Bought some Wal-Mart today at $46.75
Background information below if anyone is interested in some reading
While disappointing compared with November's results, Wal-Mart's WMT December same-store sales growth of 2.2% was reasonable and leaves the company on track to meet our full-year revenue target. We like Wal-Mart's long-term strategy of improving same-store sales by getting noncore customers to spend more in the stores (especially in areas like home electronics and softlines), but we don't expect results overnight. So even though December same-store sales growth was a little bit of a disappointment after the company's strong start to the holiday season in November, we hardly see this as a major setback, and we aren't changing our $58 fair value estimate.
Target TGT, on the other hand, showed a strong improvement in December over a disappointing November. Same-store sales for December grew 4.7% from the year-ago period, and last year's same-store sales figure was an impressive 5.1%. We think Target is on track to meet our full-year revenue estimate and are therefore not changing our $57 fair value estimate. We think the company is still in a great position, selling a more trendy selection of merchandise to a relatively younger, more affluent discount shopper.
We'll review our fair value estimates when the companies report their fourth-quarter and full-year results in mid-February.
Thesis 11-21-2005
The past couple of years have been lackluster for Wal-Mart, but we think management has a credible strategy to fix the operational problems that have nagged the company. More specifically, the company has announced plans to accelerate store growth, bolster same-store sales, increase profitability, and improve its already-impressive asset efficiency. While we expect 2006 to be a transitional year for the retail giant, we remain confident in our $58 fair value estimate.
Already the biggest company in the world, Wal-Mart is still growing sales at more than 10% per year, and we expect the company to maintain (if not improve upon) this pace. In addition to plans to add 550-600 new stores in 2006, Wal-Mart has detailed plans to drive more sales through existing stores by becoming more relevant to its "occasional shoppers," i.e., consumers who are already shopping at Wal-Mart for staples (like laundry detergent) but shop elsewhere for higher-margin products. We think that the company is capable of appealing to a wider range of customers by adding some higher-end merchandising choices (especially in housewares and home electronics) without abandoning or alienating its core customers. However, we think it will take some time for the company to change the perceptions of its noncore customers through marketing and better in-store experiences.
Higher fixed costs (including utilities, health care, and real estate), combined with slow same-store sales growth and a higher mix of low-margin products (mostly groceries), have weighed on margins in the recent past. However, if the company successfully increases its mix of higher-margin products, and cuts procurement costs, we would expect improvements in gross margins. Wal-Mart would then have more gross profit dollars to cover the fixed costs of running the stores, and therefore slightly higher operating margins. We think this is the most likely scenario.
Even as the company works to drive higher sales and improve margins, it isn't forgetting about asset efficiency, which is a key factor in the firm's wide economic moat. Management believes that it can still make improvements to its inventory turnover. The company as a whole has enviable inventory turns relative to other retailers, but management claims that the firm's most-efficient stores turn inventories 50% more quickly than the least-efficient stores. Given that inventories represent a massive amount of working capital, improvements on this front could make a big difference in the firm's returns on invested capital, a key driver of our valuation.
Valuation
We've reviewed the results of Wal-Mart's third quarter and management's guidance for the holiday season, and while we remain concerned about the macroeconomic environment, we think that our estimates remain reasonable and are therefore sticking with our $58 per share fair value estimate. We expect sales growth to average around 10% for the next five years, and gross margins should improve as a result of better international procurement, offset a bit by the increasing weight of lower-margin groceries in the mix. Operating income assumptions are affected by our expectation that labor costs will continue to increase. We've accounted for the legal and regulatory risks the company faces with a higher discount rate in our model. Our growth and margin estimates don't assume any near-term easing of energy prices.
Risk
The company's biggest near-term risk is rising energy prices and interest rates, as they could curtail consumer spending. Long term, we think that labor, legal, and regulatory issues could potentially slow growth or pressure margins.
Background information below if anyone is interested in some reading
While disappointing compared with November's results, Wal-Mart's WMT December same-store sales growth of 2.2% was reasonable and leaves the company on track to meet our full-year revenue target. We like Wal-Mart's long-term strategy of improving same-store sales by getting noncore customers to spend more in the stores (especially in areas like home electronics and softlines), but we don't expect results overnight. So even though December same-store sales growth was a little bit of a disappointment after the company's strong start to the holiday season in November, we hardly see this as a major setback, and we aren't changing our $58 fair value estimate.
Target TGT, on the other hand, showed a strong improvement in December over a disappointing November. Same-store sales for December grew 4.7% from the year-ago period, and last year's same-store sales figure was an impressive 5.1%. We think Target is on track to meet our full-year revenue estimate and are therefore not changing our $57 fair value estimate. We think the company is still in a great position, selling a more trendy selection of merchandise to a relatively younger, more affluent discount shopper.
We'll review our fair value estimates when the companies report their fourth-quarter and full-year results in mid-February.
Thesis 11-21-2005
The past couple of years have been lackluster for Wal-Mart, but we think management has a credible strategy to fix the operational problems that have nagged the company. More specifically, the company has announced plans to accelerate store growth, bolster same-store sales, increase profitability, and improve its already-impressive asset efficiency. While we expect 2006 to be a transitional year for the retail giant, we remain confident in our $58 fair value estimate.
Already the biggest company in the world, Wal-Mart is still growing sales at more than 10% per year, and we expect the company to maintain (if not improve upon) this pace. In addition to plans to add 550-600 new stores in 2006, Wal-Mart has detailed plans to drive more sales through existing stores by becoming more relevant to its "occasional shoppers," i.e., consumers who are already shopping at Wal-Mart for staples (like laundry detergent) but shop elsewhere for higher-margin products. We think that the company is capable of appealing to a wider range of customers by adding some higher-end merchandising choices (especially in housewares and home electronics) without abandoning or alienating its core customers. However, we think it will take some time for the company to change the perceptions of its noncore customers through marketing and better in-store experiences.
Higher fixed costs (including utilities, health care, and real estate), combined with slow same-store sales growth and a higher mix of low-margin products (mostly groceries), have weighed on margins in the recent past. However, if the company successfully increases its mix of higher-margin products, and cuts procurement costs, we would expect improvements in gross margins. Wal-Mart would then have more gross profit dollars to cover the fixed costs of running the stores, and therefore slightly higher operating margins. We think this is the most likely scenario.
Even as the company works to drive higher sales and improve margins, it isn't forgetting about asset efficiency, which is a key factor in the firm's wide economic moat. Management believes that it can still make improvements to its inventory turnover. The company as a whole has enviable inventory turns relative to other retailers, but management claims that the firm's most-efficient stores turn inventories 50% more quickly than the least-efficient stores. Given that inventories represent a massive amount of working capital, improvements on this front could make a big difference in the firm's returns on invested capital, a key driver of our valuation.
Valuation
We've reviewed the results of Wal-Mart's third quarter and management's guidance for the holiday season, and while we remain concerned about the macroeconomic environment, we think that our estimates remain reasonable and are therefore sticking with our $58 per share fair value estimate. We expect sales growth to average around 10% for the next five years, and gross margins should improve as a result of better international procurement, offset a bit by the increasing weight of lower-margin groceries in the mix. Operating income assumptions are affected by our expectation that labor costs will continue to increase. We've accounted for the legal and regulatory risks the company faces with a higher discount rate in our model. Our growth and margin estimates don't assume any near-term easing of energy prices.
Risk
The company's biggest near-term risk is rising energy prices and interest rates, as they could curtail consumer spending. Long term, we think that labor, legal, and regulatory issues could potentially slow growth or pressure margins.
