That Famous Wal-Mart Value

The discounter hasn't climbed all that much above its 52-week low. Even in a shaky economy, does it really belong in the bargain bin?

By Amy Tsao

It could be time for investors to start shopping Wal-Mart (WMT ). Amid widespread selling of stocks in recent months, the giant discount chain closed on around $48, not all that much above its 52-week low of $42. Still, that's well below Wal-Mart's 52-week high of $63, which means shares of one of the nation's most successful companies have been hit nearly as hard as the broad Standard & Poor's 500 index, down about 30% from its 52-week high.

The fall in Wal-Mart's share price is tied to troubling signs that the recovery is stumbling. The latest numbers indicate that the economy grew at just 1.1% in the second quarter, down from a 5% pace in the first quarter. And the Conference Board's consumer confidence index fell to 97 in July, off 9 points from its level in June. Wal-Mart's July sales results, due out Aug. 8, are expected to come in on the low end of previous projections.


  The Bentonville (Ark.)-based company is cautious about the future, too. "People are still shopping very carefully," says Tom Williams, a Wal-Mart spokesman. "They are shopping for value. That continues without a doubt."

Even if the worst comes to pass and the economy takes a significant nosedive, Wal-Mart may still emerge as the standout retailing stock to own, especially in the long term. The world's top retailer has proven its ability to "thrive in all market environments," says Russell Sheldon, senior economist at Nesbitt Burns, Bank of Montreal's equity subsidiary. If the economy worsens, Wal-Mart should still look relatively strong as thrifty consumers look for the lowest prices on the broadest range of products. "People tend to trade down in bad times, [so] Wal-Mart is much more insulated from the vagaries of economy," explains Eric Leo, chief investment officer at Allied Investment Advisers.

Wal-Mart still expects to show 5% to 7% gains in same-store sales for the second half of 2002. And despite economic concerns, analysts see Wal-Mart's earnings being up 20%, to around $8 billion, in the current fiscal year (which ends Jan. 31, 2003) on revenues likely to rise 12%, to around $248 billion. Analysts also expect earnings-per-share (EPS) to jump 20% for the year, to $1.79.


  Indeed, there's a good possibility that an economic downturn would be a replay of the early 1990s. That was when Wal-Mart and other discounters "made huge gains in market share from department stores...and mostly they've been able to hold on to them," says Carl Steidtman, chief economist at Deloitte Research, the research arm of Deloitte Consulting.

This time around, Wal-Mart has an additional opportunity to grab business from troubled Kmart, which is aggressively closings stores after declaring bankruptcy in January, 2002. In its first fiscal quarter, Kmart reported an 8.4% drop in sales from year-ago levels. Wal-Mart, which competes toe-to-toe with Kmart in many locations, could be the main beneficiary.

Given those pluses, many professional investors and analysts say the recent decline in Wal-Mart's share price is creating an attractive entry point. WR Hambrecht analyst Bill Dreher figures the stock is trading at 26.4 times 2002 consensus earnings per share expectations of $1.79, and 22.9 times the 2003 EPS projection of $2.06. The S&P 500 index is trading at around 20 times 2002 earnings. (Dreher does not own the stock and his firm has no investment-banking relationship with Wal-Mart.)


  That's a "tremendous discount" from the 36 times current-year earnings and 32 times next-year earnings at which Wal-Mart has usually traded, Dreher contends. Still, other pros see the wisdom of waiting a bit. "If the price continues to go down, I would buy it," notes Angela Auchey Kohler, portfolio manager at Federated Investors. If it falls below the mid-$40 range with a price-earnings (p-e) ratio in the low 20s, buying the stock would be a no-brainer, she adds.

Some rival discount chains will do well if the economy continues to falter, too. Design-focused Target Stores and value-conscious department-store chain Kohl's also have solid strategies for prospering in hard times. But Wal-Mart is already showing an edge over Target, which says its July sales will only increase by 3% to 5%. It also likely will outpace Kohl's, where analysts polled by Thomson Financial/First Call expect same-store sales to rise by 5.4% in July.

One of the keys to Wal-Mart's success is that it gets so many customers into its stores, even in hard times. That's especially true of its Supercenter outlets, which sell both food and general merchandise. Offering groceries at discount prices lures shoppers onto the premises, where they buy other goods. It also is making Wal-Mart a major player in food retailing, where it is taking market share away from big supermarket chains such as Albertson's.


  This year, Wal-Mart plans to open as many as 185 Supercenters, vs. just 50 new discount store that don't sell groceries. Of those new Supercenters, at least 110 will be conversions from the discount-store format. At that rate, the Supercenters will soon outnumber conventional stores: As of the end of January, Wal-Mart was operating 1,066 Supercenters, 1,647 conventional discount stores, and 500 Sam's Club stores in the U.S.

Meanwhile, Wal-Mart continues to pioneer new store concepts. Its Neighborhood Market stores, of which 33 have opened, also are expected to be a hit eventually. These are much smaller stores (about 40,000 square feet, vs. a typical Supercenter's 180,000 square feet) that offer mostly food and only some general merchandise. Analysts expect the new format will grab even more market share from supermarkets and secure the company as the biggest player in grocery retail. The stores, which are being tested primarily in Wal-Mart's home state of Arkansas, as well as in Texas and Oklahoma, are set up to accommodate "quick stop" shoppers and will be located in communities that already have a Wal-Mart Supercenter or discount store.

Wal-Mart's international expansion is another source of growth. The company has garnered a lot of critical headlines for the troubles it has encountered breaking into the German market and for the hit it has taken because of Argentina's economic crisis. A broader perspective, however, reveals that those nations are the only two of seven overseas markets in which Wal-Mart isn't seeing growth. Wal-Mart is now the No. 1 discounter in both Mexico and Canada. Overall, some 16% of its sales come from international markets, up from just 13% two years ago. While Wal-Mart continues to expand into new markets such as Japan, it is doing so with caution in the light of the uncertain global economic picture.


  Wal-Mart's international sales growth will probably slow from its blistering compounded annual rate of 45% over the last five years. But even in an iffy economy, international sales should increase faster than the company's overall sales and contribute a major boost to profits. "We would expect the international segment's operating profit to grow 25% to 30%," says Deher. "It's the next major driver in the company's arsenal of growth vehicles after Supercenters domestically."

Despite all the trump cards in its hand, the near future is likely to be challenging. Dreher is expecting third-quarter EPS of $0.39, an 18% increase from $0.33 a year ago. "The timing of sales during the quarter will be delicate," he warns. "We've got a heat wave now that will probably last through August. So, no one is interested in buying back-to-school apparel." That means Wal-Mart will need a strong September to make the quarter a success. If its past record is any indication, though, Sam Walton's creation will weather this September -- and beyond.

Tsao covers financial markets for BusinessWeek Online in New York

Edited by Thane Peterson

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