Description

Ticker: WMT

Price: $145.07

Market Cap: $398.1B

Price Target: $193

Overview

Unlike other retailers which significantly over-earned during COVID, Walmart is just now entering its own sweet spot of likely outperformance. Due to both macro factors and company-specific initiatives, we believe WMT is set up very well to sustain elevated comps and expand margins, presenting an incredibly attractive investment opportunity.

Description

Walmart Inc. is a multinational retailer of groceries and general merchandise at “Every Day Low Prices” (EDLP). As of October 31, 2021, the company operates over 10,500 stores around the world, split roughly between the United States and international markets. The entity has two main banners, Walmart, and Sam’s Club, which occupy over 1 billion square feet combined.

Since its founding in 1962, Walmart has been able to offer its iconic “Every Day Low Prices” to its customers. Geographically, 90% of the US population is within 10 miles of a Walmart store, giving it a significant competitive advantage over other retailers.

Business

Walmart’s omnichannel business model has allowed it to thrive in a world that is becoming increasingly digitally integrated. The company’s operations are divided between three different segments – Walmart US, Sam’s Club, and Walmart International.

Walmart US, which operates in all 50 states including Puerto Rico and Washington DC, is the largest division in the company (~$370B in sales), comprising roughly 66% of revenue and 77% of EBIT. WMT’s various brick and mortar formats along with its ecommerce business allow the company to engage with the consumer in multiple formats and cater to specific customers and geographies. Supercenters, the largest of WMT stores, sell everything from groceries and fresh produce to electronics and furnishings. These stores also usually include services such as banks, hair and nail salons, restaurants, and vision centers. Supercenters average about 178,000 square feet and comprise ~75% of US stores. The neighborhood market, about 15% of US stores, averages 42,000 square feet and is designed for communities in need of a pharmacy and affordable groceries. The remaining 10% of stores is comprised of discount stores – smaller version of supercenters - and other small format stores. In terms of revenue mix, grocery makes up about 55% of WMT US revenue whereas general merchandise makes up the remaining 45%. To complement its physical stores, Walmart also operates an ecommerce website, Walmart.com, which generated ~$39B in FY21, or ~11% of WMT US revenue. With offerings such as Curbside Pickup, Mobile Scan & Go, and Buy Online Pickup in Store (BOPIS), WMT caters to its consumers.

In FY21, Sam’s Club generated ~$64B in revenue, or ~11% of total WMT revenue. Sam’s Club is a membership-based store that offers its members low prices on bulk items. Sam’s Club has grown to 600 stores, which average 134,000 square feet. Like Walmart, it also offers its own ecommerce website and offers.

Lastly, Walmart’s international business makes up the remaining 22% of revenue. The company offers its same low prices in 23 different countries around the world.

In addition to its traditional retail business, Walmart also has several majority stakes in international retailers – JD.com, Massmart, and Walmex – as well as a 77% ownership stake in Flipkart, an Indian e-commerce business. During the most recent fundraising in July 2021, Flipkart was valued at $37.6B, implying WMT’s equity stake amounts to ~$29B.

Investment Thesis

Despite not immediately benefitting from pandemic-induced tailwinds, Walmart has since been able to outperform its peers and gain market share. Additionally, over the past several years, various investments and strategic initiatives have started to positively impact the company’s financials. Those changes, along with recent pandemic-driven decisions and the current macro environment have put Walmart in a position to sustain elevated MSD comps into the future while expanding margins.

Over the past several years, Walmart has been investing significantly back into the company in an effort to increase longer-term growth and profitability. Two of those strategic initiatives include Walmart Connect and Walmart+. Walmart Connect is a platform that allows Walmart to analyze and provide more data to its suppliers. It also includes advertising/media features, self-serve API for suppliers, and allows suppliers to view reported metrics via a dashboard. Additionally, the company rolled out Walmart+, a subscription service meant to compete with Amazon Prime. It includes free same day or two-day delivery of groceries and general merchandise, contact-less checkout, discounts on fuel, and more. Although never specified, both Walmart Connect and Walmart+ are higher margin businesses and have already started to contribute to WMT’s margin evolution.

Early in the pandemic, WMT lost market share to smaller retailers and traditional grocers as customers wanted to make quick trips in a smaller, “safer” environment. However, in 2021, as the world began to open up, WMT started to regain this share. During this time, other retailers began raising prices aggressively as supply chain issues rippled through the economy. On the other hand, WMT decided to absorb these incremental costs in order to sustain and even accelerate nascent market share gains. Given the current macro environment, Walmart’s wide price gaps should allow it to gain share and sustain MSD comps well into the future.

From a macro perspective, the overall health of the consumer is projected to deteriorate YoY in 2022 due to the reduction in SNAP benefits and the lapse of stimulus and enhanced unemployment benefits. This environment is likely to be a headwind for the sector at large and should result in a more price sensitive consumer. Given that WMT’s price gap to competitors is near historic highs, we expect this environment to be quite beneficial for WMT.

A large part of Walmart’s future growth is dependent on the ancillary businesses it has been building out. Those businesses include Walmart Connect, Walmart+, GoLocal, healthcare, and financial services. The first three businesses all have margins significantly above the company average and will help increase WMT’s overall margins. While the last two initiatives are still in nascent phases, they will likely have big impacts on how Walmart interacts with its consumers. The company has been expanding its flywheel model to create a world where Walmart is at every touchpoint of a consumer’s life.

As seen below, over the last five years, WMT US has steadily increased its SSS trajectory. After a slight dip in the COVID-impacted FY2020, WMT saw a large snap back in SSS in FY21 with a comp of +8.6%, more than double its five-year average of +3.8%. Despite now lapping these elevated numbers, comps through the first three quarters are trending at +6.8%, still well above historical averages. We believe WMT can continue to perform at MSD comps well into the future, given its momentum from increased traffic and ticket levels.

Furthermore, WMT gross margins have averaged 24.5% over the last five years. Despite a 40bps YoY decrease in gross margin in FY20 due to channel/mix shifts and price investments, WMT has held its gross margin constant and has even started to expand it over the last two years. Through the first three quarters of FY22, WMT’s gross margin is 24.7%, a 40bps increase YoY and 20bps above its five-year average. With its newer higher-margin ancillary businesses already starting to contribute, there is meaningful margin upside as WMT continues to grow these businesses.

Lastly, we believe WMT’s stake in Flipkart is a material value driver. In its latest round, Flipkart was valued at $37.6B, which would value WMT’s stake at about $28.9B. We believe Flipkart will pursue an IPO in the next twelve months. At a conference last fall, WMT CFO Brett Biggs confirmed that a Flipkart IPO is “definitely in the cards.” Given that WMT owns a majority stake in Flipkart, the financials of the business are consolidated into WMT’s income statement. However, because Flipkart currently operates near breakeven, typical earnings multiples completely ignore the embedded value of WMT’s ownership stake in Flipkart. Should Flipkart simply IPO at the same valuation as in its prior round one year ago, WMT would now have a public market for a stake worth ~$11 per WMT share. In all likelihood, a Flipkart IPO would likely price at a significant premium to the previous round, resulting in even further upside for WMT. Every $5B increase in Flipkart’s valuation would equate to another ~$1.42 per WMT share.

We think that the combination of WMT’s strong traffic trends, wide price gaps, high margin ancillary businesses, store growth, and macro environment provide a constructive backdrop for the stock in 2022.

Valuation

WMT currently trades at 22.5x FY23 EPS, right in-line with its five-year average, though its multiple relative to S&P 500 is in just the 14th percentile of the last five years. On an EV/EBITDA basis, WMT is trading at ~11.2x FY23 EBITDA. However, due to the complexity of the business and various equity stakes, we choose to value WMT on a sum of the parts basis.

We begin by valuing WMT’s “core” business at 12.25x EBITDA, a 15% premium to its five-year average, which we believe is warranted given the contribution of its newer higher-margin ancillary businesses and improved performance. We then value WMT’s stakes in JD.com, Massmart, and Walmex. Lastly, we assume Flipkart is worth $45B (a small premium to prior round) and apply WMT’s 77% ownership stake to that valuation. Adding this all together produces a value of $193, 35% upside from the current price. Conversely, if we give zero value to Flipkart, assume WMT misses consensus EPS by 5%, and value the company at a 20.5x P/E multiple, we see a downside target of just $130, only 9% lower than today’s price. Thus, we think WMT represents an incredibly attractive, fairly low risk opportunity with significant upside. With strong foot traffic momentum and a constructive macro environment for Walmart, we believe the company can sustain elevated MSD comps well into the future and provide robust long-term value for shareholders.

Risks

·Continued heightened supply chain costs/wage labor

Catalyst

·Flipkart IPO

·Easing of supply chain pressures