Walmart: How I approach investing

As describe previously, I have held Walmart (WMT) for a very long time.  My Grampa was the real investor there, I simply held it as instructed.  After learning how to invest better ( with much to learn), it is time for my annual deep dive into WMT and I will describe the methods I use to look over my investments.  These posts will be a record as the years go on and will provide a snapshot for future reference!  Lets take a dive!

Overview

Walmart is the largest retailer in the United States. They have over 4000 stores in a variety of formats.  These stores have been historically large (Walmart, Super Walmart), but Walmart has been building smaller stores called Neighborhood Market (grocery) and even smaller stores called Express.  Walmart operates in three divisions: Walmart US, Walmart International and Sam’s Club.  Walmart operates in 26 countries around the world.

Walmart’s economies of scale enable it to provide goods at a lower cost than other retailers.   Generally, their stores are the largest of their type and can provide a large variety of goods.

The data below is provided from a combination of sources. Including Morningstar, Google Finance and the Walmart company report.

Story for ownership

There are certain items that people need.  Food, clothing and maintenance products.  These are largely recession proof items and WMT is the biggest seller of them in the US.

Is debt under control?

When I am analyzing a stock, I want to ensure that they can manage their debt.  I look at the following ratios:

Interest Coverage Ratio: 12
Current Ratio: .83
Quick Ratio: .22
Debt/Capital: ~40%
Is maturing debt spread out?: Yes

Walmart can easily handle it’s interest expenses, with an Interest Coverage Ratio of 12, it has it well under control.  Their interest expenses have remained consistent over the previous decade.

Normally, I like to see a current ratio above 1, which is a measure of a companies ability to handle short term expenses.  WMT has a Current Ratio of .83, which is low but WMT has been around .9 over the last decade.  WMT has a Quick Ratio of .22 (current ratio excluding inventories), which is terrible.  If WMT had issues with inventory turnover this value would concern me, but they don’t.

With a debt to capital ratio of 40%, I do not think that they hold a large amount of debt.  In fact, total debt has remained fairly steady over the last few years.  Looking at the maturity dates of various bonds, WMT has them well spread out and should be able to manage maturing debt and interest without concern (with respect to current debt).

How does WMT spend your(my) money?

  • Dividends:  WMT pays out approximately 62% of FCF as dividends (~35% of EPS). WMT currently has enough cash on the balance sheet to pay 4 quarters of dividends and is yielding 2.5% as of today.
  • Share Buy Backs: Over the last 10 years, WMT has bought approximately 2.5% per year.
  • Capex: WMT consistently spends about 50% of operating cash flow back into the business.

This is very shareholder friendly.  Revenues have been increasing each year which should make it possible for WMT to continue raising dividends.  EPS has been enhanced by both share buybacks and increasing revenues.

The only downside is that WMT currently spends more on these three items than they have Operating Cash Flow.  As a result, cash on hand went down and they issued debt in the most recent year.  This is not a concern to me, because it is not out of historical norms for them to do this and their level of debt remains in the same range as it has over the last few years.

Valuation

I am still trying to determine what would be the best way to value a position.  The goal of buying high quality companies and holding for a significant window diminishes the need to place a precise value on it.  I currently look at historical metrics to determine if a position has deviated significantly from the mean.  At this time, WMT is trading at about it’s historical averages (PE, Price-to-sales).  With a dividend of 2.5, which is about 10% higher above average.

Concerns

Walmart is in the process of building new stores in smaller formats.  I think these can be a potential driver of growth. These stores appear to be popular in my area, however a case study of one doesn’t prove anything.  The main concern will be if these don’t take off and WMT wastes money.

Walmart pulls a lot of its shoppers from the lower income brackets and they are very sensitive to price.  A massive bout of food/energy inflation could potentially hurt the sale of the higher margin add-on items in the store.  It’s hard to gauge inflation, but I think food and energy inflation is higher than the official estimates say.

Doug McMillon took over as the new CEO at the end of Fiscal 2013. He is a 22 year veteran and previously ran Sams and Walmart International.  I will need to watch over the next year to see how/if he changes strategies.

Recent Developments

Walmart recently raised their dividend.  It was a disappointing 2%, or a penny per share.  The raise came on the heels of a disappointing Q4.  The results were blamed on weather and reductions in government payouts.  Blaming the weather will be validated (or disproved) when the next quarters results are in.  Personally, I can see how people would make fewer trips and would not buy as many “why not” items.

Walmart announced a plan to begin buying used games.  I like this move, it will be interesting to see how that impacts sales.  The goal of this maneuver is to increase store traffic and to sell additional items.  Used games have higher margins than new games, but I don’t expect this to be significant.  I doubt that WMT will be able to create the same atmosphere that Gamestop (GME) can without having knowledgeable employees.

Conclusion

WMT in my opinion, based on my analysis, would be a good position to hold at this time.  I like the exposure WMT gives me to other businesses through variety and necessity of the products it sells.  WMT is a good defensive play, but I may not be adding to my position because WMT is currently 3.5% of my portfolio, its yield is on lower end and recent growth has been low.  At this time, I feel like I can find a higher yielding investment with more growth.  However, if the economy heads south I may look into adding to my position.

Disclaimer:  Long WMT.  The purpose of this article is to keep a record of information I find valuable, which will be used in the future to help me with my investing decisions