Back in April of this year, I published my Wal-Mart (WMT) analysis. At that time, I believed the company was trading at a 10% discount and shares were trading around $80 back then. If you have been following the company since then, you now know the company is trading slightly under $60. Does this make WMT a huge deal or is it becoming a dividend trap where investors won’t get anything more than their quarterly distributions? Let’s dig deeper.
The company shows an interesting revenue uptrend over the past 10 years:
Unfortunately, WMT announced on October 14th that earnings won’t follow for the next…three years! While revenues are expected to grow by 3-4%, net earnings will face many headwinds:
Stronger currency impact than expected
Lower growth in China
Increase in minimum wages directly affecting margins
US consumers paying off debts instead of buying more
The stock took a 9% hit on that day. Let’s just say institutional investors are not the most patient beasts in the stock market zoo. Management certainly didn’t help their stock price when they mentioned they expected EPS to drop by 6-12% in 2017… but expects to see it bounce back in 2019 by 5-10%. Let’s just say it’s not the most comforting announcement we have seen so far this year.
While there are many factors counting against WMT at the moment, the current price drop brings the company to a very attractive level. First, the new price reflects a PE ratio of 12 today and will be around 13-14 in 2017. The dividend yield is trending at 3.33% at the moment and the payments are sustainable for a very long time as you can appreciate the relation between the dividend paid and the payout ratio in the following graph:
There are roughly 200 million clients going into Wal-Mart stores across the world on a weekly basis. This makes WMT an enormous cash flow making machine. During the next three years, the company expects to generate 80 billion. Management intends to use $20B to buy back shares massively in the next two years. They are probably a pretty good deal at the current price.
Let’s assume current financial situation will arm WMT with the ability to increase its dividend distribution as it I calculated it 7 months ago. At that time, I used at first dividend growth rate of 10% and reduced it to 7% after the first 10 years. Let’s assume the first 10 years will show a dividend growth rate of 5% and then, a dividend growth rate of 7%. At a discount rate of 10% (the company is still showing some risks), we get a fair value at $59 which is roughly what the company currently trades at.
As you can see, even in a very bad scenario, WMT seems to offer enough dividend growth power to justify its current valuation. I think there is enough room for investors to jump in at this price and be well rewarded for their courage.