While WMT’s dividend is completely secure (96 Safety Score) and even offers reasonable growth prospects going forward (60 Growth Score), fundamental concerns about the company’s ability to grow its profits in an environment marked by increasingly upward wage pressure and sluggish sales trends keep the stock OUT of our Top 20 Dividend Stocks list and our four other hand-picked dividend portfolios. For these reasons, we believe WMT’s total return prospects are limited compared to other opportunities in the market. The dividend itself doesn’t look bad, but we would like to see at least a 3% dividend yield to get more interested.
To view all of WMT’s key fundamental and dividend data in easy-to-read charts, click here. This helps us save hours of time finding and researching quality dividend stocks and is the source of most of the data referenced in our analysis below.
Business Overview
Almost everyone knows what WMT does. Each week, WMT literally serves over 3.5% of the entire world’s population –260 million customers. With over $480 billion in annual sales (the equivalent of $66 for every person in the world), WMT sells just about everything in its stores. Grocery (56% of US sales) is WMT’s biggest merchandise category, followed by health & wellness (11%) and entertainment (10%). WMT has its own private-label store brands, but branded merchandise still represents a significant portion of total sales. The company’s general strategy is to be the low-price leader in its categories.
WMT has over 11,000 stores in 27 countries (international operations began in 1991) and currently generates about 40% of its sales (but only 20% of profits) outside of the US with Mexico, Latin America, and Brazil accounting for the majority of international business. Domestic store mix is dominated by “supercenters” which average 178,000 square feet per store and account for 89% of WMT’s US square footage.
In addition to its significant brick-and-mortar operations, WMT has fast-growing e-commerce websites operating in 11 countries. Walmart.com averages 60 million unique visits a month and offers 8 million SKUs that can be shipped or picked up at one of WMT’s many physical locations. E-commerce sales account for less than 5% of WMT’s total revenue but will continue taking advantage of WMT’s extensive distribution footprint.
Stock Performance
WMT has trailed the market considerably over the past 3- and 5-year periods. Longer-term, WMT returned 7.2% per year from 2005-2014, trailing the market’s 8.1% annualized return. More recently, WMT has returned -6% over the past year, trailing the market and large caps. With profits struggling to grow, investors have taken an increasingly “show me” stance with WMT.
For defensive investors feeling perhaps a bit jittery with the market’s recent volatility, WMT’s stock held up quite well in 2008 – the 2008 upward spike seen in the following chart means WMT significantly outperformed the market that year.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. WMT’s long-term dividend and fundamental data charts can all be seen here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
WMT scored a very high Safety Score of 96, suggesting its dividend is safer than 96% of all other dividend stocks.
As seen below, WMT’s EPS payout ratio (41%) and free cash flow payout ratio (40%) remained at very healthy levels in fiscal year 2015. The company’s EPS payout ratio has gradually risen over the last decade, but its free cash flow payout ratio has generally stayed between 30% and 40% for the past 5+ years. A lower payout ratio gives WMT more wiggle room to support and increase its dividend.
For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. With over half of its sales tied to groceries, WMT put up one of the most impressive performances, increasing sales 1%, growing earnings by 8%, and holding margins relatively steady:
We can also see that WMT has demonstrated its strength by generating and growing free cash flow per share over the past decade. WMT is an incredibly durable business.
While payout ratios, margins, industry cyclicality, free cash flow generation, and business performance during the recession help give us a better sense of a dividend’s safety, the balance sheet is an extremely important indicator as well.
WMT’s balance sheet is in pretty good shape. Net Debt / Trailing EBIT is a moderate 1.7x, and the company’s significant and consistent free cash flow generation make the debt load extremely manageable. No concerns here. As a testament to WMT’s negotiating power with vendors, we see it is able to maintain a current ratio under 1.0x – in other words, it negotiates very favorable payment terms where it doesn’t have to pay vendors nearly as quickly as it collects cash for their merchandise that it sells.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios.
WMT’s Growth Score is 60, meaning its dividend’s growth potential ranks slightly above the average dividend stock’s growth potential (a score of 50 is “average”). Despite some of our skepticism over WMT’s ability to profitably grow going forward, we do have to acknowledge its low payout ratios and strong free cash flow generation.
With that said, the dividend growth rate has decelerated in recent years. As seen below, WMT has increased its dividend for more than 20 consecutive years (42 years to be precise), but the rate of growth has slowed down. The dividend grew at a 13% annualized rate over the last 10 years and slowed to an 11% rate the last five years and a 9% rate the last three years. Most recently, the dividend was raised by just 2%.
Yield Score
Our Yield Score simply ranks a stock’s current dividend yield against all of the other dividend yields in the market. A score of 50 means the stock’s yield is right in the middle of the pack. A score of 100 means it has the highest yield. The Yield Score helps assess a dividend stock’s relative value.
WMT’s Yield Score is currently 56, placing it approximately in line with the market’s average dividend yield despite its prospects for slower profit growth (in our opinion). We would like to see a higher yield score to get more interested.
Competitive Strengths
Walmart is a business with a very wide moat. The company’s sheer size (over $480 billion in revenue) gives it the volume and purchasing power necessary to be a genuine price leader in many merchandise categories. Few companies will ever be able to compete with WMT’s scale in the brick-and-mortar space.
The company’s ability to manage its size is impressive by itself. With millions of SKUs and operations spanning the globe, finding qualified suppliers and sourcing its products are no small feats and act as additional competitive advantages.
WMT’s sprawling operations could also serve it well long-term as more business occurs online. WMT owns or leases over 150 distribution facilities in the US and another 150+ internationally. These facilities represent billions of dollars in spending and years of expertise in running them effectively. Impressively, 80% of the Walmart US segment’s purchases of merchandise were shipped through its distribution facilities rather than the vendor itself, highlighting their strategic locations and the company’s supply chain know-how. Of course, the company also has substantial brand value.
One of the quickest ways to assess the strength of a business model is to evaluate the level and durability of a company’s return on invested capital. As seen below, WMT has earned some of the steadiest returns on invested capital of any company over the past decade, underscoring its competitive strengths.
From a growth perspective, WMT has been challenged in recent years. Overall sales growth has decelerated over the past decade, driven by moderating square footage growth (from high single-digit rates to about 3% annually in recent years as capital spending is shifting towards e-commerce growth and management is focusing more on maximizing ROIC rather than store expansion) and generally lackluster same-store sales.
While you might think international operations would be a source of stronger growth, WMT has actually slowed growth in this segment as it closes some unprofitable stores and looks to improve existing operations (international sales account for 40% of total sales but only 20% of profits).
Retailers’ sales are driven by two factors – new store builds (i.e. square footage growth) and more sales from existing stores (i.e. same-store sales).
Looking at same-store sales, WMT’s results have been sluggish at best over the past two years, remaining between -1% and +1%. Such results appear lackluster given the improving US economy and strength observed at other retailers. For comparison’s sake, TGT grew its same-store sales by 1.3% last year, more than doubling WMT’s same-store growth despite dealing with the consequences of a data breach that occurred at the end of 2013.
To improve same-store sales, WMT is focusing on local market share positions as it continues expanding its supercenter format and adds more smaller-format Neighborhood Market stores, consistent with the strategy it outlined in October 2013.
We can see this playing out if we look at WMT’s 5-year square footage history. As seen below, US supercenters account for 89% of WMT’s total US square footage, but Neighborhood Markets have shown the most growth. Unfortunately, these stores make up a miniscule 3% of total square footage and don’t seem likely to move the needle anytime soon. Overall, WMT’s US square footage growth has decelerated a bit over the last five years to hit a low of 3% last year. We expect this trend to continue.
Given the company’s size, the marginal effect of these efforts continues to diminish. As seen in WMT’s latest 10-K, the company acknowledges that new stores are having a negative impact on its existing properties, which already cover most of the US:
“As we continue to add new stores and clubs in the U.S., we do so with an understanding that additional stores and clubs may take sales away from existing units. We estimate the negative impact on comparable store and club sales as a result of opening new stores and clubs was approximately 0.9% and 0.8% in fiscal 2015 and 2014, respectively.”
Key Risks
For bulls pointing at WMT’s e-commerce opportunity, made possible by the company’s impressive distribution network and store reach, do you know what percentage of WMT’s revenue is currently generated from e-commerce?
Less than 5%. And, it’s recently been putting up sub-20% growth rates. Still enough to contribute +0.2% to +0.3% to same-store sales growth, but with over $480 billion in company-wide sales last year, it takes A LOT to move the needle.
By the way, WMT is not generating any profit from its e-commerce operations and likely won’t for a very long time. Look at Amazon’s profitability during its current investment phase. Then realize Amazon has over 6x more online sales than WMT and sells over 300 million items compared to fewer than 10 million items available at Walmart.com. While WMT’s scale in brick-and-mortar helped it dominate traditional retail for decades, it is important to realize that Amazon has a similar position now in online retail, and WMT could be 5-10+ years away from catching up (if ever).
If WMT is trying to play catchup / defense, it must “invest” just as aggressively as Amazon. The future return from these multi-billion dollar efforts is unknown, but any positive, material e-commerce developments seem unlikely for at least the next several years. If anything, e-commerce investments seem likely to be an ever-increasing drag on profits.
With e-commerce out of the way, let’s dig in to our primary concern with an investment in WMT – rising labor and healthcare costs. But first, please remember that we think WMT’s dividend looks great (96 Safety Score) and has reasonable growth prospects (60 Growth Score). We would just be surprised to see the stock outperform the market over the next several years (barring a broad market selloff – WMT probably won’t go down as much).
Nationwide, pressure has been building to gradually raise federal minimum wages from $7.25 an hour to $15 an hour. Even at $15 an hour, pay would still be below average private sector pay of $22 an hour. From New York to Oregon, different political figures have already proposed hiking minimum wage in certain industries to $15 an hour.
In an attempt to save face and front run some of this building pressure, WMT announced in February 2015 that it would raise the starting wage of its employees to $9 an hour this year and get up to a minimum of $10 an hour by next year. WMT anticipates $1 billion in additional expenses in fiscal 2016 as a result, which will likely prevent the company from leveraging operating expenses yet again.
It should also be noted that rising healthcare costs pose additional risk to profits – employers spent an average of $11,204 per worker for health benefits in 2014, up 4.6% from a year earlier, according to Mercer. Indeed, WMT had bigger health care costs than it anticipated, enrolling more workers and experiencing faster-rising costs than expected; the company said its health care expenses would increase $500 million last year, equal to about 2% of its operating income. Note that about 60% of WMT’s 2.2 million workers are full-time.
We dug into WMT’s financial statements to estimate the impact continually rising wages and healthcare costs might have on overall profitability, especially in light of the company’s sluggish sales growth. In fiscal year 2015, WMT reported about $117 billion gross profit, $93.5 billion in operating expenses, and $23.6 billion in pretax operating income. While the company does not explicitly breakout labor costs, we can estimate what proportion of operating expenses (“opex”) they account for.
Each column in the table below assumes a different percentage of opex represents the bulk of WMT’s annual labor costs. In the first column, “20% of Opex”, the “Estimated Labor Cost” is simply the $93.5 billion in fiscal year 2015 operating expenses multiplied by 20%, or $18.7 billion in estimated labor cost. With 2.2 million employees, that amounts to $8,505 per employee, which seems low.
Regardless, you can see the incremental operating expense that would be associated with different wage increases, ranging from an 8% wage hike to a 28% wage hike for sensitivity purposes. In our table, the minimum cost increase estimate would be about $1.5 billion (20% of Opex, 8% Wage Hike) but ranges up to over $18 billion. If the government raised the federal minimum wage to $15 an hour over the next 10 years, wages would increase at an 8% annualized rate (from the current $7.25 minimum wage). Over five years, the annual increase jumps to 16%. WMT is a bit ahead of this with its announcement earlier this year, which will put its minimum wage at about $10 by next year (double-digit annual increases).
This is a problem because WMT’s same-store growth has stalled out (or come at the expense of gross profit, like we saw with Q2 results) while square footage growth is likely to decelerate below 3% per year going forward. With labor being such a material cost for WMT, we are not sure if the company will be able to leverage operating expenses for at least the next several years, especially in light of increasing e-commerce investments. This would mean minimal, if any, profit growth.
In our analysis below, we give WMT credit for growing sales at a 3% clip while maintaining historical gross margins, which could prove to be generous. We can see that the company would generate $3 billion to $4 billion in incremental gross profit each year in such a scenario. However, looking back at the wage expense table above, we can see that incremental wage expenses wipe out most, if not all, incremental gross profit in many scenarios. And this doesn’t even begin to account for increasing e-commerce costs. If WMT cannot figure out a way to rejuvenate sales growth without hurting gross margins, the next five years could be tough with increased labor and healthcare laws.
As previously mentioned, the company’s most recent earnings report showed that higher same-store sales growth is coming at the expense of gross margins – lower prices are an easy way to draw in traffic and make growth look better, but margins are taking a hit. It remains uncertain if WMT can sustain positive same-store sales growth without hurting margins in light of rising e-commerce competitive threats. For now, results show that this will be a challenge:
In addition to rising labor costs challenging WMT’s bottom line, they could also add to the company’s sales growth issues. According to company estimates told to the Wall Street Journal in 2013, about 18% of all food stamp dollars are spent at Walmart. This amounts to over $10 billion each year, or more than 2% of WMT’s total sales. Because wages have been stagnant for a long time, the number of food stamp recipients remains extremely high. States are tightening their eligibility requirements for food stamps and re-imposing work requirements that were allowed to lapse when the financial recession struck. This could hurt demand, and longer-term, a higher minimum wage could reduce reliance on assistance programs and encourage some shoppers to go to more “premium” retailers rather than WMT.
While we only looked at a few impacts from a potential rise in the federal minimum wage, such a move would likely change many variables – for example, labor turnover could drop and layoffs could increase to recoup some of the extra expense (although layoffs might ultimately hurt store service and same-store growth), or people might have more to spend at WMT.
A final risk to consider started building almost four years ago. WMT paid $282 million and $173 million of professional fees in FY14 and FY15, respectively, related to an SEC investigation. This news was first announced in late 2011 and relates to alleged bribes WMT made in 2005 to local officials in Mexico to accelerate the permitting process for their new store sites. Certain senior management allegedly participated in hiding these payments at the time, but the investigation is still going on. While these aren’t huge dollar figures for a company of WMT’s size, it does raise some flags about internal policies and the corporate culture.
Valuation
Trading at 15x forward EPS estimates, WMT trades at a discount to the market’s multiple. However, given our concerns about the company’s long-term ability to continue growing its earnings, the discount seems to be reasonable and arguably not steep enough for a profit-declining business, even if the rate of decline in moderate.
If market turbulence continues, WMT could outperform in the near-term, but we believe it will be hard for the stock to keep up longer-term if our profit growth concerns play out – the multiple doesn’t have room to “re-rate”, and EPS growth could prove to be non-existent or unsustainable.
As previously mentioned, the stock’s Yield Score is 56, meaning its 2.9% dividend yield is higher than 56% of all dividend stocks. We would be more interested in a 3%+ yield, recognizing the safety of the dividend but also the uncertainty surrounding long-term profit growth.
Conclusion
WMT’s scale has served it well for decades, but the company’s massive size has posed challenges in recent years. With same-store sales struggling to record profitable growth, slowing new store expansion plans (saturated domestic market), and a distant second place position to Amazon in the (unprofitable – for now) e-commerce world, it’s challenging for us to see how WMT will generate 3%+ growth going forward. Even in a 3% growth scenario, rising labor, healthcare, and e-commerce costs appear to have potential to erode most, if not all, or WMT’s incremental gross profit gains. Trading at about 15x forward earnings and a sub-3% dividend yield, we will look elsewhere for dividend growth.
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