Joseph J. Fitzsimmons goes by the name Jay on Wall Street. There, the Wal-Mart Stores (WMT) veteran serves as the voice of earth's dominant retailer. Boy, is his voice humble right now. "My CEO has lost faith in me," he told big investors recently. "He's done his job. Sales are up 83% since he took over five years ago, and net income is up almost 100%. So the only reason he can think of that the stock isn't moving is because the person in charge of investor relations isn't doing a particularly good job. We started today at 51.09. Could you help me out?"
So far, Wall Street has resisted Jay's disarming plea. The stock lingers near 47, a two-year low. The knocks on it seem as abundant and varied as a supercenter's inventory: Rising energy prices that lighten the working-class wallet. Merchandising mistakes, particularly next to rival Target (TGT). Slower gains in U.S. same-store sales, which last year rose 3%, half the 2002 rate. Hostility in some spots to Wal-Mart's inexorable expansion. A slew of employee lawsuits, notably one claiming discrimination against 1.6 million women. Wal-Mart denies that but warns that the suit could lead to material, unestimatable losses.
DESPITE THIS WORLD OF WOE, Wal-Mart to me looks like a buy. Do I have an inside line to its Bentonville (Ark.) home? No; in fact, Fitzsimmons declined to speak with me. My hunch about Wal-Mart is based on its balance-sheet strength and earnings power, plus the record of how other dominant companies responded to similar symptoms of corporate elephantiasis.
In fiscal 2005, ended on Jan. 31, Wal-Mart netted $10.3 billion on $285 billion in sales. Earnings per share rose almost 19%; this year, the average estimate is for a 13% rise. Slowing growth is never welcome, yet the stock goes for 17.5 times this year's profit, a modest premium to the broad market (15.5 times) and a discount to Target (18.7). The certainty of its profit is far superior to the average stock's, and Wal-Mart is financially stronger than Target. The ratio of Wal-Mart's earnings to its fixed charges rose in each of the past four years. So has Target's, to 5.4 times fixed costs at last report, but Wal-Mart's earnings covered fixed costs 10.5 times over. Wal-Mart, awash in cash, has hiked dividends and bought back tons of stock. Mostly, though, it keeps expanding like mad. It plowed nearly $32 billion into operations in the past three years. This year it sees a $14 billion outlay.
We've seen this before. Remember Gap (GPS)? Success at dressing Gen X led to vast expansion and a whole new chain, Old Navy. In the 1990s, Gap's shares soared even as it reinvested 60 cents of each dollar of operating cash flow. Then, in a fin de siecle flourish, it boosted that rate to 84 cents in 1999; in 2000 capital projects ate $1.43 of each $1 in cash flow. By 2002, Gap shares had lost 82% of their value. The company soon slashed capital outlays to 12% of cash flow -- and the stock jumped 50%. Next came McDonald's (MCD). In 2000, 2001, and 2002, some 70 cents of each dollar in cash flow went to capital spending. Its stock in those years fell 16%, 22%, and 39%. In 2003 and 2004, McDonald's slashed capital spending to 40% or less of cash flow. The stock jumped 54% in 2003 and 29% in 2004.
At Wal-Mart, capital spending last year took 86 cents of each dollar of cash flow, up from 64 cents in fiscal 2004 and 71 cents the year before. It has not discussed capital plans beyond this year. But there are few fools in Bentonville. If capital projects start claiming a smaller slice of cash flow, leaving more for the dividends, buybacks, and debt repayments investors love, Jay Fitzsimmons might just get off the hook.
By Robert Barker