Should I Do It? Wal-Mart's a Bargain

Several weeks ago, Merrill Lynch downgraded Wal-Mart (WMT) to neutral from buy, citing higher energy costs and slower sales trends. The stock dropped 2% on the news to $44.19, and is now trading 13% off its 52-week high of $50.87.

Increased interest rates, a potential slowdown in consumer spending, and media reports (and public outrage) over the company's low wages and alleged poor employee benefits also have led to negative sentiment for Wal-Mart. But have the shares of the giant retailer fallen enough that they could be a buy for investors?

The short answer is yes. Shares of Wal-Mart, priced below $45, are a sound investment.

Wal-Mart's market cap is 4.5 times Target's ( TGT) and 7.4 times that of Costco ( COST), its two closest competitors. Compared with its rivals, Wal-Mart is considered a discount retailer, meaning it caters to consumers with annual average household incomes of less than $30,000.

During a general economic slowdown, less-affluent consumers are more likely to tighten their spending habits. With record fuel prices and rising interest rates, the U.S. is expected to see a gradual slowdown in consumer spending.

I believe lower-income consumers will be more inclined to shop at Wal-Mart, most notably for groceries. Looking at recent surveys, Wal-Mart's food prices are more than 25% lower than its competitors. Because of an ability to squeeze its suppliers, the company is able to sell items at much lower prices than its competitors.

Opponents of Wal-Mart have criticized this tactic. But for an investor, it creates more shareholder value by increasing the amount of foot traffic in stores. Suppliers face the dilemma of either pulling their products out of Wal-Mart stores because of tighter margins or having those products offered to 176 million customers around the world on a weekly basis.

Wal-Mart also is changing its demographic reach.

Instead of only offering items at discounted prices, the company is introducing new products for more affluent consumers in an effort to compete in that sector with Target and Costco. With a history of offering consumer products at cheap prices, Wal-Mart has a proven record of efficiency. I believe the company could offer high-end suppliers better deals than its competitors.

To date, Wal-Mart's strategies have proven effective for both the company and consumers because the average savings for American households shopping at Wal-Mart is more than $2,300 per year compared with other retailers, according to the company's Web site. But investors can't be happy with Wal-Mart's shares, which have lagged over the past five years.

In January 2001, the company's net sales totaled $191 billion and shares traded at $51.42. Value Line is projecting revenue to grow to $360 billion by the end of 2006, which is roughly 90% higher than in 2001. But despite almost 100% revenue growth over the past five years, Wal-Mart shares are down 13% during this period.

Wal-Mart is trading at 14 times 2007 earnings estimates and has a long-term growth rate of 13%. It pays a 1.5% dividend and derives more than 20% of sales from overseas, which provides a slight hedge in the event of a major economic slowdown in the U.S. Costco receives only 6% of revenue from abroad, and Target has no international exposure.

Slower same-stores sales have led to the revamping of about half of Wal-Mart's U.S. stores, a process scheduled to be completed by mid-2007. Remodeled stores will feature wider aisles, wood floors and an overall upscale look. Restructuring efforts are usually applauded by Wall Street, but modifying 1,200 stores in one year could prove to be a difficult task.

Looking at the restructuring plan, the economic landscape and the company's fundamentals, I believe Wal-Mart is trading at a reasonable level. Over the next 12 to 18 months, new stores will be revamped and marketing initiatives will eventually materialize. I believe this could lead to a 15% rise in the stock over this period.

Interested in more value stock picks? Check out David Peltier's TheStreet.com Value Investor.

To view Frank Curzio's video take of this column, click here .

In keeping with TSC's editorial policy, Frank Curzio doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Frank X. Curzio is a research associate at TheStreet.com, where he works closely with Jim Cramer. Previously, he was the editor of The FXC Newsletter and senior research analyst for Greentree Financial.

He appreciates your feedback; click here to send him an email.

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