Wal-Mart Gets Back to Growth: Best in Class

BOSTON (TheStreet) -- Wal-Mart (WMT) - Get Report is among the most criticized U.S. companies for its low wages and use of overseas suppliers. It also employs more people than any other company and charges the lowest prices on items ranging from food to electronics. A bastion of free-market ideals, Wal-Mart is an American mainstay with a storied history.

Founded in 1962 by Sam Walton, Wal-Mart initially lagged behind discount-retail competitors

K-Mart

, now part of

Sears

(SHLD)

, and

Target

(TGT) - Get Report

. But, after going public in 1972, Wal-Mart gained the capital it needed to rapidly expand. By the end of the decade, Wal-Mart was doing business in 10 states. In the '80s, it pioneered the supercenter model, opening its first

Sam's Club

. By the end of that decade, sales had ballooned to $26 billion. Wal-Mart, now a member of the blue-chip

Dow Jones Industrial Average

, is still a compelling growth company.

Criticism of the low-cost business model became subdued during the recession as once-righteous Americans flocked to its stores to lock in discounts amid the worst employment contraction since the Depression. Wal-Mart has increased sales 4.7% annually, on average, since 2007. Its stock delivered annualized gains of 7.8% over that span, outperforming U.S. indices. Wal-Mart is scheduled to report fiscal third-quarter results Nov. 16. Its fiscal second-quarter net income rose 3.6% to $3.6 billion.

Wal-Mart beat analysts' consensus earnings target by 0.5%, but missed their sales target narrowly, by 1.7%. It has an earnings-surprise average of 1.9%. Quarterly return on equity rose from 20% to 22%, exceeding the industry average of 18% and the

S&P 500

average of 13%. Wal-Mart isn't much of an earnings play. Its business is largely predictable, making profit swings less likely than for other companies. But, as a fundamental investment, Wal-Mart is attractive. It's reasonably priced, pays steady dividends and offers international exposure.

Wal-Mart's stock trades at a forward earnings multiple of 13 and a cash flow multiple of 7.8, 15% and 10% discounts to consumer non-discretionary peer averages. Its book value multiple of 3.1 is on par with the peer average. Currently, Wal-Mart offers a 2.2% dividend yield with a payout ratio of 31%. Analysts are bullish on the stock, with 22, or 69%, rating it "buy," nine rating it "hold" and one ranking it "sell." Based on that aggregate rating, Wal-Mart places as analysts' 11th favorite Dow stock. But, it has decent upside based on expected growth.

A median price target of $60 suggests Wal-Mart will return 9.5% in 12 months, excluding dividends. Although that gain may seem modest relative to riskier equities, it is also more certain. Wal-Mart has counter cyclical appeal, so if the economic recovery were to slacken, it would gain customers. Optimistic forecaster

HSBC

expects Wal-Mart's stock to advance 24% to $68.

Deutsche Bank

predicts a gain of 20% to $66. Such returns are contingent upon overseas expansion. In the last quarter, Wal-Mart's international sales popped 11%.

Wal-Mart's international sales, which no longer include sales in Puerto Rico, passed $25 billion during the quarter, accounting for 25% of total revenue. Mexico, Brazil and China were geographic leaders. A weak dollar and strong emerging market currencies will benefit this segment amid QE2. On a constant currency basis, Wal-Mart's international sales rose 7.3%. International operating income jumped an impressive 17%. With U.S. comparable-store sales expected to stagnate in the current quarter, management is now focused internationally.

On Sept. 29, Wal-Mart announced a deal to purchase

MassMart

, which owns 290 stores in 13 African countries, for about $4 billion. Rumors are now circulating that Wal-Mart will halve its bid and opt to purchase 50% of the company, allowing the stock to remain listed in Johannesburg. Wal-Mart currently has $10 billion of cash on its balance sheet and $65 billion of debt, converting to a poor quick ratio of 0.2, but a reasonable debt-to-equity ratio of 0.8. The consistency of its revenue makes it easier to secure cheap debt.

Wal-Mart is the world's largest company, with $408 billion in annual revenue. In an era of globalization, Wal-Mart, though already a corporate goliath, has mammoth growth opportunities because it has perfected the discount-retail model. Wal-Mart rewards its shareholders with steady gains and its customers with low prices.

TheStreet

rates it "buy."

-- Written by Jake Lynch in Boston.

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