Wall Street’s Lukewarm Reaction to Wal-Mart Annual Meeting is Shortsighted
Before, during and after Wal-Mart’s shareholder’s meeting we spent time with WMT management and Wall Street analysts (finance nerds) who evaluate the giant retailer and whose job is to advise mutual funds and legions of stockbrokers (flamboyant salespeople) on whether to buy or sell the stock. As former analysts (finance nerds) ourselves, we can offer insight into how Wall Street thinks (or doesn’t think).
Wall Street’s view is short-term, one-year, at most. As such, the messages they zeroed in on were that expenses would be higher and that comp sales (because of commodity price deflation) would be challenging this year. Thus, few were excited about prospects for the stock. Yet, if one views WMT through the lens of a business owner, associate, or long-term investor, a different picture emerges. First, consider why the stock has not budged in the past decade. (Read our full analysis here)
There are two lines on the chart depicting results from 1999 to 2009. The first line is EPS, which represent performance of the business – 12% EPS growth per year, that’s pretty good. The second line is Price/Earnings or P/E ratio. The P/E measures how much investor’s think each dollar of earnings are worth. During the late 1990’s investors were willing to pay $45 for each dollar of Wal-Mart’s earnings (much higher than Google’s P/E!).
WMT was not alone in this mania, as Wall Street bid up the shares of blue-chip companies like Coke, Proctor & Gamble and others to valuations that were out-of-line with those companies’ growth potential. It’s taken a decade, but the fast money has realized that they were overpaying for WMT’s earnings. Though EPS has been growing, it was being offset by a decline in the P/E multiple, keeping the stock basically between $45 and $50. Now, WMT has a P/E of 15x, which is about what the market and big, strong companies have historically traded at. Thus, looking ahead, it is likely that if EPS doubles so should the stock price—finally!
Wal-Mart EPS Growth, Stock Price and Investor Returns
With any investment, whether one buys the entire company or a single share of stock, the financial logic applied to the decision is the same, says Warren Buffett. There are more complex models, but here is a simple and concise approach.
At $50 per share, WMT’s 3.92 billion shares are collectively worth $195 billion. Because of its size, it is clear that WMT will not grow earnings at 38%, 34%,15%, and 12% like it did in the 70’s, 80’s, 90’s, and last 10 years. But, the company is highly profitable and seems capable of producing 6-8% EPS growth based on modest sales increases, steady margins, and using its billions in excess cash flow to reduce the number of shares outstanding. So, if you bought the entire company today for $195 billion, how long would it take you to get your money back? About 9 years. Here’s how. WMT is expected to produce $14 billion in net income this year, which, if grown 8% per year, would accumulate to $195 billion in 9 years -- that’s a 11% return on investment (1/9 = 11%) whether one share is purchased or the entire company. Of course, stock prices don’t necessarily mirror growth in earnings or value in the short term but tend to reflect that value over time.
But What About My Options & Restricted Stock?
Astute investors recognize the quality and depth of managerial talent at Wal-Mart. However, the company is at an inflexion point. The stock price performance over the next 3-5 years is critical to retention and therefore, vital to the company’s future. Although WMT has increased pay and grown managerial talent from within and from outside, the stock price, which is the engine of wealth creation, has been stuck in neutral.
Most associates don’t become rich from their salaries. However, thousands of current and former employees have become wealthier than they ever imagined because they owned the stock. It may be the biggest elephant in the room, but there’s an expectation that the stock will move higher.
In the past 10 years, WMT has granted its associates approximately 145 million options, restricted stock, restricted stock rights, and performance shares, handing over ownership of 4% of the company to associates. Currently, 74 million of these share awards are outstanding at an average grant price of $49.00.
If the stock price is now more likely to track EPS growth, and if EPS growth is likely to be 6-8% per year, then it follows that the value of the company would increase by about (at least) $4 per share over each of the next few years. Multiplying the 74 million in share awards by $4 equals about $300 million in additional annual compensation/wealth for associates. Keep it up for a few years and associates are a billion dollars wealthier. Imagine what that would do for the economy in Northwest Arkansas! It might be a boon for sellers of jewelry, boats, RV’s and other discretionary items.
CPG Investors Avoid Recent Onslaught of Stockholder Dilution
Recently, common stockholders of General Motors have seen their entire investment essentially wiped out, and several companies within the financial industry have issued significant amounts of stock to raise money. Unless existing shareholders receive new stock for free or purchase more when these deals are priced, their ownership (and hence, the value of their investment) will be reduced. According to data from IPO Monitor, we estimate that year-to-date approximately $20 billion has been raised by about 85 public companies that sold additional stock to raise money; and the average shareholder saw their existing ownership diluted by about 15% if they did not pony up additional money to buy more stock. Not surprisingly, financial companies and real estate investment trusts (REITs) comprised nearly one-half of the companies and dollar amount raised.
We believe that so far the damage to CPG investors has been minimal, with notable offerings from Energizer Holdings (ENR) and Jarden (JAH). ENR issued new stock in May at a price of $49. After paying investment banking fees of $25 million, net proceeds of $510 million will fund the purchase of the Edge/Skintimate shave prep business for $275 million from S.C. Johnson & Son, and reduce ENR's existing $2.8 billion in debt. Dilution to existing ENR shareholders was around 17%. Jarden issued shares at $17.50 in April, netting proceeds of $203 million. JAH intends to use the money for general purposes and to reduce some of its $3 billion in debt; dilution to shareholders was about 16%.
Best use of the word “fissiparous” in a Scholarly Publication
While we don’t usually hang out with the crowd that wears bowties, v-neck sweaters under their suits, are named Thurston and refer to their wives as “lovie darling” (not that there’s anything wrong with that), we discovered a very insightful article on globalization and geography in a recent issue of Foreign Policy (read full article here). Unlike conventional thinking (e.g., NY Times bestseller, The World is Flat), the author constructs a case that globalization actually makes geography (and natural resources) more relevant, not less relevant. If you like politics, history, and global markets, this article is right in your wheelhouse. Source: Foreign Policy.
Department of Corporate Doublespeak
Ted Eliopoulos, head of CalPERS’ real estate portfolio (CalPERS is the nation’s largest pension fund with some $170 billion in assets invested on behalf of state of California employees) remarked in an interview: “No one in the marketplace knew how swiftly the housing market would fall – not the Federal Reserve, not the Treasury.”
Translation: “I have just invested tons of money at the absolute top and lost 103% I put into the deals due to using recourse debt. I am a moron. I could not have predicted the housing market would fall. No one could have…other than Ron Paul, John Paulson, Robert Shiller, and Long or Short Capital.” source: Long or Short Capital
Abs in a Box
Its swimsuit season, but forget doing the crunches. We saw an ad for Abs in a Box recently. For a mere $69, you’ll receive a kit containing contouring shades, semi-permanent stain, sprays and a mini Kabuki Brush to paint on your new, chiseled abs. Just when we thought we had heard of everything…
And One More Thing…
Father’s Day is next week and this awesome gift is (at least for now) the one missing item from my outdoor gear collection (aka, my garage). Wilderness Solutions of Shortsville, NY manufactures hand-made fire-starting pistons (see the video here) that generate heat via compression. Though mostly used by survivalist types, guys, you can impress your friends & neighbors with your pyrotechnic skills when you whip one of these out to light the grill. -- Scott
Quote of the Day:
On the topic of fire, Jamie Dimon, CEO of JP Morgan delivered this one-liner when questioned why JP Morgan paid so little to acquire the then-imploding Bear Stearns:
“There’s a difference between buying a house and buying a house that’s on fire.”
Scott Alaniz, CFA
scott@bostonmmm.com
Joe Chumbler, CFA
joe@bostonmmm.com
Rogers (479) 657-6940
Information in this report has been obtained from sources that we believe to be reliable. Boston Mountain Money Management does not guarantee its accuracy or completeness and assumes no responsibility for actions taken with respect to information contained herein. The authors held a position in Wal-Mart Stores at the time of this newsletter.
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