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Walmart

Financial Analysis and Valuation

4/25/2013

Walmart (WMT)

Current Price: 78.03 (as of 4/24/2013)

Recommendation and Target

Based on my quantitative valuations and qualitative analysis, my one year target price for Walmart is

$85.00 per share. I expect Walmart to hit this price by the close of the firms FY2014 (1/31/2014). Based

on my analysis and my projected target price, I recommend executing a buy.

Furthermore, my 5 year target price on Walmart is $106.00 per share. I expect the stock to realize this

value by the end of the firm’s FY2018 (1/31/2018).

Company Background

Wal-Mart Store Inc. was founded in 1945, and operates retail stores in over 27 countries in three main

segments - Walmart US, Walmart International and Sam’s Club. 1 Walmart’s business includes retail

stores, restaurants, warehouse clubs, superstores, and ecommerce via walmart.com. Walmart’s retail

reach spans the grocery, health, baby products, household, holiday, electronics, toys, paper goods, pet

supplies, photo processing, books, automotive supplies, apparel, home furnishings, décor, outdoor

living, tobacco, and alcohol categories, among others. 2

Current Position 3

Walmart’s continued success is driven by its focus on leveraging Everyday Low Price (EDLP) as the

cornerstone of its competitive strategy. By offering a vast assortment of products across numerous

1 From Yahoo! Finance, Walmart Stores. Business Summary. http://finance.yahoo.com/q/pr?s=WMT

2 From Yahoo! Finance, Walmart Stores. Business Summary. http://finance.yahoo.com/q/pr?s=WMT

categories, while integrating the EDLP strategy, Walmart is able to build a unique shopping experience

for consumers that is unmatched by competitors. Walmart works closely with suppliers to push down

purchasing and supply chain expenses, allowing them to obtain goods at the lowest possible prices.

These savings translate directly to consumers.

Walmart’s new initiatives include a redesigned walmart.com that aims to better integrate ecommerce

with in-store purchasing, while capitalizing on logistical efficiency and inventory management.

Walmart.com, now equipped with a new search engine, and new mobile application solutions, are now

being used as innovative vessels to enhance the customer experience by aiding consumers in planning

shopping trips, managing budgets, and finding merchandise more efficiently.

Disciplined international growth is also key to Walmart’s success, as the EDLP strategy is continuously

being implemented in key global areas like China, the UK and Brazil. Walmart aims to customize its

shopping experience for international consumers by offering diverse shopping formats through

understanding local needs and compliance, while simultaneously pushing the EDLP strategy.

Walmart has refocused its internal commitment to empowering employees and strengthening its

associate team. As part of this engagement and responsibility plan, Walmart has pledged to hire over

100,000 honorably discharged US veterans over the next five years. Deeper talent on an international

level is also key in Walmart’s future success, and thus Walmart is focusing on hiring energetic and

capable leaders to head international operations in key areas.

Lastly, Walmart has embraced its role as an international leader on social and environmental issues.

Issues like women’s economic empowerment, sustainable agriculture, and environmental sustainability

are key to Walmart’s new brand image. New efficiency and zero waste goals have been implemented to

benefit communities, promote global sustainability and drive down costs.

Financial Analysis (Inputs and Assumptions)

I expect Walmart’s revenue to grow in proportion to various estimates on Bloomberg, averaging around

4.64%. The growth is consistent with historical growth trends and recognizes Walmart’s continued

ability to gain market share and expand internationally. The relative decrease in growth of costs is a

result of Walmart’s cost saving sustainability initiatives and their stated goal of reducing operating

expenses as a percentage of sales by 100 basis points by fiscal 2017. 4

Due to proposed policy changes in by the Obama administration, I factored in a slightly higher effective

tax rate for the upcoming 5 years. The historical tax rate has been around 31%, but I expect the rate to

return to the pre-2010 levels of around 34%.

Another driving factor in my bullish view on Walmart is the overall bullish view on the retail industry. As

the economy rebounds, consumers will have more disposable income that will translate into increased

purchases. Walmart has historically outperformed the retail industry in areas like inventory turnover,

receivables turnover, receivable collection period, total asset turnover and payables turnover. I expect

these trends to continue into 2014 and beyond. Walmart’s performance in these key areas accurately

displays the health of the company as well as demonstrates a driving factor in its competitive success.

Walmart’s debt to equity ratio (currently around 60.6%) is significantly higher than the industry average

of 42.9%. Walmart’s continued commitment to leverage leads me to believe that the firm will maintain a

high debt to equity ratio, specifically to finance more stores, better infrastructure, and increased

international operations. However, Walmart’s sales growth and profit margins will also rise as a result,

and the overall strength of the company mitigates any concerns over the high debt ratio.

I used a terminal growth rate of 3% in an effort to be conservative in my future estimates. While

revenue should grow at around 4% for the next 5 years, Walmart is still a mature company and 3% more

accurately estimates distant growth, as it takes into account possible speed bumps in growth. As

Walmart is becoming increasingly international, compliance issues, trade barriers and cultural

adjustments may slow growth, although I believe these effects will be minimal.

Valuation Analysis

For a detailed breakdown of my valuation analysis, including supplemental valuation models, please see

the attached financial report. Below is a breakdown of the two driving methods in my valuations:

Operating Free Cash Flow and Relative Value.

Operating Free Cash Flow

Based on my use of the Operating Free Cash Flow method, I have valued Walmart at $87.58 per share.

While I realize the market may not reflect this true valuation right away, I still expect the stock to grow

to around $85.00 per share by the end of FY2014. The OFCF method takes into account my calculated

WACC of 4.4%, terminal growth rate of 3%, and my 5 year sales growth percentages. The OFCF fair

value of $87.58 is a key factor in my buy decision and target price estimates.

Relative Value

While the OFCF model is an absolute model, which only takes into account past and estimated cash

flows for outputting an intrinsic value, relative value analysis takes into account key ratios that evaluate

Walmart’s business compared to the overall retail industry.

Walmart has a current P/E ratio of around 14.18, which is lower than the industry average of 20.42. This

lower P/E ratio means that the stock price has not yet reflected earnings potential. Historically,

Walmart’s P/E ratios have been steadily increasing, and I project them to continue this trend as evident

by my forward ratio calculations.

The current P/BV of Walmart, around 2.95, is also lower than the industry average, around 5.67. The P/B

ratio represents the value if the company were torn up and sold today. Typically, a lower P/B ratio

means that the stock is either undervalued or has operating issues that could impact future

performance. Due to Walmart’s successful history and solid plans, I view the relative low P/B ratio as a

reflection that the stock is undervalue. The presented forward ratios lend me to believe that the stock

will become more accurately valued in the future, but nonetheless undervalued still.

Walmart has a current P/CF ratio of about 6.91, which is less than half of the industry average ratio of

16.91. A low P/CF ratio tends to show, depending on the industry, that a firm is generating ample cash

flows to sustain its business and that the stock price has not yet accurately reflected the excess cash. I

believe that due to reinvestment activities, Walmart’s stock has not yet reflected its large cash flows. Its

forward P/CF ratio remains lower than industry averages, thus contributes to my buy decision.

Lastly, Walmart has a current P/S ratio of .48, which is less than the industry average of .77. Typically

speaking, a low P/S ratio signifies a good investment opportunity for investors. In Walmart’s case, the

P/S ratio absolutely reflects that the stock in undervalued. However, we must also consider Walmart’s

appetite for debt as a method of financing, as this factors in to the low P/S. Walmart’s historical strength

and projected revenue increases help negate the risks of the increased debt, further validating the

value derived from the low P/S ratio.

Overall, based on the below industry averages of these 4 key ratios, Walmart is undervalued in

comparison to the retail industry. These general sense of the stock price being undervalued heavily

influenced my decision to buy.

Option Strategy

In choosing between a covered call and a protective put option strategy, I would chose to execute a

protective put strategy based on the fact that I am bullish on the stock in both the short and long terms.

Assuming I own 1000 shares of WMT, a protective put would look as follows:

1000 shares x $78.03 = $78030

January 2014 Strike price = $70

Cost of Option= $1.89 x 1000= $1890

Stock Rises to 85:

$85-$78.03= $6.97 x 1000 = $6970 gain on stock

$6970 $1890 (cost of option) = $5080 gain

Conclusion and Investor Expectations Comparison

Based on my quantitative analysis, the OFCF valuation and the relative value ratios, and qualitative

research, I view Walmart as undervalued in terms of current stock price. The OFCF fair value of $87.58 is

about $10 per share higher than the current value of $78.03. While I realize the market may not fully

reflect this full fair value in the next year, I’m confident that most of this unrealized potential will be

recognized by the end of FY2014. The low ratios shown in the relative value calculations, particularly the

low P/B and P/CF ratios strengthen my confidence that the OFCF method is accurately depicting the

stock value as underpriced.

Investors that have reported projections on Bloomberg seem to generally fall in line with my

assumptions. 45.7% of reported

recommendations are to buy, 48.6% are to

hold, while only 5.7% recommend a sell action.

Stock estimates for a buy position have target

prices that range from $80 to $90 per share. I

fall in the middle of the bullish investors with a

one year target price of $85 per share. The

general positive consensus shown by industry

analysts strengthens my independent buy

decision.

price of $85 per share. The general positive consensus shown by industry analysts strengthens my independent

References

Yahoo! Finance, Walmart Stores. Business Summary. http://finance.yahoo.com/q/pr?s=WMT

Yahoo! Finance. Walmart. Options

Bloomberg

Wall Street Journal

Investopedia.com

http://www.theoptionsguide.com/covered-call-writing.aspx