Walmart: Omnichannel Growth Potential Fully Priced (WMT)

WMT Stock: Dividend Yield at Record Low

I covered Walmart last time (New York Stock Exchange: WMT) inventory in October 2023 (see chart below). At the time, the stock had just joined the elite club of Dividend Kings after consecutive dividend increases 50 years. My article defends a bullish thesis based on the following two considerations:

Dividend growth investors may complain about WMT’s declining yield and slow dividend increases in recent years. For long-term investors, the focus should be on total shareholder return rather than dividend yield. When total shareholder return is considered, the picture changes a bit as WMT has been consistently buying back its own shares over the past at a strong pace.

In terms of valuation, and given its competitive advantages, the stock deserves a valuation premium above the sector average. The current valuation multiples are close to (or below) their historical averages. For example, FWD’s dividend yield of 4.13% is higher than the five-year average of 4.01%.

In fact, stock prices have risen significantly since then, as you can see from the chart below. The stock price is up about 27% and the total return is close to 28%.

The problem with the working Taurus thesis is that it tends to be self-defeating. As prices advance, valuation expands, and risks increase. The remainder of this article will explain why this is exactly the case I see with WMT. For these reasons, I am downgrading the stock from my previous Buy rating to Hold.

Given its status as a dividend king, the dividend yield provides a good measure of valuation and an excellent starting point. As you can see from the chart below, the stock is currently yielding 1.19%, not only well below its long-term average but also near the lowest levels in at least a decade, suggesting significant overvaluation.

Admittedly, the stock has a healthy growth outlook going forward, but I think the current valuation is already priced in years of growth already, as shown below.

WMT Stock: Growth Expectations

The chart below shows consensus EPS estimates for WMT stock in the next decade. Based on the chart, the market expects WMT’s EPS to grow at a compound annual growth rate (“CAGR”) of 7.3% over the next 10 years. CAGR may seem boring to growth investors, who are only excited by double-digit growth rates. However, I consider it a very healthy pace for the retail giant. At this projected rate, earnings per share will grow to $4.94 by fiscal year 2034, up from $2.43 currently. That’s pretty respectable for a company whose sales exceed the GDP of many countries and more than double its profits in a decade.

Indeed, there are good catalysts that could support the above growth forecasts. I don’t really consider WMT a traditional retailer these days. The company is well positioned as a technology-enabled multi-channel player. For example, the company has made significant progress toward automating its fulfillment centers in the past and has more aggressive goals for the future. I expect it to be able to successfully automate over 55% of its fulfillment center volume and achieve better results in its hyper centers over the next year or two. After that, I expect progress to be reflected in lower fulfillment costs, improved inventory management, and increased store efficiency, all of which lead to a better overall experience for its broad customer base.

Speaking of its wide customer base, advertising is another growth opportunity for WMT. Similar to Amazon, Walmart already sells advertising space on its website and e-commerce app, which has a much higher margin than retail. Its advertising revenue “only” reached $3.4 billion last year. But the growth potential is huge. For example, last year, growth was 28% year-on-year. The company recently announced that it has agreed to acquire low-end TV maker VIZIO to leverage its user interface and deliver targeted ads based on user viewing patterns. I expect the advertising platform to be a key enabler of operating income growth in the coming years.

The problem is that, after the recent price rises, I consider this growth to have already been fully priced in, as detailed below.

WMT Stock: Growth is fully priced in

At a current P/E ratio of about 28 times (see chart above) and a projected growth rate of 7.3% CAGR, the PEG ratio is over 3.8 times, which is very expensive in my view both from Where is the absolute or relative value. . It is well above the 1x gold standard sought by GARP (Growth at a Reasonable Price) investors.

Admittedly, the PEG ratio can be misleading for dividend stocks (especially dividend kings) like WMT. If a stock pays a consistent dividend, investors don’t need a lot of growth to get a good total return. This is the idea behind the following PEGY ratio promoted by Peter Lynch:

For dividend stocks, Lynch uses a revised version of the PEG ratio – the PEGY ratio, which is defined as the price-to-earnings ratio divided by the sum of the earnings growth rate and the dividend yield. The idea behind PEGY is very simple and effective (the most effective ideas are simple). If a stock pays a large portion of its earnings as dividends, investors don’t need a high growth rate to enjoy good returns. vice versa. Similar to the PEG ratio, the PEGY ratio is preferably less than 1x.

If you remember from the early chart, WMT’s current dividend yield is around 1.19%. Dividing the P/E of 28x by the sum of 7.3% CAGR and 1.19% yield, the PEGY ratio turns out to be around 3.3x, still well above the 1x threshold. To be completely fair, we should also take into account share buybacks here as well. As mentioned in my previous article, WMT has been constantly buying back its own shares over the past. But the current repo is much lower as shown by the 0.58% repo yield as you can see from the next chart below. I don’t expect the company to significantly increase buybacks in the coming years, considering its plans to invest in growth, especially in the areas of e-commerce and omnichannel experiences as we just mentioned.

Other risks and final thoughts

Beyond valuation risks, WMT faces macroeconomic risks similar to its retail peers. These risks include global supply chain disruptions, geopolitical risks, rising inflation, etc. Supply chain disruptions, often caused by geopolitical instability or natural disasters, can lead to product shortages and higher costs for retailers. Additionally, higher inflation can put pressure on profit margins as retailers struggle to raise prices quickly enough to offset rising costs of goods and labor.

The last point is more relevant to WMT, in my view, given its business model. WMT’s business model focuses on lower prices and lower margins, which may make it more sensitive to cost pressures than peers with more differentiated pricing strategies. More specifically, WMT’s operating expenses have increased steadily over the past (see top panel in the following chart) and operating margins have declined in tandem (see bottom panel). Going forward, I’m keen to see how/if it can control its expenses and stabilize its margin in the face of rising inflation, rising labor costs, and rising fuel costs.

To reiterate, the goal of this article is to call for a downgrade of the stock to Hold from my previous Buy recommendation. For existing shareholders, there’s nothing wrong with holding on to a quality stock like WMT (and congratulations on the great capital gain!) even at a premium valuation. The stock has a healthy growth curve ahead, supported by factors such as e-commerce expansion and continued consumer demand for value. However, for potential investors, my view is that a lot of the growth has already been priced in, judging by the high PEG ratio (or PEGY) and record low dividend yield.