investor Benjamin Graham, long-term debt coverage demonstrates balance sheet liquidity or a company’s capacity to pay down debt in a crisis. Generally, at least one-and-a-half times current assets to long-term debt is ideal. Notably, as reported on its January 2022 financial statements, Walmart’s long-term debt coverage was well above the threshold at 2.25 times.

Thus, Walmart has more than ample liquidity to cover its longer-term leveraging needs. Moreover, in a further test of paydown capacity, the company’s long-term debt to equity was 46.97%, well below my 200% ceiling. In other words, investors should become concerned only when a company’s debt is more than twice its equity.

Current liabilities coverage or current ratio measures the short-term liquidity of the balance sheet. I target higher than 1.00, and Walmart’s short-term debt coverage was 0.93, just short of the liquid assets necessary to pay down all of its current liabilities such as accounts payable, accrued expenses, income taxes, and unearned revenue.

Keep in mind that retailers tend to have current ratios below 1.00 because of the fast turnover of high inventories purchased by the business on credit but sold to the customer for cash, i.e., predominantly consumer credit from third-party issuers.

I use a two-year beta trend line and screen for stocks lower than 1.25 or no more than 125% volatility in the market. WMT’s 24-month trailing beta was just 0.54, against the S&P 500 standard of 1.00. Thus, the stock trades as a low-volatility defensive holding.

The short interest percentage of the float for WMT was 0.93%, well below my 10% ceiling. As a result, near-sighted bears view the stock as a safe, core holding in professional and retail portfolios.

Overall, Walmart is a fundamentally sound company with a balanced risk profile of a wide economic moat, excellent debt coverage, and low volatility.

My weighted downside risk rating for Walmart: Low.

Catalysts & Final Thoughts

Catalysts confirming or contradicting my overall neutral investment thesis on Walmart, Inc. and its common shares include, but are not limited to:

  • Walmart, the company, needs to step up its Sam’s Club warehouse and Walmart+ omnichannel to stay competitive with Costco Wholesale and Amazon Prime.
  • WMT, the stock, is a defensive core staple with a predicable margin of safety, which has led to its market-beating performance over the last several years. There is inherent potential to continue this outperformance over the long term through all market cycles.

Because of its legendary value proposition, solid fundamentals, and low downside risk, Walmart remains an excellent long-term holding if shares are bought at reasonable prices, as reflected in its shareholder yields and valuation multiples.