Wal-Mart (WMT) is the largest discount retailer in the world.  Wal-Mart is the 8th largest publicly traded US corporation. Wal-Mart is 4.3 times the size of Costco (COST) and 5.8 times the size of Target (TGT) based on market cap. Wal-Mart has generated 5.67 times the amount of revenue Amazon (AMZN) has over the past 12 months. Wal-Mart is the dominant force in discount retail.

The company was founded by Sam Walton in 1962.  Sam Walton’s 6 heirs are worth an estimated $140 billion today; wealthier than Warren Buffett and Bill Gates combined. The scale of what Sam Walton accomplished is truly impressive, yet he is much less celebrated than other multi-billionaires like John Rockefeller, Andrew Carnegie, Bill Gates, or Warren Buffett.

Wal-Mart is the focus of the final installment of the 54 part Dividend Aristocrats In Focus series. The company’s massive operations, competitive advantage, and future growth prospects are analyzed below.

Business Overview

Wal-Mart operates a total of 11,156 stores on 5 continents (none in Australia or Antarctica). The company operates primarily under the Wal-Mart and Sam’s Club names in the US.  In total, about 45% of the company’s stores are in the US.  Wal-Mart’s top 10 countries based on store count are listed below:

1. US: 4,987
2. Mexico : 2,226
3. United Kingdom: 584
4. Brazil: 557
5. Japan: 433
6. China: 401
7. Canada: 391
8. Chile: 388
9. South Africa: 352
10. Costa Rica: 216

Wal-Mart is geographically diversified, but it has its strongest presence in North America through its US, Mexico, and Canada operations. Together, these 3 countries account for 68% of Wal-Mart’s store count.

Wal-Mart breaks its operations down into 3 segments:  Wal-Mart U.S., Wal-Mart International, and Sam’s Club.  The Wal-Mart U.S. segment is home to Wal-Mart’s non-Sam’s Club operations in the United States, as well as walmart.com. The Wal-Mart International segment includes all of the company’s non-U.S. operations, including websites.  The Sam’s Club segment includes all Sam’s Club operations in the US.  Wal-Mart has 195 Sam’s Club locations located outside the U.S. which are run by Wal-Mart International, not Sam’s Club.  The company’s operating profit for each segment through the first 9 months of Wal-Mart’s fiscal 2015 are shown below:

• Wal-Mart U.S. has generated 73% of operating income
• Wal-Mart International has generated 20% of operating income
• Sam’s Club has generated 7% of operating income

Competitive Advantage

Wal-Mart’s competitive advantage comes from its brand recognition and its focus on low-prices. The company is well known as a “low cost leader”.  The perception of Wal-Mart as a place to buy brand name and generic products for low prices has driven its success. The reason Wal-Mart is perceived to have low prices is because it actually has low prices. The company’s brand recognition is second to its ability to deliver on its promise of low prices.

Wal-Mart is able to offer consumers low prices due to its massive scale and strong global supply chain. As discussed in the introduction of this article, Wal-Mart is about 5.8 times (based on market cap) the size of its nearest competitor, Costco. The company puts tremendous pressure on its suppliers to give it rock bottom prices and make up profits on the volume Wal-Mart provides. This drives shoppers to Wal-Mart’s stores which grows the company’s operations, allowing them to put more pressure on suppliers in a virtuous cycle.

Wal-Mart has over 10,900 points of distribution globally. The company’s robust supply chain is the strongest of any retailer.  Wal-Mart has long invested in its supply chain. The company spent $2.53 billion on information systems, distribution, and e-commerce in its fiscal 2014. Wal-Mart had its own satellite system for voice and data transmission between all segments of the company as far back as 1987.  Today, Wal-Mart is using the massive amount of data it collects to drive innovation in the shopping experience. The company has a presence of 2,100 employees in silicon valley who make up Wal-Mart’s IT, e-commerce, and big data efforts.  The company continues to innovate in the supply chain and distribution field.

Growth Prospects

Wal-Mart recently announced a shift in its future growth program. The company is reducing growth investments in international markets and increasing investment in its digital operations. Specifically, the company updated its full fiscal 2015 capital expenditure guidance versus its previous guidance as follows:

• Wal-Mart U.S. capital expenditures budget up 0.8%
• Wal-Mart International capital expenditures budget down 7.1%
• Sam’s Club capital expenditures budget down 10%

The growth in the Wal-Mart U.S. budget is a result of increased spending on digital and e-commerce operations. Wal-Mart plans to use funds that were ear-marked for international and domestic expansion and use them for digital expansion instead. The company’s increase in digital versus physical spending versus its prior fiscal 2015 outlook is shown below:

• Physical capital expenditures budget down 2.9%
• Digital capital expenditures budget up 25%

Wal-Mart is expecting to spend 7.8% of its capital expenditures budget on digital investments. For comparison, the company spent just 3.1% on digital investments in its full fiscal 2014. Wal-Mart plans to spend about 11% of its capital expenditures budget on digital investments in its fiscal 2016.

Wal-Mart’s increase in digital spending shows where the company’s management believes future growth will come from. Wal-Mart is experiencing rapid growth in digital sales, with strong growth expected to continue. The company is growing digital sales faster than the overall e-commerce market, and faster than its largest competitor, Amazon. The company saw e-commerce sales grow about 21% on a constant currency basis in its most recent quarter.

Wal-Mart’s big bet on digital sales will impact short-term growth. The company is expecting sales growth of just 2% to 4% for full fiscal 2016. Wal-Mart’s management projected an 18 to 24 month period of increased investment in digital as the company refocuses on online growth. Wal-Mart is not abandoning its physical growth in the U.S. or Internationally; the company is still projected to pour 89% of capital expenditures into physical investments. Wal-Mart’s management is positioning the company for long-term growth at the detriment of short-term growth. Long-term shareholders should be happy with the company’s vision beyond next quarter’s earnings.

Dividend Analysis

Wal-Mart currently pays a dividend yield of about 2.3%. The company has a fairly low payout ratio of under 40%. I expect Wal-Mart to deliver only modest dividend increases over the next two years as it continues to invest in digital expansion.  After this period, I expect the company to grow its dividend payments faster than overall company growth as it has more cash flows available for dividend payments.

Over the past 10 years, Wal-Mart has grown revenue per share EPS at between 7.5% and 8% a year. The company has grown its dividend payments nearly 14% a year over the same time period. Wal-Mart’s slow transition toward a higher payout ratio will likely continue. I believe the company will manage strong dividend growth of at least 8% a year over the next decade, and likely 10% or higher. Dividend growth will be fueled by increases in store count, e-commerce sales, and an increasing payout ratio.

Valuation

Wal-Mart is currently trading at a P/E ratio of about 16.75.  The S&P 500 has a P/E ratio of close to 20 at this time. The company has not traded at a premium to the S&P 500 since 2004. I believe Wal-Mart’s fair value is in line with the S&P 500’s P/E ratio due to the company’s long-term growth prospects and low-risk operations.  At current market levels, I believe Wal-Mart to be undervalued.

This analysis does not take into account the market’s current overvalued level. If the S&P 500’s P/E ratio were to revert to its historical average of about 15, I believe the fair value for Wal-Mart would be a P/E ratio of around 15 as well. We do not know if the market will remain overvalued for a decade or more, or if it will fall tomorrow. As a result, it is prudent to invest based on current market levels rather than long-term historical market levels since timing the market is virtually impossible. If the market were seriously overvalued (like the tech bubble), then it would be more prudent to withhold investments.

Recession Performance

Wal-Mart performs well through recessions. The company grew EPS each year through the Great Recession of 2007 to 2009. Wal-Mart does well during recessions because its lower prices tend to attract customers who are financially distressed or worried they may soon become financially distressed. Wal-Mart’s EPS from 2007 to 2010 are shown below to illustrate the company’s success during the last recessions:

• 2007 EPS of $3.16
• 2008 EPS of $3.42 (8.2% growth)
• 2009 EPS of $3.66 (7.0% growth)
• 2010 EPS of $4.07 (11.2% growth)

Final Thoughts

Wal-Mart is a Top 10 ranked stock using The 8 Rules of Dividend Investing, and has been for some time. The company trades at a fair price, has solid future growth prospects, is its industry’s leader, and has an extremely strong competitive advantage. In addition, the company has a long history of rewarding shareholders with both dividend payments and share repurchases.