Alexis Bernet & Paul Guérin
alexis.bernet@hec.edu
27-Aug-2020
Walmart’s recent updates
· Q2 results: Walmart has beaten Bloomberg consensus forecasts, mainly driven by online sales and US government’s stimulus spending.
- Revenue: $137.7bn vs $135.6bn expected
- Adjusted EPS: $1.56bn vs $1.24 expected
- US e-commerce sales: +97% vs +60% expected
- US comp-store sales: +9,3% vs +5.3% expected
· Partnership with Shopify to boost online sales: third-party sellers using Shopify will be able to sell their products on Walmart online marketplace.
· Best Price, Walmart’s cash-and-carry business in India, acquired by Flipkart, an Indian e-commerce company in which the American retailer has a controlling 81% stake. It confirms Walmart’s ambition to consolidate its retail units.
Business description
· Activity
Walmart is a U.S. multinational company specialized in mass retailing, a leader in the entire retail world that generated worth US$523.96 billion sales in 2019. Its activity is divided into three main distribution networks:
1. Walmart Stores U.S. Division (65.1%): Groceries (56%), General Merchandise (32%), Health and Wellness (11%).
2. Walmart International (22.9%)
3. Sam's Club (11.2%): Groceries & Consumables (60%), Cigarette & Other (19%), Home & Apparel (9%), Health & Wellness (6%), Office Technology & Entertainment (6%)
· Geographic
Walmart operates more than 11,700 retail units under 59 banners in 28 countries and commercial websites in 10 countries. Walmart's sales are primarily domestic (77% in the United States with 265 million customer visits) and 23% foreign.
· Industry chain
Walmart’s success is undoubtedly due to the success of its supply chain. An effective supply chain management strategy and system is critical to a business model based on reducing supply chain costs to save consumers money and improve their lives. Walmart has become the most powerful retailer with the highest sales per square foot, highest inventory turns and highest operating profit of any discount retailer, thanks to its multiscale strategy:
- Vendor Managed Inventory (VMI): Manufacturers are responsible for managing their products in Walmart’s warehouses. As a result, Walmart is close to 100% fulfillment rate and distribution costs only amounts to 1.7% of cost of sales.
- Strategic partnerships with suppliers: long term & large volume purchasing at low prices.
- Communication and supplier relationship networks to improve material flow with lower inventories.
- Cross-docking: logistical practice of stock replenishment. Direct transfer of products from inbound or outbound truck trailers without the need for additional storage.
- Delivery of products by suppliers directly to Walmart distribution centers and then delivered to stores.
- Continuous delivery by a fleet of Walmart trucks of goods to distribution centers.
- Champion of innovation in logistics: first use of barcodes, “Savings Catcher” app to compare product prices and creation of Retail Link (database to forecast supplier demands).
· Competitive landscape
There is a large number of players in the U.S. retail industry, including physical retail leader Walmart and e-commerce leader Amazon.
- Amazon (US$ 280,5 billion): world’s largest e-commerce brand that reaches a broad audience. Its e-commerce sites are supported by a global network of supply and distribution warehouses and, more recently, by a network of stores.
Costco (US$ 149,40 billion): its business model is different from that of Walmart and other retailers. It has invested heavily in technology to accelerate e-commerce sales growth. Highly regarded for its customer focus and organizational culture of diversity, inclusion and satisfaction of customers, employees and other stakeholders. It operates 785 warehouses, including 546 in the US.
- Walgreens (US$ 122.30 billion): it is one of the largest food retailers in the US, operating in 35 states. It has 2,757 supermarkets and multiple department stores operating in the US, supported by 45 distribution centers.
- The Home Depot (US$ 110.23 billion): The world’s largest brand of home improvement products, including building materials, lawn and garden products and home decor products.
· Walmart’s key competitive advantages
- Logistics management: recording of the handling of each product in a database used to feed algorithms to determine the quantity of stock to be ordered. These orders are delivered in less than 24 hours thanks to continuous supplies.
- Supplier management: linking all suppliers to branches through Retail-Link. Suppliers have access to a large database on consumer behavior, allowing them to adjust their offers according to regions, types of consumers and budgets.
- Very large range of products in its portfolio
- Strong investment capacity (e-commerce, infrastructures…).
Industry outlook
· Most retail sales are operated by big chains (94,8%) rather than independents in the U.S. (5,2%)
· E-commerce is literally booming: the highest CAGR of grocery store chains belongs to Amazon with 52,6% followed by Dollar Tree with 30,1% while Walmart only amounts to 3,6%.
· Fastest growing supermarket categories in the U.S are breakfast meals, meal kits, bread and soft drinks while greatest declining categories are yogurt, smoothies and tortillas.
· Location appears to be the most important factor of the grocery shopping experience (28%), followed by the Price (22%) and Checkout experience (18%).
· Coronavirus crisis has led to the largest U.S. CPI decline since 2008 except for food, for which the CPI has increased by 2,6%.
Financial analysis and estimates
· Due to current sanitary conditions, e-commerce sales have skyrocketed in the past few months, boosting Walmart’s transition towards omni-channel solutions. We think it will allow the retailer to gain market shares in the long term among traditional actors of the retail industry. However, fast-growing e-commerce companies (Amazon, MercadoLibre, Shopee, Jumia…) have a better technology support for online sales. We then estimate an average of 2% sales growth but stable operating margins (6,2% of EBITDA margin).
· The group has a strong and stable operating cash-flow generation ($25.250bn for 2020), due to growing sales, operating costs containment and a highly negative working capital ($(17.208)bn) which is decreasing slightly, at the pace of sales. It allows the retailer to finance capital expenditures ($10.705bn) and leads to positive FCF ($14.550bn).
We estimate Walmart’s cash-flow generation will continue this trend, with limited growth of FCF, due to the maturity of the business.
· Walmart maintains its Capex level above 10 billion dollars. Capex are mainly allocated to the development of distribution channels (53%) and store remodels (20%). The US activity captures 74% of the capital expenditures, in line with Walmart’s sales. We think the retailer, while maintaining this level of Capex will invest increasingly in technologies related to online sales in order to build an efficient omni-channel model. Expansions and relocations of stores investments might continue declining as the rental of premises gets much expensive in US towns.
· Walmart’s capital structure is very healthy, providing strong guarantees for liquidity and solvency. Net debt to EBITDA ratio for 2020 is worth 1.8; capital structure is composed of 66% debt and 34% of equity. Walmart is a family-owned group, controlled by Walton Family (50.1%). Other traditional investment funds have shares in Walmart (The Vanguard Group (4.55%), Blackrock (1.21%) …), as the stock is very used by portfolio strategists. The retailer also disposes of a consequent amount of cash ($9.465bn) that can be engaged for investments or acquisition opportunities.
· The financial strength and profitability of the company are also reflected by a flexible redistribution to shareholders. Walmart pay out each year around $6bn of dividends (6.048bn in 2020) and carries out adjustable capital reduction through share buyback plans.
Valuation
· Our 12-month $139.9 price target is based on a 50:50 DCF:Comps. $137.9/shr (DCF based on discount rate 6%, terminal growth 1.5%). $142.0/shr from Comps.
· We adopted a conservative approach for DCF valuation, betting on stable growth and margins, sustained by e-commerce sales growth. Our capex and change in WCR projections for Walmart are based on the evolution of its revenues, taking constant ratios. The WACC calculation was quite challenging due to COVID-19 crisis that has lowered discount rates for retailers at very low levels (~4%). Based on 10-Y historical data, we note that Walmart’s WACC tends to converge towards 6.5%, a percentage that we weighted down to 6% to reflect the actual situation for our 12-month valuation.
· Comparable companies analysis shows that US retailers are trading high (average PER of 29.1 on the list chosen), Walmart’s ratios being in line with those of its competitors. We chose for Walmart’s Target and Costco, two traditional actors of the retail industry in the US and Dollar General and Dollar Tree, both smaller actors but detaining very active distribution networks in a local scale. We consider this pool as very representative of the US retail industry. Using EV/EBITDA LTM ratio to value Wamart, we see potential upside of 7.8% compared to current share price.
Investment thesis
· We set a hold recommendation for Walmart stock, with a 12-month target price of $139.9 vs $131.65 currently.
· We think Walmart will keep behaving as a defensive stock in a long-term perspective, with limited risks coming from macroeconomic conditions and economic uncertainties. We are convinced about Walmart’s proven ability to acquire new customers and its efficient logistics support and omni-channel solutions, integrating e-commerce and on-stores activities via retail consolidation. Walmart’s leading position on the retail market is trusted by investors who consider this security as a key stock for portfolio strategies; inflation and increasing dry powder in a low interest rate environment could benefit Walmart.
· However, we see potential downside risks for Walmart stock in the short-term. There are still uncertainties on health conditions in some states and on the recovery of consumption. US CPI evolution will be a key factor within the next few weeks for Walmart stock. We are bearish on the probability of a second stimulus check, part of the recovery plan. Although unemployment remains very high (28 mn people according to Forbes) and risks of mass housing evictions in the country are rising, the Senate’s does not seem to be prone to act quickly a second round of stimulus payments, in the context of pre-elections, holding in November. Then, it is probable that lower classes spending, yet a real driver for consumption, might not recover completely at the end of 2020. This could worry investors on the retail industry outlook.