Wal-Mart’s Growth Potential

• Wal-Mart is betting big on digital sales
• The company is seeing 5%+ comparable store sales growth in its Neighborhood Market stores
• A strong U.S. Dollar is a net positive for Wal-Mart

Wal-Mart has long been a favorite of The 8 Rules of Dividend Investing.  Wal-Mart is the industry leader in discount retail by a wide margin.  The company generates more sales than Costco (COST), Target (TGT), Amazon (AMZN), Kroger (KR), and Whole Foods (WF) combined.

Wal-Mart’s dogged focus on controlling costs drives its strong competitive advantage.  The company’s scale allows it to pressure suppliers into the best possible deals.  Wal-Mart’s established infrastructure and supply chain help keep costs low.  Focusing on maximizing the value of customers’ dollars has grown Wal-Mart shareholder’s dollars as well.  The company has increased its dividend payments for 41 consecutive years, making Wal-Mart a Dividend Aristocrat.

Wal-Mart Current Growth & Growth Driver Overview

Wal-Mart’s latest results  showed only modest revenue growth of 2.8% versus the same quarter a year ago.  Revenue growth by segment is shown below:

• Wal-Mart US: 3.4%
• Wal-Mart International: 1.7%
• Sam’s Club: 2.3%

In addition, the company reduced its diluted share count by 1% versus the same quarter a year ago for total revenue per share growth of 3.8%.  Wal-Mart currently has a dividend yield of 2.2%.  The company’s revenue per share growth combined with its dividend yield has given investors a total return of about 6% over the last year, not counting valuation multiple changes.  6% growth over the last year is not particularly impressive, but it is not cause for alarm either.

Wal-Mart reduced its full year EPS guidance from a range of $4.90 to $5.15 to a range of $4.92 to $5.02. This is a reduction of about 1% based on the average of the ranges. Wal-Mart expects a higher tax rate in its fourth quarter than previously anticipated. Despite the guidance reduction, I believe the company’s third quarter results point to recovering operations and long-term growth ahead.

Wal-Mart has suffered from declining comparable store sales in its U.S. segment for much of the last 2 years.  This more than anything else has retarded growth.  The company’s comparable store sales in the U.S. did increase in the company’s latest earnings release, however.  The company’s same store sales in the U.S. were likely due to cuts in food stamp benefits in October of 2013.  Amazingly, about 18% of all food stamp benefits are spent at Wal-Mart.  The company’s recent comparable store sales increase shows that it has recovered from the food stamp benefit reduction in 2013.

Over the long run, Wal-Mart will likely grow faster than it did in 2014.  The company is projecting relatively slow sales growth in 2015 of 2% to 4%, however.  The company has 3 key growth drivers working in its favor that should increase the company’s long-term growth rate.  Each of these 3 growth drivers are discussed below.  The 3 areas that will fuel Wal-Mart’s growth are:

• Digital growth
• Smaller store layouts
• A stronger U.S. Dollar

Digital Growth

Wal-Mart grew digital sales by 21% in its most recent quarter.  The retail giant expects to finish its fiscal year out (4th quarter results come out mid-February) with about $12.5 billion in digital sales.  For comparison, e-commerce leader Amazon has $89 billion in sales over the last 12 months.  Wal-Mart’s digital segment is about 1/7th the size of Amazon.

Wal-Mart is driving digital growth through investments in its website, mobile platform, and people. The company recently acquired smaller tech firms including Adchemy, Stylr, and Luvocracy. Wal-Mart is building a team of talented ‘silicon valley’ employees to drive digital innovation and growth.

Wal-Mart is betting big on its digital growth.  The company has significantly shifted its capital spending budget to drive growth in digital/e-commerce sales.  Wal-Mart is reducing growth investments in international markets and Sam’s Club while increasing investment in its digital operations.  The company updated its full fiscal 2015 capital expenditure guidance as follows:

• Wal-Mart U.S. capital expenditures budget up 0.8%
• Wal-Mart International capital expenditures budget down 7.1%
• Sam’s Club capital expenditures budget down 10%

The growth in the Wal-Mart U.S. budget is a result of increased spending on digital and e-commerce operations.  Wal-Mart will use money it was going to invest in international brick-and-mortar growth as well as Sam’s Club growth and use those funds for digital growth instead.  The physical/digital budget update for Wal-Mart is shown below:

• Physical capital expenditures budget down 2.9%
• Digital capital expenditures budget up 25%

Wal-Mart is expecting to spend 7.8% of its capital expenditures budget on digital investment, versus just 3.1% on digital investments in its full fiscal 2014.  Wal-Mart plans to spend about 11% of its capital expenditures budget on digital investments in its fiscal 2016 (basically calendar year 2015), another huge leap up from fiscal 2015 (again, Wal-Mart’s ‘fiscal 2015’ is basically calendar 2014).

Wal-Mart’s big bet on digital sales will impact growth this year and next year.  The company is expecting sales growth of just 2% to 4% for full fiscal 2016.  Wal-Mart’s management projected an 18 to 24 month period of increased investment in digital.

Neighborhood Market Stores

In the U.S., Wal-Mart is employing a ‘fill-in-the-gaps’ strategy.  The company is focusing on building smaller stores to compliment its large super center locations.  Wal-Mart has seen success with its neighborhood market stores.

Source:  TXK Today

The neighborhood market store is Wal-Mart’s take on a grocery store. The stores are significantly smaller than Wal-Mart’s flagship Super Centers.   The company’s neighborhood market stores focus on both fresh and packaged grocery products, as well as pharmaceuticals.  This quarter, Wal-Mart saw comparable store sales growth of 5.5% versus the same quarter a year ago. This builds on 5.6% comparable store sales growth in the previous quarter.  5%+ comparable sales growth is an excellent sign that Wal-Mart is stealing market share from other grocery store chains with its neighborhood market stores.

The stores are successful because of their focus on low prices which appeals to cost-conscious consumers. Wal-Mart is leveraging success in its neighborhood market stores by expanding store count. The company is on track to open between 180 and 200 neighborhood market stores in the US in its full fiscal 2015.

In addition to its neighborhood market stores, Wal-Mart is also experimenting with even smaller express stores.

Source:  Forbes

The express stores are just one-tenth the size of a Wal-Mart super center.  The stores are a hybrid between a corner drug store and a dollar store in that they provide both pharmaceuticals and a decent assortment of low cost items.

Strong Dollar

The U.S. Dollar index has risen about 17% since July of 2014.  The strong dollar has interesting consequences for Wal-Mart.  Wal-Mart generates about 70% of its revenues inside the U.S.  The company imports the vast majority of its products from overseas.

Wal-Mart’s has long focused on pressuring suppliers into the lowest possible prices.  The company will benefit from a strong U.S. dollar as it will be able to purchase even more goods for the same amount of dollars.

Do not be fooled by Wal-Mart’s marketing  department.  The ‘Buy American’ publicity campaign is mostly just that; publicity.  The company still purchases the vast majority of its products internationally. In the Buy American campaign, Wal-Mart pledged to buy $50 billion in U.S. products over 10 years. While $50 billion sounds impressive, over a 10 year period, this amounts to about 1% of Wal-Mart’s revenues.  One percent of revenues sounds decidedly less impressive than $50 billion.

The U.S. Dollar will likely remain strong through 2015.  The Federal Reserve continues to hint at a possible interest rate increase in 2015.  This would further strengthen the U.S. Dollar.  Even rumors of a rate increase will likely be enough to keep the dollar strong over the coming year.

Final Thoughts

Wal-Mart is the market leader in discount retail, by a wide margin.  The stock has long been a favorite of The 8 Rules of Dividend Investing.  Wal-Mart stock has the following characteristics:

• 41 consecutive years of dividend increases
• 2% dividend yield
• 3% 10 year revenue per share growth rate
• 38% payout ratio
• 19% 10 year stock price standard deviation

The company has a slightly above average dividend yield, above-average long-term revenue per share growth rate, a conservative payout ratio, and exceptionally low stock price volatility.  The company  will likely see slow growth in 2015, but then faster growth thereafter as both the smaller store layouts and digital sales continue to scale.