- Walmart's valuation has never been cheaper across all its main metrics.
- Walmart stock has demonstrated that it is not a mover. Use high volatility to bring in extra income by selling option premium.
- The stock's performance in the great recession was excellent. If the US enters a recession, I see Walmart gaining market share especially against its online rivals.
Walmart (NYSE:WMT) looks very attractive at its present price of $63.69 for a variety of reasons. First of all, you have a solid dividend of 3.1% which is rock solid when you consider the huge amount of free cash flow Walmart spins out every quarter. Furthermore, the payout ratio is low at 41% which indicates that the retailer should have no problem increasing the dividend meaningfully over the next few years.
In fact Walmart is on course to raise its quarterly payout to at least $0.50 a share next quarter which will bring the annual rate up to $2 a share. Walmart stock tumbled almost 30% in 2015 primarily due to both falling top and bottom lines plus lower than expected guidance for the next two years. However, now is the time to be a contrarian in my opinion by buying into perceived weakness in the stock price. Walmart's core valuation metrics stack up, in the sense that Walmart has never been cheaper when it is compared to its earnings, sales, book value and cash flow. (see chart)
These four valuation metrics are the core ratios I use when valuing a company as long as earnings are still positive and debt levels are under control. Well, Walmart's debt to equity levels are not increasing and have been generally stable over the last 6 quarters, whereas the retailers earnings per share are expected to hit $4.66 in its next fiscal year. Moreover when you throw Walmart's increasing dividend into the mix, downside risk is not as great as many assume.
Walmart stock's present implied volatility rank is 53. Implied volatility rank is volatility measured against itself over a 12 month period and any time this metric is over 50, it means that the stock's options are rich in premium. My recommendation with Walmart would be to sell premium (either through naked puts or put spreads based on your buying power) especially with the stock hovering around the $60 level.
Why sell premium over buying the stock outright? Well this stock has shown over the last 10 years that it is not a mover despite the stock rallying over 3% since the start of this year. There is nothing wrong with holding the stock and collecting the dividends long term but gains may not be overly impressive. I believe it would be a better strategy to combine some bullish option strategies with the stock and dividends to boost overall gains long term. The stock has ample liquidity to perform this type of trading and the goal here is to reduce one's cost basis - getting the stock for a much lower price over time than it is currently trading for.
The reason why I believe it is a good idea to bring in some extra income through option premium in Walmart is because Walmart stock may continue to struggle in the near term. Operating margins are expected to fall to 5.3% this year (down from 5.6% last year) and the trend has been going south since 2011. One has to remember that this organization is huge ($480+ billion in sales) and once trends get established, it nearly always takes longer than expected to move the needle. However once the trend does change, the snap-back rally can be violent as we have seen in McDonalds (NYSE:MCD) since its third quarter results 3 months ago.
Investments that will hurt the retailer's numbers in the short term are in its staff, where $2.7 billion will be deployed and furthermore $2 billion is to be deployed into the e-commerce side of the business. Staff training and wage hikes will make up most of the $2.7 billion. I do think these initiatives will eventually be a good investment but customer perception will take a while to change. The idea of walking into a Walmart store and receiving excellent customer service and expertise when buying a high ticket item is still a novel idea to many. Nevertheless this is precisely where the retailer can turn around its bottom line numbers as its the higher priced items that usually have the fatter margins. Furthermore this is definitely an area where Walmart has an advantage over the likes of Amazon (NASDAQ:AMZN). Customers are wary of buying expensive items online and still prefer to deal with someone in person before placing the order.
In terms of e-commerce, Walmart presently is at a disadvantage to Amazon due to Amazon's huge assortment of products, its speed of service (delivery now in some areas is 2 hours or less), and the simplicity of its website. However Walmart needed to act here swiftly and it has. Walmart's infrastructure is key here as it enables customers to pick up their ordered goods at the retailer's extensive list of neighborhood markets. These pick up points ensure customers can also get their goods super fast and as the US has one of the highest car ownership rates in the world, collecting these goods for the majority wont be a problem. Walmart knows it has to keep on dominating its grocery division as groceries is its biggest earner. Speed of service combined with pick up locations on customers demonstrate to me that Amazon will find it difficult to penetrate here.
But probably the biggest reason to be long this stock is that it is recession proof. Walmart's EPS grew from $3.13 in 2008 to $3.7 in 2010 and its top line grew by $30 billion in the same period. The 3% top line growth expected over the next 3 to 4 years will increase in my opinion if the US enters another recession. A fundamental rule in investing is to protect the downside. This stock only rallied 15% in 2008 where the S&P500 lost 40% (see chart). Furthermore the US is due a recession. The recovery has been long and slow and we still do not know if its economy can withstand a series of interest rate hikes. One thing is for sure. If things get tight and money contracts once more, Walmart will thrive as it has in the past.
To sum up, Walmart is attractive at current levels despite its pessimistic forward looking guidance. Walmart valuation, dividend and recession proof history illustrate to me that downside risk is limited. Use inflated option premium to try and reduce basis to improve overall gains. This stock wont be a home run but if you are bearish on the economy, it is a good position to have.