- With a high risk of the US entering a recession, Wal-Mart should act as a flight to safety in equities if the S&P500 continues to fall.
- Dividend growth, buybacks, free cash flow levels and its present valuation will keep on attracting income investors.
- The recently announced store closures only account for 1% of total sales. Wal-Mart's strategy is to meaningfully increase the sales per square foot number in its superstores through pick up and e-commerce connectivity.
You may find the title counter-intuitive in that Walmart (NYSE:WMT) will most likely announce lower top and bottom lines in its upcoming earnings release this week for full-year 2015 numbers as compared to 2014, but the performance of Wal-Mart stock has been exceptional in 2016. Wal-Mart stock price is up 7%+ since the turn of the year.
Is the Wal-Mart stock price action a pre-cursor of what is to come in the global economy? It may very well be when you see the carnage that is happening globally. European banks are on their knees, fixed income yields are at record lows and Sweden has been the latest country to cut rates in a bid to boost inflation. Obviously, oil dropping to less than $30 a barrel is not helping. Safe havens such as US bonds and Gold are thriving with both already up by 10% and 12%, respectively, this year. If indeed the global economy goes back into recession, protecting the downside is key.
Wal-Mart stock only dropped around $10 a share in the great recession and its earnings per share increased robustly. Furthermore, throughout the cycle the company kept on raising its quarterly dividend which went from $0.23 in 2008 to over $0.30 in 2010. Many investors overlook the fact that Chinese markets haven't participated in recent volatility due to markets being shut 3 days last week owing to the lunar new year holiday. When markets open and volume returns in earnest this week (Feb 15), we will see how they have digested Janet Yellen's recent comments in the US. If volatility increases another notch, Wal-Mart stock is my pick as a flight to safety in equities. Here are three strong reasons to consider holding Walmart stock for 2016 which is presently providing a 3% dividend yield.
Firstly, Wal-Mart is a dividend aristocrat and obvious trade in the stock over the last 8+ years has been to sell option premium as the stock price has remained range-bound and rarely dipped below $60 a share. Income investors flock to this stock because of the cash flows it spins off every year. Last quarter, the company spun off $1.72 billion in free cash flow which had dividend investors worried as it was well below the quarterly average. Over $16 billion in free cash flow was reported in 2015 but 2016's figure will be substantially lower than this. Why? Well, the company has decided to invest heavily in parts of its business in the form of raising salaries, training, and e-commerce. Forward-looking earnings guidance has been adversely affected which always happens when a company undergoes an intensive capex program especially for a company like Wal-Mart with operating margins of just over 5%. However, if a worldwide recession is looming, now is the time for this retailer to invest heavily in its business as market share gains can be at their most robust during a downturn. Furthermore, as the company grows more in areas such as superstores and e-commerce, it will wind down markets and stores where it hasn't been able to make an impact. In Brazil, for example, the company will close 60 stores as profit margins are too low and many small format stores will also lose out due to cost pressures. This should be good news for income investors in that the company is being prudent and disciplined in how it wants to grow. Protecting the financials is key so expect at least a 2% rise in the quarterly dividend to $0.50 a share in fiscal 2017.
After this year though (fiscal 2016), capex expenditure guidance will decrease down to $11 billion for fiscal 2017 which makes me wonder if the company is sniffing out a steep recession in the US. Why? The US may be the retailer's biggest and most profitable market but this is where most of the cuts and store closings will occur. Why has the company decided to cut heavily in its most profitable market when you have the likes of Costco (NASDAQ:COST) and Target (NYSE:TGT) expanding at present. Wal-Mart's strategy is to significantly increase its net dollar amount in sales per square foot in its superstores. Costco (NASDAQ:COST) sales, for example, clock in at $1,100 per square foot compared to Wal-Mart's $400. Better trained and paid staff and e-commerce gains should be able to up-sell customers on higher ticket items which carry more margin. Just because the company is drastically lowering its store openings doesn't mean a declining company. Location of its stores is crucial for Wal-Mart going forward. In fact, management is expecting top line expansion going forward despite lower earnings due to near-term higher wages and e-commerce investments. Once these near-term headwinds are overcome, free cash flow will return to (if not increase) former levels which is why I believe the pay-out ratio will eventually come back to the 40% mark after the expected hike in fiscal 2016
The profit warning issued last month caused Wal-Mart stock to sell off after the news but investors should consider the following before even entertaining the idea of selling this stock. The stores that are being closed represent less than 1% of both global square footage and turnover which means earnings will only be adversely impacted in the near term before e-commerce and pick-up gain more traction. Speaking of e-commerce and as noted earlier, Wal-Mart has decided to invest heavily in this area (and take on $AMZN) as illustrated by its relentless hunt for software developers. If the company could poach some employees from Amazon with this job description, it would definitely be a huge advantage in fast-racking its e-commerce service. The advantage that Wal-Mart has with respect to the roll-out of its e-commerce service is its current superstores and neighbourhood markets which will act as pick up points for its customers. Furthermore, with auto sales booming in the US, low oil prices and high ownership rates, I believe the ongoing roll out of "pick up" will become very profitable for the retailer as long as the process is seamless and lightning quick for the customer. Therefore, investors have to see the big picture here. Yes, earnings will be affected near term but the long term picture looks bright especially when you consider the current trajectory of e-commerce sales. It is going to take Amazon head on at least in the US and the advantage it has is its store footprint, which will definitely provide upselling opportunities across different product categories.
To sum up, I believe bearish analysis on Wal-Mart stock is over-blown because of recent declining earnings and store closures. The company is transitioning which it has to do in order to survive in a fiercely competitive environment. There may be pain in the short term but I can only see long-term market share from 2017 on. Why? E-commerce is the future and Wal-Mart is taking bold actions to address it. From an investor's point of view, Wal-Mart has stated that maintaining robust cash flows are imperative, so I see no risk to continued growth of dividend but the glaring risk of a recession in the US is probably the biggest reason to hold this stock now as I see limited downside risk here. With an earnings multiple of just over 14, the stock is still undervalued despite its recent rally. Therefore, if your portfolio demands diversification in US equities, I believe Wal-Mart stock is the best play right now considering its valuation, strong dividend and limited downside risk to its share price