What you’ll learn
- likely reason why Buffett is selling Wal-Mart
- Whether Wal-Mart has any chance to compete in e-commerce
- Understanding fundamental, quality checks and Walmart’s stock value
The press likes to say that Buffett is a hold forever investor, but in his 2016 letter, Buffett specifically addresses this mis-interpretation.
Sometimes the comments of shareholders or media imply that we will own certain stocks “forever.” It is true that we own some stocks that I have no intention of selling for as far as the eye can see (and we’re talking 20/20 vision). But we have made no commitment that Berkshire will hold any of its marketable securities forever. – Bershire 2016 letter
Einhorn’s FOF Re-positions Portfolio, Makes New Seed Investment In Year Marked By “Speculative Exuberance”
It has not just been rough year for David Einhorn's own fund. Einhorn's Greenlight Masters fund of hedge funds was down 3% net for the first half of 2020, matching the S&P 500's return for those six months. In his August letter to investors, which was reviewed by ValueWalk, the Greenlight Masters team noted that Read More
Confusion about this point may have resulted from a too-casual reading of Economic Principle 11 on pages 110 – 111, which has been included in our annual reports since 1983. That principle covers controlled businesses, not marketable securities. This year I’ve added a final sentence to #11 to ensure that our owners understand that we regard any marketable security as available for sale, however unlikely such a sale now seems.
You’re seeing this with Wal-Mart (WMT).
Buffett has clearly fallen out of love with Wal-Mart with his ownership now at 1.4M shares – just 0.04% of his portfolio.
You don’t allocate 0.04% of your portfolio to your best idea.
Buffett WMT Holding Size
Why is Buffett selling and are you wasting money on Wal-Mart?
Retail is Brutal
On the surface, retail is easy to understand.
- Buy or manufacture a product
- open a store
- sell it
Between steps 1 to 3 there are a gazillion things to be done. Then another zillion things after step 3 we don’t think about.
When you realize there are hundreds of thousands of stores doing the same thing, it a competitive nightmare for the weak, slow or inexperienced.
In 2005, Buffett was asked about Eddie Lampert, K-Mart and Sears.
A classic Buffett response (emphasis added).
Eddie is a very smart guy but putting Kmart and Sears together is a tough hand.
Turning around a retailer that has been slipping for a long time would be very difficult. Can you think of an example of a retailer that was successfully turned around? Broadcasting is easy; retailing is the other extreme. If you had a network television station 50 years ago, you didn’t really have to invent or being a good salesman. The network paid you; car dealers paid you, and you made money.
But in retail you have to be smarter than Wal-Mart. Every day retailers are constantly thinking about ways to get ahead of what they were doing the previous day.
Retailing is like shooting at a moving target.
In the past, people didn’t like to go excessive distances from the street cars to buy things. People would flock to those retailers that were near by. In 1966 we bought the Hochschild Kohn department store in Baltimore. We learned quickly that it wasn’t going to be a winner, long-term, in a very short period of time. We had an antiquated distribution system. We did everything else right. We put in escalators. We gave people more credit. We had a great guy running it, and we still couldn’t win. So we sold it around 1970. That store isn’t there anymore. It isn’t good enough that there were smart people running it.
How many retailers have really sunk, and then come back? Not many. I can’t think of any. Don’t bet against the best. Costco is working on a 10-11% gross margin that is better than the Wal-Mart’s and Sams’. In comparison, department stores have 35% gross margins. It’s tough to compete against the best deal for customers. Department stores will keep their old customers that have a habit of shopping there, but they won’t pick up new ones. Wal-Mart is also a tough competitor because others can’t compete at their margins. It’s very efficient.
In other words, investing in retail is hard.
I’ve lost plenty of money on what I considered to be good bets.
Would Warren Buffett Use Wal-Mart in this Example Today?
If Buffett is asked this question today, would he replace Wal-Mart for Amazon?
Buffett made it clear that he admires what Bezos has done.
We haven’t seen many businessmen like him. Overwhelmingly, he’s taken things you and I’ve been buying, and he’s figured out a way to make us happier buying those products, either by fast delivery or prices or whatever it may be, and that’s remarkable. – Buffett
If you consider the retail environment as brick and mortar stores only, Wal-Mart is still on top of the list.
However, with the ubiquitous shopping experience needed to compete and grow in today’s environment, Amazon is hands down the favorite, despite Wal-Mart’s revenue of $485B.
Maybe the following charts explains why Buffett divorced Wal-Mart.
Don’t Bet Against Wal-Mart Just Yet
Wal-Mart has been left in the dust in terms of innovation (and stock price), but their core competency of low prices and efficiency is what keeps them on top of the ladder despite the falling dominoes of retail companies.
Their Q4 results show why Wal-Mart is king of retail (brick and mortar).
- Walmart U.S. comp sales increased 1.8%, driven by a traffic increase of 1.4%. Neighborhood Market comps increased approximately 5.3%.
- E-commerce growth at Walmart U.S. was strong as sales and GMV increased 29.0% and 36.1%, respectively, including Jet.com and online grocer
- Net sales at Walmart International were $31.0 billion, a decrease of 5.1%. Excluding currency, net sales were $33.7 billion, an increase of 3.0%
- Free Cash Flow increased 39.5% due to improved working capital management.
The segment that everyone will continue to monitor closely will be on e-commerce.
Will Jet.com and ShoeBuy make a dent to Amazon?
Doesn’t move the needle for Wal-Mart revenues.
According to Prosper Insights & Analytics, 81% of US consumers have never heard of Jet.com.
What it does show is Wal-Mart’s willingness to make acquisitions and start to build a portfolio of e-commerce stores.
Don’t expect a huge, cash gushing portfolio overnight or within a few years.Amazon didn’t get to where they are in a few short years.
But here’s a data driven and bottoms up approach of why you shouldn’t give up on Wal-Mart.
One of my recent rules of thumb is to stay clear of failing retailers that are supposed to be in turnaround mode.
- Sears Holdings
- JC Penney
To make sure signs aren’t pointing towards a slow and painful death, here are some quality indicators I look at.
Wal-Mart’s Piotroski Score
The Piotroski F score is made up of 9 fundamental accounting checks.
I use the Piotroski Score extensively because it has been proven. It cuts down a lot of time and makes it easy to analyze a stock.
The current Piotroski Score of 7 is good. Return on Assets and Current Ratio dropped, but other fundamentals are going strong.
WMT Piotroski F Score Trend | source: old school value
Wal-Mart’s DuPont Analysis
Not all ROE is created equal.
The DuPont analysis breaks down the components of ROE so that you get a clear picture of how the company is driving its profits.
It helps you answer the following questions:
- Is the company increasing margins?
- Is the inventory turnover increasing?
- Is leverage being used?
Take a look at Wal-Mart and Target.
Wal-Mart’s ROE is consistent, has been consistent, and even during the recession it didn’t register a blip.
Wal-Mart 5 Step DuPont Analysis | source: old school value analyzer spreadsheet
The decrease is operating income is the main driver behind the dip in ROE. There’s no breakdown in the fundamentals, unless operating income falls further.
Compare this to Target’s DuPont analysis.
Target DuPont Analysis | source: oldschoolvalue analyzer spreadsheet
Target is a well run company, but has difficulties and their recent jump in ROE is due to improving Operating Income and increased leverage.
Despite Target’s latest achievements in ROE, and Wal-Mart’s slight dip, I’m giving it to Wal-Mart for consistency.
Wal-Mart's Cash Conversion Cycle
Cash flow is the lifeblood of a retailer.
- Can the business get good terms from vendors?
- How quickly can they turn over inventory?
- How any days does it take to turn their assets into cash?
The quicker this process happens, the better. You don’t want to be in Sears situation.
WMT Cash Conversion Cycle Comparison
To see it up close, here’s a detailed breakdown of the Cash Conversion Cycle.
WMT Cash Conversion Cycle Performance
You see that Wal-Mart has fantastic buying power, currently paying its bills 43 days after being billed.
For the heck of it, here’s Amazon.
AMZN Cash Conversion Cycle Performance
This includes the AWS segment, so it’s not an exact comparison, but it goes to show the muscle that Amazon flexes.
Think of a negative cash conversion cycle like an interest free loan from their suppliers. Suppliers are paying Amazon 35 days before Amazon has to pay anything off. Amazon can use this cash like float to finance their operations.
For a brick and mortar operation, Wal-Mart is still elite. Stellar fundamentals with no concern of deterioration.
Now it comes down to what price makes sense.
Wal-Mart Ballpark Valuation
Ben Graham said that the price you pay will determine the result of the investment.
A great company can be a bad investment if the price is too high. Conversely, a horrific company can be a superb investment if the price is cheap enough.
The question to answer is whether the current price offers a margin of safety.
WMT Valuation Ratio Trends
Rather than focus on a single method to value stocks, I cover my bases and look at different views.
Valuation multiples gives you a comp view. Much like how you value home prices.
DCF tells you that the value of a company is the sum of its future cash flows.
Earnings is also used in valuation because stock prices track earnings.
With Wal-Mart, their EV/EBIT is 11 which is at the upper range of my preferred range.
I like to look for companies trading below EV/EBIT of 11.
You see a different picture with FCF and owner earnings. FCF and Owner Earnings is growing year over year, and Wal-Mart is cheap with this metric. Anything under P/FCF or P/OwnerEarnings of 15 is value.
Wal-Mart Stock Value (Ballpark DCF)
Before getting deeper into the numbers, valuation is more art than science.
Depending on your narrative of the company, the valuation will change.
If you believe Wal-Mart’s business will see a revival, your growth rates will be different to mine.
On the flip side, if your narrative is that Wal-Mart is going down the drain, your valuation is going to be lower.
This is why I go for a valuation range.
Fair value is a moving target.
Using a FCF starting value of 20.9B, growth rate of 5.9%, discount rate of 6.8% using Prof Damodaran’s industry specific rates and then applying a multi-stage DCF where the growth rate decays, the fair value comes out to $98.
WMT DCF using FCF
Take note of the reverse growth rate.
The reverse growth rate signifies that Wal-Mart’s current stock price is pricing in a growth rate of 1.6% when compared to Free Cash Flow.
The question for you is, will Wal-Mart fair value based on FCF grow faster than 1.6%?
That’s an easy yes.
So I know that $98 is a possibility.
Let’s look at it from another angle though.
WMT Earnings based DCF Stock Value
If I use an earnings based valuation where the starting value is 13.6B, Wal-Mart has to grow earnings faster than 8.37%.
Is this possible?
Not as likely.
Putting together the two DCF’s and the valuation ratios, the fair value range looks like it is between $60-$98.
That’s a big spread and the current price of $72 sits in the middle.
If Wal-Mart shot up to the 80’s I’d be a seller. Current price is a hold for me and I’d be a buyer if the stock price was in the lower $60’s unless you want a bigger margin of safety.
Buffett may be selling, but it’s not the end for Wal-Mart.
Patient investors will receive value, but make sure the price is right.
- Buffett knows that retail is a tough industry. Turnarounds rarely happen. Go for a leader.
- Is Wal-Mart a bad investment? No, but don’t expect huge returns. Fundamentals are strong and will let you sleep at night without worrying.
- A successful investment comes down to the price you pay, and your price will be based on your narrative of the company.
- An uphill battle for e-commerce, but Jet.com and ShoeBuy acquisitions are a step in the right direction.
Long WMT at the time of writing.
Article by Jae Jun, Oldschool Value