Wal-Mart Stores Inc (NYSE:WMT) will continue to grow its dividends. WMT stock is trading at a premium valuation.
Wal-Mart Stores Inc (NYSE:WMT), the largest retailer in the world has generally attracted strong interest from dividend investors, given the fact the company figures in the much vaunted list of Dividend Aristocrats. The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index which have increased their dividends for minimum 25 consecutive years. The growth, as well as the consistency of the dividend payment, is the main reason why Dividend Aristocrats are so highly regarded.
Walmart dividend growth.
Wal-Mart, which was founded by Sam Walton, has consistently increased its dividends every since 1974 when the company paid out 20 cents in dividends. This has increased nearly 10x since then to $2.04 in 2017. However, just by being a Dividend Aristocrat, Wal-Mart stock doesn't automatically qualify to be in your portfolio. We need to make sure that company's fundamentals are in good shape and it is likely to keep increasing its dividend in the future, especially given the competitive landscape in the retail sector.
Like most other retail chains, the Bentonville, Arkansas based retail giant had come under tremendous pressure as eCommerce players like Amazon.com Inc (NASDAQ:AMZN) were taking away a huge chunk of business from these companies. Walmart revenue growth was stagnating and profit margin was coming under pressure. Wal-Mart stock was even part of "Death by Amazon Index" created by Bespoke Investment Group. The index consists of a list of companies which are considered to be most vulnerable to Amazon and other eCommerce players.
Improving business climate.
But things have started to change for better for Walmart driven by its successful eCommerce strategy and more importantly growth in same-store sales. Wal-Mart reported same-store sales growth of over 2.7% in the third quarter compared to 1.8% in the previous quarter and 1.2% in the comparable quarter last year. This is especially impressive given a part of this same-store sales growth was driven by an increase in traffic. In-store traffic growth is hard to come by given the trend towards of online shopping.
The company has also managed to execute its eCommerce strategy to a strong degree of success. Wal-Mart's e-commerce sales jumped 50% in its most recent quarter, marking the third consecutive quarter of 50% or above growth rate. The acquisition of Jet.com for $3 billion last year has greatly improved the company's capabilities in eCommerce market. Wal-Mart has significantly increased products in its online store. Wal-Mart now covers more than 70 million SKUs to date, up from mere 7 million SKUs in 2015.
Wal-Mart also has a stake in JD.com, second largest eCommerce company in China which is also delivering strong performance. Given the strong performance of both its brick and mortar stores and eCommerce, Walmart reported a revenue beat of over $2 billion in the previous quarter. Walmart revenues grew by over 4% in the third quarter. The recent performance indicates that Wal-Mart is now on the right track and its business prospects look strong. The company also generates billions of dollars in cash flows.
Walmart's sustainable rate of growth.
Another important metric which we need to check is the company's sustainable growth rate. We can calculate the company's sustainable earnings growth rate based on its return on equity and retention ratio to get an idea of what the company's dividend growth is going to look like. Walmart has a return on equity of 14% and a retention ratio (1-payout ratio) of 46%, which gives us a sustainable growth rate of 6.6%. So, given its current ROE and payout ratio, Walmart can continue to grow its earnings at 6.6% in the coming years. In the past three years, Walmart has grown its dividend's at a CAGR of 2.21% despite earnings declining at a CAGR of 8%. So, the dividend growth is here to stay.
Profit margin under pressure.
While things are looking up for Wal-Mart, investors need to keep a watch on company's profit margins and operating cash flows. Given the cut-throat competition in the offline and eCommerce, Wal-Mart has been regularly cutting prices, which has helped revenue growth but has kept profit margins and cash flows under pressure. Walmart's operating margin has been declining consistently this year and down from 5.6% a couple of years ago to 4.48%. Same is the story with net margin.
The declining profitability has also impacted the company's return on equity which is down from over 22% in FY 2013 to 15% in the previous quarter. Company's free cash flows, as well as operating cash flows, are also down. Given that the company will continue investing significantly in its both eCommerce as well as brick and mortar operations, margins are likely to fall even lower. While sustainable earnings growth rate for Walmart is around 6.6%, analysts expect the EPS to grow at a CAGR of 5.8% in the next five years due to higher spending.
Walmart stock is trading at a premium.
Driven by the improving business scenario, Wal-Mart stock has rallied heavily this year. WMT stock is up 43% in the year-to-day period, widely outperforming S&P 500. This also best yearly performance by WMT stock in the last decade. However, this rally has also led to multiple expansion. Walmart stock is currently trading at a trailing PE multiple of 26x, which is more than 50% higher than its five-year average PE of 15x and ten-year average PE of 14.6x.
This premium valuation can be explained to large extent by a couple of factors. Firstly the recent tax rate changes will greatly help Walt-Mart. Walmart currently has an effective tax rate of 33.8% in the previous quarters. Given that tax rate is likely to fall to around 20%, the company could see strong growth in its margins. Also, the improving business fundamentals will help companies long-term EPS growth. This is the reason why most analysts are bullish on Walmart stock.
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