Stockwatch: A buy for low-risk equity portfolios

by Edmond Jackson from interactive investor |

This resilient stock has done well since Warren Buffett sold out, and strong figures make it one to own.

This resilient stock has done well since Warren Buffett sold out, and strong figures make it one to own.

Does this $290 billion multinational retailer's recent performance imply capability to buck weaker consumer spending? And can its digital prowess underwrite a record of annual dividend growth since 1974?

Total fourth-quarter 2018 sales for Walmart (NYSE:WMT) grew 1.9% to $138.8 billion, pretty much in line with consensus and with the US representing about two-thirds of group sales.  US growth is Walmart's strongest in nine years as e-commerce sales surged 43%, with grocery store pick-up and home delivery services being extended nationally, and greater product availability on Walmart.com after various clothing brand acquisitions.

Resilient performance despite volatile consumer confidence

Overall US retail sales fell by 1.7% in December, the most in 20 years and a shudder given the US is a relatively domestic-driven economy where consumer spending is the key.  Possibly this influenced the Federal Reserve to soften its stance on monetary policy early last January, which many analysts credit being a chief reason for US stocks soaring - also markets globally.

Encouragingly, one of the most-watched indicators of US consumer sentiment – the University of Michigan index – has recovered in February to 95.5 after dropping from about 98 through October to December, to 91.2 in January. This takes consumer confidence levels from the second lowest since 2016, back up to those seen in mid-2018, with more respondents willing to buy a major household item or vehicle or house. Analysts conclude that personal consumption spending will remain the strongest element of the US economy this year.

An end to the US government shutdown and lower gas prices will have helped, also a general context of low unemployment and rising wages. Moreover, Congress has now passed legislation to avoid another shutdown.

Without a lot more negativity from consumer demand, all this should defer the risk of a US recession. Walmart is an important bellwether too. For equity investors, generally it's lucky how the Fed turned dovish shortly before these more encouraging signs of consumer resilience have appeared, hence a double-whammy effect to justify the 2019 equities rally as more than a "snapback in a bear market". 

Now the third-largest online retailer in the US

Last November, Walmart overtook Apple (NASDAQ:AAPL), and though still behind eBay and Amazon (NASDAQ:AMZN) it continues to take share. In 2017 for example, Walmart began contesting Amazon's Prime (subscription) service with free, two-day deliveries on orders of $35 or more, and expanded this last year. For the long run it implies a traditional retailer's format, its sourcing/warehousing and e-marketing skills can work very well together, like Walmart's recent initiative to stock more toys after the demise of Toys R Us, which paid off last Christmas.

More online options are being introduced such as Lord & Taylor designer wear, 3D shopping, a sports-fan focused Fanatics shop, a Nursery destination and Walmart eBooks in partnership with Kobo.

Groceries are the priority, a new website making it easier to order and re-order favourite items. Some 90% of the US population lives within 10 miles of a Walmart store, hence the US equivalent of "click-and-collect" is being advanced. I recall drawing attention to this regarding Argos stores in the UK a few years ago, quite novel at the time and which really helped their turnaround.

Walmart's offering is "kerb-side" collection as a cheaper alternative to home delivery. It appears to believe this is a way forward as it extends the service from 2,100 to 3,100 stores by end-2020, relative to a US estate of around 4,700. Home deliveries are planned to rise from about 800 to 1,600 stores with the help of new partners. In relative contrast to online-driven growth, only 10 new stores are expected to open this year.

Walmart Inc.            
summary income statement to 31 Jan 2019        
  Q4 Yr-on-yr Change Year to Yr-on-yr Change
  $ $ % 31-Jan-19 $ %
Total revenue 138,793 2,526 1.9 514,405 14,062 2.8
at constant currency 140,485 4,218 3.1 515,107 14,764 3.0
Net sales 137,743 2,583 1.9 510,329 14,568 2.9
at constant currency 139,423 4,273 3.2 511,037 15,276 3.1
Membership income 1,050 -67 -6.0 4,076 -506 -11.0
Operating income 6,067 1,600 35.8 21,957 1,520 7.4
at constant currency 6,159 1,692 37.9 21,959 1,522 7.4
Interest charge, net 605 106 21.2 2,129 -49 -2.2
Other gains/losses -202 -202 0 8,368 8,368 0
Consolidated income 3,687 1,512 69.5 6,670 -3,192 -32.4
EPS 1.27 0.54 74.0 2.26 -1.02 -31.1
Adjusted EPS 1.41 0.08 6.0 4.91 0.49 11.1

Reflected in stock market valuation

In marketing terms then, Walmart is a success story with further potential in the US and increasingly in Canada and overseas. This kind of strong consumer franchise, mainly in essential than discretionary goods, helps explain why, just below $100 currently, its stock trades on a multiple of 20.4 times normalised earnings per share (EPS) of $4.91 for 2018.

This compares with 11% underlying earnings growth (a slight beat on consensus), hence a premium in respect of Walmart's durable consumer franchise, giving a sense this company can prosper despite risks with the US economy.

What extent, if at all, should a disciplined investor pay for "qualitative" strengths above what the raw numbers imply, at the risk of double-counting?

A modest 2.1% yield doesn't ease that concern, relative to yields around 5% or more on various big cap stocks listed in London, as if initially it seems Wall Street remains willing to engage bubble valuations. Yet Walmart's premium follows from a very long history of defensive growth: since the early 1970's its stock has enjoyed two major re-ratings, first in the late 1990s to 2000, then from mid-2015 coinciding with the company's push into digital marketing.

Source: TradingView, monthly chart (*) Past performance is not a guide to future performance

There have been very few down-dips - the biggest by a third in the first half of 2015 - as if patient holders of Walmart cannot go wrong, hence you can expect the stock to be priced for only modest yield.

To assert a medium-term bearish view of Walmart implies belief that global assets are due a major de-rating, which a few conservative monetarists do still warn (albeit have since 2010).  Thus, Walmart is likely to remain on 'buy' lists for low-risk equity savings portfolios as a building block for pension funds etc. 

Better all-round than key UK grocers

At 233p, Sainsbury (LSE:SBRY) shares yield just over 5% and is about 4 times covered by earnings, on a forward price/earnings (PE) around 12 times; Morrison (LSE:MRW) at 228p yields 4.4% about 1.6 times covered, on a forward PE of around 17 times; while perennial recovery situation Marks & Spencer (LSE:MKS) yields 6.5% covered 1.3 times, after a three-year downturn in market price, on a forward PE of 11.5.

Marks is a particularly good example why Walmart justifies a premium rating, hence lower yield; Marks' five-year record shows a major challenge to grind revenues higher, profits/earnings being volatile and cash flow per share in historic decline.

After rebounding in 2016, Morrison shares are in a volatile-sideways range and, though yielding over twice Walmart, it does not have the same extent of consumer marketing scope as Walmart, also Morrison's operating margin has been in decline below 2% in the tussle versus Aldi & Lidl. Sainsbury's is obviously in the news for current challenges, with the competition watchdog giving a damning report on its proposed merger with Asda.

So, while on initial comparison, major British grocers offer at least twice Walmart's yield, their stocks are arguably worse in terms of premium to earning power. Sainsbury's now trades at a near 20% discount to net tangible assets, however, Morrison is at a near 30% premium so, with the exception of Marks on a 101% premium, you could say these UK stocks are buttressed.

And the conclusion for the investment stance? If asked to pick one of these only, for the long term it's Walmart for its track record and marketing ability in the robust US economy, growing internationally too.

Though I am wary of US stocks being at historically high levels, 'hold' makes no sense for anyone reading with fresh money. 'Buy on weakness' understates Walmart, however, compared with AIM-listed Angling Direct (LSE:ANG) I wrote about last Tuesday, which has yet to prove a durable consumer franchise. Accumulate.

*Horizontal lines on charts represent levels of previous technical support and resistance. Trendlines are marked in red.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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