What You’ll Learn
- Why Wal-Mart has been losing to Amazon in e-commerce
- How I am able to witness the growth in Wal-Mart e-commerce vs Amazon
- What’s Wal-Mart Worth with several fair value calculations
“Wal-Mart will go to $100”.
“Wal-Mart is inexpensive and it is the inexpensive alternative to Amazon.”
Oops… Jim Cramer said it.
Sorry, but that’s a just a “filler” thesis.
I’ll share real reasons for why Wal-Mart (WMT) is inexpensive through a unique perspective experienced over the past 6 months.
First, let me start with some confessions.
- I haven’t done well with retail investments. Have avoided them generally.
- I bought Whole Foods estimating the intrinsic value to be between $38-$50 but then lowered it down to $32 to $36 a couple of years later. Sure it was bought out by Amazon at $42, but I find that to be a lucky ending.
- I have been part of the Amazon ecosystem (Amazon buyer, Amazon seller, AWS, PPC) in a far more intricate way than most investors, but couldn’t see past the price.
- Purchased Wal-Mart based on quantitative fundamentals measures. Otherwise would not have purchased it.
Now here’s why I’m long Wal-Mart and why it’s a long term hold for my portfolio.
Why Wal-Mart is Up 26%
These giant companies show that it’s not impossible for giants to grow.
Finally, Wal-Mart has joined the party.
Until now, Wal-Mart’s biggest problem was that of a typical brick and mortar company.
It’s relationship with customers were purely transactional.
Compare that to Amazon where the relationship is a deep and trusting friendship.
For a company like Wal-Mart:
- you go into a store
- you get your item
- hand it to the cashier
- get annoyed if they are super slow
- walk out
With Amazon, the experience is drastically different.
- You go to the homepage and there’s a list of recommendations.
- To make a purchase you need to trust that their site will be safe
- You trust they will keep your credit card(s) safe.
- You trust they will send you the correct item.
- You trust they will delivery the item when they say they will.
I’m sure you’ve experienced the difference in the relationship yourself.
Also, Amazon has become so ingrained with the US population that its Amazon Basics branded products fly off the shelf.
Wal-Mart has finally wised up and understands the big picture in order to compete. It’s not just about “Everyday Low Prices”.
It’s about the relationship.
The market is slowly catching on as positive progress is being shown with the various omni-channel strategies taking place throughout the company.
Market Excitement about Wal-Mart
Wal-Mart up 26% YTD isn’t something you see often.
With Marc Lore having been granted full blessings to go all out, the company has undertaken various strategies to fully utilize their potential.
- Free shipping over $35, with many items available with free shipping
- Adding electronic pick up kiosks
- 35 second convenient online order returns using their app in stores
Rather than trying to compete and copy Amazon, Wal-Mart is playing to their strength by utilizing their biggest asset.
Why Do I See Value?
Our objective of prioritizing strong, efficient growth means we will focus on increasing comparable store and club sales and accelerating e-commerce sales growth while slowing the rate of growth of new stores and clubs. At times, we make strategic investments which are focused on the long-term growth of the Company, which may not benefit comparable sales in the near term. – 2017 Q2 10Q
Here’s where and how I see value.
My wife being a seller on Amazon since 2012, has given me a first hand opportunity to fully dig into the Amazon seller ecosystem.
Everything from listing products, SEO, API access, Paid Per Click ads, becoming a supplier to Amazon directly, loans, legal issues, China copycats and more.
Seeing the growth directly from inside the Amazon system and the way her business has grown, it’s not surprising the way the stock has responded.
Fast forward to 2017 and earlier this year, with the rate of growth in her Amazon sales, she was also accepted to sell on walmart.com.
Boy, was I disappointed when I saw the overall backend product of walmart.com
It literally feels like it is 10 years behind Amazon.
That is the opportunity and value.
Walmart takes some getting used to – they are lucky if they even have 1/10 of the features that Amazon provides to sellers.
Their support is horribly slow, your products are delisted regularly without warning or explanation, SEO is horrible, and worst of all, they do not support a simple email notification if you receive an order.
You have to rely on external software or custom code your own to get a notification.
That aside, it’s given me the opportunity to talk with many sellers and hear from others. Wal-Mart seller Facebook groups and other community boards provide a good a sense of how things are going.
The news and results showing the growth on the e-commerce side does indeed match what I’m hearing and seeing.
Sure the technology is far behind.
And although it feels like it is 10 years behind Amazon, with the speed of coding and development nowadays, they could easily catch up on tech front in 5 years.
The only direction of their e-commerce growth, is up.
The Wal-Mart brand value is there and the physical footprint is there.
Now it’s a matter of building the trust in the relationship and getting people into their own ecosystem.
I never thought I’d be saying those two words together.
A Revival of a Quality Stock
Overall, majority of sales is still driven by stores.
- Revenue rose by 2.1%.
- Walmart U.S. comp sales increased 1.8% with traffic growth of 1.3%.
- E-commerce net sales and Gross Merchandise Value grew 60% and 67%, respectively.
The basic idea is to look for stocks from the pool of “A” and “B” rated stocks as our research and backtesting have shown that this group provides the highest chance of picking winners.
The ratings are scored based on Quality, Value and Growth. The three factors are then combined to calculate our “Action score“.
Currently, Wal-Mart is a B rated stock. The increase in stock price has caused the value score to drop.
I’m not complaining.
When I do a quick side by side analysis with other retailers, Wal-Mart is not cheap by the numbers in terms of traditional valuation metrics.
From this point of view, Target is currently the cheapest of the bunch, but at this stage, I will still take Wal-Mart over Target based on the initiative and potential.
What’s Wal-Mart Worth? Fair Value Calculation.
When it comes to valuation, I like to use different models to prevent myself from focusing too much on one angle and number.
- A DCF for a free cash flow based analysis
- An earnings based estimate using Ben Graham’s Formula
- Income statement valuation using EBIT multiples
Getting into the details of each valuation method and model will be left for another write up.
Instead, you can see and test the models for yourself at the old school value demo.
Discounted Cash Flow Fair Value
Using latest FCF numbers, DCF shows that the current Wal-Mart growth rate is 5.7%. However, the reverse growth rate (or market implied growth) is coming to 3.7%.
This means the market thinks that Wal-Mart is growing a little too quickly than it should.
With a 6.7% discount rate and 2% terminal rate, the fair value comes out to $101.
Wal-Mart DCF Inputs and Fair ValueThis chart sums up the DCF well.
Graham Formula Fair Value
Using earnings estimates and a simple formula created by Graham to simulate valuation of growth, the valuation yields a fair value of $66.
Keep in mind that Wal-Mart is reinvesting a lot to the e-commerce space. Rather than just returning as much as possible to shareholders, you can see how EPS has dropped with the dedication to e-commerce starting in 2016.
If I redo the valuation using estimate 2019 numbers of $4.60 adjusted EPS, the fair value comes out to $89.
Income Statement EBIT Multiples
Lastly, when the income statement is valued based on EBIT multiples, the conservative, normal and aggressive fair values look like this.
- Conservative value: $68
- Normal value: $73
- Aggressive value: $93
Put all of this together and the fair value range is $67 to $101 with the average fair value at $80.
That’s a big range, but that’s what valuation is.
Valuation is a range and the $80 price target is an approximation.
Outside of the Graham’s formula model, projections with the e-commerce growth has not been included.
This is more of an acid test example to show that at current numbers, Wal-Mart is in fair value territory.
If you believe that Wal-Mart has what it takes to grow with e-commerce, the current value of $88 is inexpensive.
That’s probably what Cramer meant.
Would I buy more at $88?
I’d definitely like to see it go below $80 before adding more. But at the current price, Wal-Mart is a strong hold in my portfolio.
5 Reasons of How I Could be Wrong
I can’t possibly end this without going over the important question of “how could I be wrong?”.
- My what-if scenarios are wrong. Most obvious thing is that my assumptions, which I consider conservative, are biased and off the mark. Being a seller on Wal-Mart and Amazon doesn’t mean I know everything about the business or what I’m hearing on the ground is correct.
- Wal-Mart continues to invest without ROI. All the new initiatives could turn out to be a dud. A lot is being spent on the app, improving the total experience, implementing new technology. It could turn out to yield little results.
- Target market does not expand. Wal-Mart caters to a select demographic. Paris Hilton thinks they sell “wall stuff”. If the online demographic doesn’t expand to include everyone like Amazon, it will be a tough ride.
- Losing focus and to competitors. Online sales is where the anticipation and excitement is being generated, but their bread and butter is their brick and mortar. If they lose focus, they could lose market share to Aldi.
- Amazon expands retail footprint much faster than anticipated. There are more Wal-Mart stores than Whole Foods, but if Amazon starts going on a shopping spree and creates more partnerships like Kohl’s – who knows what can happen.
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Article by Jae Jun, Old School Value