Published by Bob Ciura on November 27th, 2017
The Dividend Aristocrats are a select group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Every year, we review all 51 Dividend Aristocrats. The final installment in the 2017 Dividend Aristocrats in Focus series is discount retail heavyweight Wal-Mart Stores, Inc. (WMT).
Wal-Mart’s first dividend was $0.05 per share, paid in 1974. It has increased its dividend each year since, and now pays a quarterly dividend of $0.51 per share.
Wal-Mart is one of 350 dividend-paying stocks in the consumer staples sector. You can see the full list of all 350 consumer staples dividend stocks here.
2017 has been a very difficult year for many retailers. The threat of e-commerce, led by Internet retail giant Amazon (AMZN), has blown a huge hole in retailers, particularly those with a large brick-and-mortar presence.
However, Wal-Mart has fared very well this year. The stock is up 40% year-to-date, as Wal-Mart has proven it is the best-equipped retail to compete with Amazon.
Business Overview
The first Wal-Mart store opened in 1962 in Rogers, Arkansas. It was founded by Sam Walton, who started the business with a simple vision: to offer the lowest prices. This philosophy led to Wal-Mart’s huge growth over the years.
Wal-Mart went public in 1972. At that time, it had 51 stores, and annual sales of $78 million.
Today, Wal-Mart generates annual sales of $485 billion. It operates over 11,600 stores, located in 28 countries around the world.
Source: 2017 Factbook, page 5
The Wal-Mart U.S. segment includes retail stores in all 50 U.S. states, Washington D.C., and Puerto Rico. It also includes Wal-Mart’s digital business. Walmart International consists of operations in 27 countries outside of the U.S.
Lastly, Sam’s Club consists of membership-only warehouse clubs and operates in 48 states in the U.S. and in Puerto Rico.
Wal-Mart’s earnings-per-share declined 4% in fiscal 2017, as the company accelerated its strategic growth investments. The good news is, these investments have provided the company with a return to growth.
Growth Prospects
Wal-Mart’s total sales increased 4.2% last quarter, to $123 billion. Comparable U.S. sales increased 2.7%, thanks to a 1.5% increase in traffic. U.S. e-commerce sales soared 50% for the quarter.
Wal-Mart’s resurgence is due mostly to its e-commerce investments. E-commerce sales reached $15 billion last fiscal year, and have continued to grow at a high rate each quarter.
Source: 2017 Factbook, page 4
Wal-Mart has also made a number of acquisitions to accelerate its e-commerce growth, including the $3.3 billion purchase of Jet.com. It also has an investment stake in Chinese e-commerce site JD.com.
Another growth catalyst for Wal-Mart is international growth. The company expects to open 255 new international stores each year in 2018 and 2019. By contrast, Wal-Mart will open fewer than 15 Supercenters in the U.S. next year.
New international store openings will be focused on Mexico and China, which are major growth opportunities for Wal-Mart. Both countries have large consumer classes, and high economic growth. For example, last quarter Walmex grew comparable sales by 7%, while sales increased 4% in China.
For fiscal 2018, Wal-Mart expects adjusted earnings-per-share of $4.38 to $4.46. This would represent a growth rate of 1.4% to 3.2% from the previous fiscal year. This should allow Wal-Mart to continue increasing its dividend.
Competitive Advantages & Recession Performance
Wal-Mart’s main competitive advantage is its massive scale. A Wal-Mart store is located within 10 miles of approximately 90% of the U.S. population.
Its distribution efficiencies allow Wal-Mart to keep transportation costs low. It can pass on these savings to customers through everyday low prices.
Wal-Mart retains its brand strength through advertising. Because of its immense financial resources, Wal-Mart can afford to spend heavily on advertising:
- 2015 advertising expense of $2.4 billion
- 2016 advertising expense of $2.5 billion
- 2017 advertising expense of $2.9 billion
Wal-Mart’s competitive advantage, in addition to being the low-cost leader in the discount retail space, provide the company with steady profitability. This is true, even during recessions.
Wal-Mart performed phenomenally well during the Great Recession. The company steadily grew earnings-per-share each year in that time.
- 2007 earnings-per-share of $3.16
- 2008 earnings-per-share of $3.42 (8.2% increase)
- 2009 earnings-per-share of $3.66 (7% increase)
- 2010 earnings-per-share of $4.07 (11% increase)
This was a very impressive performance, in one of the worst recessions in decades. Wal-Mart’s growth indicates the company might actually benefit from recessions.
As the low-cost leader in retail, Wal-Mart conceivably sees higher traffic during economic downturns, as consumers scale down from higher-priced retailers.
Valuation & Expected Returns
Wal-Mart management is expecting the company to report adjusted earnings-per-share of $4.38 to $4.46 for 2017. At the midpoint of guidance for the full year, the stock has a price-to-earnings ratio of approximately 21.8.
Source: Value Line
As you can see, Wal-Mart’s current valuation stands well above its historical levels. In the past 10 years, the stock held an average price-to-earnings ratio of 14.6. Wal-Mart is currently valued roughly 50% above its 10-year average.
The stock has not held a price-to-earnings ratio above 22, since 2004. A prolonged period of multiple contraction soon followed, with Wal-Mart’s price-to-earnings ratio spending most of the past 10 years in the mid-teens.
Aside from its valuation multiple, Wal-Mart will generate returns from earnings growth and dividends. A projection of expected returns is below:
- 2%-3% sales growth
- 2%-3% share repurchases
- 2% dividend yield
In this scenario, total returns would reach approximately 6%-8% per year. However, a contracting price-to-earnings ratio would negatively impact total returns. If Wal-Mart returned to its average valuation over the past 10 years, the stock would decline by approximately 33%.
As a result, Wal-Mart appears to be overvalued.
Final Thoughts
Heading into 2017, Wal-Mart had struggled through a lengthy turnaround. But the company made big strides this year, particularly in e-commerce. This has allowed it to compete much more effectively with Amazon, than most other retailers.
Not surprisingly, Wal-Mart stock has been a standout performer among retailers. While this has rewarded the investors who were patient enough to hold on through the turnaround, the downside of Wal-Mart’s impressive rally is that it no longer appears attractive as an investment.
That said, Wal-Mart should continue to generate steady earnings growth, and raise its dividend modestly each year. This makes it a quality hold for dividend growth investors.
