Wal-Mart's Stock: No Bargain Here


By Amy Tsao As it expands beyond the scope of any company in history, Wal-Mart (WMT) has racked up quite a few detractors. Many local communities still fight to keep it from plopping one of its massive stores down in their environs. Former employees are suing, alleging discrimination and other labor grievances. Retailing rivals -- from toy stores to supermarkets to mom-and-pop shops -- complain about how hard it is to compete against a giant with so much buying and selling power (see BW Cover Story, 10/6/03, "Is Wal-Mart Too Powerful?").

Yet while Wal-Mart may be reviled in some circles, at least one group has prospered by being on its side: Wall Street. The retailer has a long track record of sales and earnings growth. In recent months, Bentonville (Ark.) giant has announced solid back-to-school sales results and improved performance at its Sam's Clubs warehouse division. With $8.2 billion in net income and sales of $244.5 billion in 2002, Wal-Mart plans to keep getting bigger at a stable pace with a combination of new store formats, international expansion, and market-share growth in the fashion department and grocery aisle.

BUY ON A DIP? The question for investors is: How much upside does the stock have left? At around $57.50 a share, it's just shy of a 52-week high of $60, reached in early September, and up from around $46 earlier this year. It trades at a price-earnings ratio of 28 on the current year's earnings. That's down from its average current year p-e of about 33 in the past five years, when earnings growth averaged 17% a year. Earnings this year are expected to rise about 14%, according to analysts polled by First Call. The bottom line: The stock price isn't likely to stumble in the near term, but it's unrealistic to expect any huge gains, even if the nascent economic recovery is stronger than expected.

With predictions of a decent holiday season of 5% sales growth at stores open at least a year, Mark Mandel, analyst at Blaylock & Partners, recommends buying the shares only if they fall below $50. "That's where it gets interesting. Then it gets closer to 20 times next year's estimates," says Mandel, who rates Wal-Mart a hold. (He doesn't own the shares, and the firm doesn't do investment banking business with Wal-Mart.)

Citing valuation concerns, Bernstein analyst Emme Kozloff recently cut her rating to market perform. She says the retailer would need to show 22% earnings growth next year for the stock to merit a 15% gain. Kozloff figures the probability of that to be low. In the next fiscal year, which ends in January, 2005, she expects earnings per share of $2.33, up from $2.05 in the current fiscal year. (Kozloff doesn't own the shares, and the firm has no banking ties with Wal-Mart.)

SPENDING ON PAYDAY. Some external issues could prove challenging for Wal-Mart in the coming months. Rising energy costs and the economy's persistent lack of job creation could offset some of the gains it has realized from President Bush's tax plan. The retailer said during a recent sales call that it's seeing sales spikes mid-month, which in the past has suggested that consumers are spending when they get their paychecks but keeping their wallets shut the rest of the time.

And higher energy costs are "like a big tax increase to those in the Wal-Mart hinterland where transportation is a major expense," says Jim Luke, director of growth equity at BB&T Asset Management. (Wal-Mart is a holding at BB&T. Luke doesn't own the stock personally.)

Wal-Mart also needs to prove that its new fashion-conscious George clothing line is selling. Furthermore, overseas stores, which account for some $40 billion in sales, have yet to "reach the critical mass they're looking to achieve," says Ira Kalish, global director at Deloitte Research, a unit of Deloitte & Touche. He expects that Wal-Mart will keep searching for acquisition targets in Europe and Asia.

LONG-TERM WINNER. A weaker dollar could help Wal-Mart in its overseas forays, but any gains would offset by higher costs for international merchandise that the retailer buys. Finally, analysts are watching to make sure the new "neighborhood markets," which are smaller stores that more closely resemble traditional supermarkets, don't pilfer sales from supercenters -- Wal-Mart's most profitable store model yet.

Still, analysts and investors largely expect the retailer to continue growing at an impressive pace for the long term (see BW Online, 4/16/03, "How Wal-Mart Keeps Getting It Right"). And no doubt the stock will remain a large holding in many professional portfolios. "Our official rating is a hold, but we've always said it's a long-term holding," says Morgan Keenan analyst John Lawrence. (Lawrence doesn't own the stock, and the firm does no banking with Wal-Mart.)

While confidence in Wal-Mart's ability to produce earnings is well-founded, for this economic cycle the stock has probably made most of its gains. As a long-term holding, Wal-Mart is a likely winner. But if you're looking for big gains quickly, chances are you'll need to shop elsewhere. Tsao covers the markets for BusinessWeek Online and writes for the Street Wise column


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