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Walmart: Good Quarter, Expensive Stock

GuruFocus.com

- By Nathan Parsh

Walmart Inc (NYSE:WMT) is the largest retailer in the world both by store count and market capitalization. The company has 3,570 supercenters, 813 Neighborhood Markets, 599 Sam's Clubs and 386 discount stores in the U.S. alone. Walmart also has nearly 6,000 stores in international markets. The company currently has a market cap of $372 billion.

Shares of the company have performed decently over the last year, returning 17.5%. The stock has increased 10.8%, more than double that of the return for the S&P 500, through Friday's close.


The company recently reported quarterly results that beat analyst estimates. While the results were good, shares of Walmart may not necessarily represent a good entry point at the moment. Let's take a look.

Quarterly highlights

Walmart released earnings results for the second quarter of fiscal 2020 on Aug. 18. Revenue increased 5.6% year over year to $137.7 billion. This was almost $4 billion higher than the average analyst estimate. Currency translation reduced revenue results by $2.5 million. Adjusted earnings per share was higher by 29 cents, or 23%, to $1.27, topping expectations by 5 cents.

Net sales for Walmart U.S. were up 9.5% to $93.3 billion. Comparable sales increased 9.3%. Analysts had expected this figure to be 6.4%. Transactions overall decreased 14%, but this was more than offset by 27% growth in average ticket size.

The number of transactions that took place at physical locations may have declined, but online sales nearly doubled. Customers were shopping less at U.S. physical locations, but buying a lot more overall. E-commerce added approximately 600 basis points to comparable sales. Walmart managed to pivot quickly and was quite successful at handling this increased load in online sales. Customers were able to pick up orders at 3,450 locations and received same-day delivery from roughly 2,730 stores.

General merchandise was the best performing category in the quarter, with a mid-teen increase in comparable sales and growth across the portfolio. This category saw a benefit from government stimulus money as customers spent more on home, electronics, outdoor living and lawn and garden.

Grocery had mid-single-digit gains, primarily due to higher food sales. Chemicals and paper goods also performed well. Walmart saw an all-time high sales volume for pickup and delivery services as customers were staying at home more often.

Health & Wellness grew low single-digits. Pharmacy sales were strong because of drug inflation and product mix. Walmart's Vision Centers were closed for much of second quarter, which was a headwind to results for this category.

Also aiding results was that Walmart didn't have to mark down higher margin merchandise in order to drive sales. This helped lead to a 42-basis point increase in gross profit margins.

International sales fell 6.8% to $27.2 billion, but were higher by 1.6% when adjusting for currency exchange. Walmart saw positive sales figures in seven out of 10 markets. On a constant currency basis, overall sales grew double-digits for both China and Canada. The number of total transactions declined in both countries, but the average ticket was higher by 38.9% in Canada and up 20.5% in China.

The company struggled in India, Africa and Central America due to forced store closures. E-commerce was again strong for this segment of the company as online shopping accounted for 12% of total sales.

Revenue for Sam's Club was higher by 8.8% to $16.4 billion. Comparable sales were up 8.7%. Transactions and average basket size both grew as the quarter progressed. Unlike the other segments, transactions were positive for the quarter, also growing 8.7%. The fresh, freezer and cooler category was the standout performer, as comparable sales were up more than 20%.

E-commerce sales surged 39% as direct-to-home was an especially popular way for customers to acquire goods. Online shopping added about 190 basis points to sales growth. Income from memberships for Sam's Club was up almost 8% as customers looked to buy in bulk, likely in order to avoid shopping as often. This was the highest growth rate in more than five years. New member count was up 60%.

Gross profit margins improved 63 basis points to 24.9%. Selling, general and administrative expenses increased 7.9% mostly due to higher costs associated with the Covid-19 pandemic. SG&A expenses as a percentage of revenue increased just 40 basis points to 21.2%.

The balance sheet remains in excellent condition, making it likely that Walmart will be able to successfully navigate any unforeseen negative impact to the economy or its business. The company ended the quarter with $65 billion in current assets, including almost $17 billion of cash and cash equivalents. Walmart managed its business well during the quarter as inventories decreased almost 7% to $41.1 billion. The company has $82 billion in current liabilities, but just $5.9 billion of debt is due within a year. Total debt stands at $69.5 billion.

Walmart's free cash flow more than doubled to $10.1 billion for the quarter and stands at $15.4 billion for the first half of the year. Shareholders were paid $1.5 billion of dividends during the quarter, but the company did not buy back any stock during the quarter. So far in 2020, Walmart has returned a total of $3.8 billion in capital to shareholders in the form of dividends and share repurchases.

Valuation

Walmart had a fairly strong second quarter. Comparable sales were solid even with the number of transactions declining in several segments. Sam's Club proved especially stout as new memberships were extremely high. E-commerce also added a lot to results.

The issue that I have with Walmart is that the stock is expensive, perhaps more so than any other time over the last 15 years. Shares closed Friday's trading session at $131.63. With Wall Street analysts expecting EPS of $5.22 for the year, the stock has a forward price-earnings ratio of 25.2.

The stock's 10-year average price-earnings ratio is just over 16. Putting it into context, the current price-earnings ratio would be the highest for Walmart since at least 2004 were the stock to average this valuation for an entire year. In fact, there have only been two years over this period of time (2004 and 2019) that shares of Walmart traded with an average price-earnings ratio above 19.

Walmart's comparable sales growth was impressive and the company did much better than the market had expected.

That said, the stock is expensive on a historical basis. As I mentioned in a previous article, I believe that Target Corporation (NYSE:TGT) had an even better quarter on nearly every metric. Target is also cheaper than Walmart, but I still find the stock to be too expensive to purchase today.

I believe a price-earnings ratio target range of 16 to 18 appropriately measures Walmart's market place leadership and strength in its businesses during a difficult economic environment. I would begin to consider buying Walmart at $94, which would be 18 times this year's EPS estimates. Shares would have to decline at least 27% to reach my target valuation range. For this reason, I am not a buyer of Walmart.

Author disclosure: The author has a long position in Target Corporation.

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This article first appeared on GuruFocus.