This Discount Retailer Is Way Too Cheap!

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Wal-Mart (NYSE: WMT), the largest retailer in the world, has done very well over the past decade and so have the company’s shareholders.  With an excellent buyback program, growing dividend, and ever-increasing revenues (see below), the stock should be worth even more than it is.                                                

 

What I mean by that last line is that while revenues have doubled since 2003, the share price has only increased by 31% in that time period. During the same time period, the dividend payout has grown from 30 cents per share to $1.59, and the number of outstanding shares has decreased from 4.43 billion to 3.35 billion.  The market seems to be pricing in a dramatic slowdown in revenue growth, as evidenced by the P/E multiples of the stock throughout the years.

 

I think that this is wrong, and I believe Wal-Mart still has a lot of growth ahead of it, particularly internationally, and deserves a higher valuation. 

Wal-Mart operates in three divisions: Wal-Mart U.S., Sam’s Club, and Wal-Mart International.  Currently, the international division accounts for 28.6% of the company’s revenue, and operates 347 stores in Africa, 88 in Argentina, 512 in Brazil, 333 in Canada, 822 in Central America, 316 in Chile, 370 in China (joint ventures), 419 in Japan, 2,088 in Mexico, 541 in the U.K., and 15 in India. 

Now, compare those numbers with the 4,468 U.S. stores the company has.  Wal-Mart has 370 stores in China and 15 in India, the two most populated countries in the world, and the countries with the fastest-growing middle class in the world.  Starting to see the room for growth yet?

Wal-Mart also has proven to be very shareholder-friendly with its efforts to create value, particularly in the form of buybacks.  Just since 2009, the number of outstanding shares has dropped from 3.95 billion to 3.35 billion, a reduction of 15.2% in just four years.  

When the company reports FY 2013 earnings (their fiscal year ends January 31) next Thursday, they are expected to report $4.92 per share, up from $4.49 last year, meaning the stock trades at 14.3 times current earnings, provided the estimates are accurate.  Earnings are expected to grow to $5.38 and $5.96 in 2013 and 2014, respectively, or a 3-year annual growth rate of 9.9% which more than justifies the valuation. 

For comparison purposes, let’s look at the valuation of Wal-Mart’s two closest competitors, Target (NYSE: TGT) and Costco (NASDAQ: COST).

Similar to Wal-Mart, Target trades at 14.2 times current year earnings, and is expected to grow earnings at around the same rate.  As far as Target and Wal-Mart goes, either one is a winner.  I think Target has more room for growth, as there are much less Target stores than Wal-Mart stores, however I think Wal-Mart works better as a business model, especially in developing nations, where the lower-priced option will win.

Costco is priced for tremendous growth at 22.4 times current earnings, and is projected to have a 3-year average growth rate of 12%.  Although this is a better growth rate than the other two, the P/E multiple is just too high.  I really don’t see why Costco trades at such a premium.  It has a better balance sheet than the other two, with $4.9 billion in cash and just $1.4 billion in debt, but that is not a significant enough amount to warrant such a high valuation relative to its peers.

Conclusion

Wal-Mart is a great long-term investment that should be worth a lot more than it is.  Over time, I think this will correct itself, especially as the company’s foreign expansion plans begin to unfold.  It is common knowledge that if you want to buy something for the lowest price possible, and don’t want to shop online, you go to Wal-Mart.  This should work exceptionally well in developing economies where every penny truly counts.


KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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