wal-mart case write-up f.m

8/18/2019 Wal-Mart Case Write-up F.M

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Fis Malësori 3/20/2016

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Fis Malësori

3/20/2016

V ALUING W AL-M ART

C ASE REPORT

FIN 7410


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Introduction

Sabrina Gupta, an investment advisor is examining Wal-Mart Stores Inc. (NYSE: WMT) stock and its

valuation. She wants to use multiple methods to value the stock and come to a conclusion on its value and

the reflection of the share price on the market. Her goal is to confidently recommend her clients to buy,

hold or sell Wal-Mart stock based on her analysis.

Wal-Mart currently operates in multiple markets and sub-markets and compares well to its competitors

both domestically and internationally. However, determining Wal-Mart’s performance relative to its

competitors is difficult since very few if any of its competitors has the diversification that Wal-Mart has.

A thorough analysis of separate divisions of Wal-Mart and other companies would be needed. Moreover,

with the information given in the case such as: P/E Ratio, Return Ratios, D/E Ratio and other, we can

conclude that overall, Wal-Mart is performing better than the industry average and S&P 500. Relative to

its closest competitor in general merchandise, Target, the company is providing higher return on equity to

shareholders but is less leveraged, yet has a slightly lower net margin and a lower P/E Ratio than Target

and the industry. A thorough comparison of Wal-Mart with its competitors given the information in the

case is not easily done due to the different capital structures of the companies in different sub-sectors.

Given the data in the case, analysts see Wal-Mart growing at 10.40% over the next five year, lower than

Target and the Standard & Poor 500, and significantly lower than the industry projections for the next five

years. Wal-Mart’ was founded to save people money and offer them convenient shopping under one roof

& this business model is one of the company’s major drivers of growth and expansion as it has captured

millions of people worldwide generating 405 billion dollars in revenue just in 2010. One of its major

weaknesses is Wal-Mart’s diversification itself, as it creates opportunities for competitors to specialize

and capture market share in specific sub-industries.

From 1974, Wal-Mart has enjoyed an earnings growth of an average of 25% annually, yet it hassignificantly slowed to a high of 16.4% in 2005 and a low of 6.0 % in 2009 indicating a matured company.


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Historical Analysis

Analyzing Wal-Mart’s Historical growth in earnings, dividends and payout ratios will reveal the trends

that emerge for the company and will show a better picture of the company for investors.

In the table above, generated from the data given in the case we can see that both Earnings per Share as

well as Dividends per share have grown significantly in the last 30 years. Annual Earnings growth

however, has recently stalled and as explained earlier, will indicate a more matured company to investors.

Dividend growth has also significantly declined in the long-term, yet in the last decade, it has had some

growth in 2005 and 2008. Wal-Mart’s Dividend Payout Ratio has increased overtime, roughly twice the

amount from the beginning of this millennium to a 29.3% payout ratio in 2010, also indicating that Wal-

Mart is not growing rapidly anymore. The most recent payout ratio is still significantly lower than an

industry average of 45%, which still leaves much room for investors to question about potential growth

opportunities of the company to invest in attractive projects by retaining and reinvesting cash as opposed

to paying out more to shareholders.

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Historical Growth, Payout Ratio & EPS

Annual Earnings Growth (%) Annual Dividends Growth (%)

Dividends Payout (%) Earnings/Share

Dividends/Share


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Perpetual Dividend Growth Model

Initially, a Perpetual Dividend Growth Model will be used accompanied with a three scenario sensitivity

analysis to value Wal-Mart’s shares and give a recommendation to investors.

Major Assumptions for the Perpetual Growth DDM:

Consensus Dividend of D1= $1.21

Perpetual Dividend Growth Rate of g=5.0%

Cost of Equity Capital re= 7.1%

With the above mentioned method, the following results are computed:

P =

D

r − g

P =1.21

0.071 − 0.05

Using this perpetuity dividend growth model, share price of $57.62 is valued, which when compared to

Wal-Mart’s recent close price of $53.48 indicates an undervalued stock price and therefore would yield

a “Buy” and/or “Hold” recommendation to Ms. Gupta’s clients, depending on their portfolios and

whether they already hold WMT shares.

If the assumptions above about growth and cost of equity capital where to be altered and a three scenario

analysis would be conducted, the following would emerge:

Sensitivity Scenarios*

Worst Current Best

Assumptions R e=10.1% g=3.0% R e=7.1% g=5.0% R e=7.1% g=6.0%

Stock Value $17.04 $57.62 $110.00

Recommendation Sell Buy/Hold Buy

*A detailed Scenario Analysis to show a thorough sensitivity of the perpetual model is provided in the

appendix (Exhibit 1.1).


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Multi-Stage Dividend Discount Model

Due to the simplicity of the perpetual growth model, it is very unlikely that it captures the growth and

expansion potential of the company correctly, and thus reflecting the value of the stock accurately.

Therefore I will use a three-stage valuation model to analyze and value Wal-Mart’s share price.

Major Assumptions:

Cost of Equity Capital re= 7.1%

Growth Period

o Years - 5yrs

o Starting EPS – $3.72 * Growth Rate (1+10.40%) = $4.11

o Growth Rate – 10.40%

o Payout Ratio – 29.3 %

Transition Period

o Years – 12yrs

o Growth Rate – Incremental Declining factor approx. 0.5%

o Payout Ratio – Incremental Increasing Factor approx. 1.20%

Maturity Period

o Payout Ratio – 45%

o

Retention Rate – 55%

o Growth Rate ( Retention Rate*Cost of Equity Capital) – 3.91%

Using a three stage dividend discount model, Wal-Mart’s stock should be valued at $90.05 (See Exhibit

2.1), which indicates that the shares are undervalued and therefore, would also yield a “Buy” and/or

“Hold” recommendation, relative to Ms. Guptas clients’ portfolio structure.

In order to meet analyst consensus price of $60.5, a perpetual growth rate of 1.9843% has to be assumed,

keeping retention rate at maturity & cost of equity capital unchanged.


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The following table will show a scenario analysis of the three stage dividend discount model given some

major assumption changes in growth of Earnings in the growing period as well as at maturity:

Initial Growth of EPS

Long-Term GrowthIG-2% Initial Assumption IG+2%

8.4% 10.4% 12.4%

G-1% 2.91% $59.48 $71.30 $85.40

Initial Assumption (G) 3.91% $74.81 $90.05 $108.28

G+1% 4.91% $104.06 $125.84 $151.94

From the scenario analysis above, we can conclude that almost in every considered scenario, we meet

and exceed analyst consensus price target of $60.5 indicating that even if Wal-Mart doesn’t meetanalyst’s expectation on earning growth in the next five years, nor long term growth expectation given

the expected payout ratio at maturity, it will still render current share price valuation higher than recent

close price of $53.48 meaning its undervalued in every above considered scenario.

Market Multiple Valuation – P/E Ratio Method

I will use a P/E Ratio Method because there is readily available data given in the case for this method.

Conversely, if for instance the EV/EBIT Multiple would be considered, there is room for mistake when

assuming excess cash and potentially market value of net debt. I will use both a Wal-Mart’s projected

P/E Multiple as well as an industry average projected P/E Ratio Multiple.

First, let’s look at Wal-Mart’s P/E Multiple approach using their projected EPS of $4.11 for next year:

Pwm = P/E Ratio × EPS

Pwm = 13.4 × $4.11

Pwm = $.

Conversely, the forward looking approach using industry average projected P/E and Wal-Mart’s next

years expected EPS will generate the following:

Pndusy = P/E Ratio × EPS

Pndusy = 14.23 × $4.11

Pndusy = $.


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The valuation of Wal-Mart stock using the P/E Ratio renders similar conclusions like the earlier used

methods, yet the major assumption in this valuation method is that Wal-Mart will exceed its P/E Multiple

projections and will eventually meet the industry average P/E ratio of 14.23.

First, the trailing approach yields the stock to be slightly undervalued and would therefore be a

“Hold/Buy” for clients with WMT stock or a “Buy” for the ones without the stock in their portfolio.

Similarly, the forward looking approach renders the stock as undervalued and would therefore suggest

a “Buy” recommendation to WMT holding clients as well as non-holding ones.

However, the P/E Ratio Multiple Valuation method has some underlying considerations about a

company’s accounting methods and financing structure. Also, taking the industry average is risky as

companies in the same industry will very unlikely have similar risk factors, payout ratios, or growth

expectations.

Conclusion and Recommendation

First, the use of DDM with the given data in the case seems appropriate as Wal-Mart has consistently paid

out dividends since it became a public company. However, this method requires for dividend projections

which are discretionary to the company and is thus subject to significant error. Furthermore, given

information in the Consolidated Statements of Shareholders Equity in Wal-Mart’s 10-K report, it

shows that the company uses other methods of returning capital to investors, such as share repurchases.

Therefore, we can confidently conclude that Ms. Guptas approach is not the most appropriate to use since

share repurchases decrease the number of shares outstanding thus increasing EPS and Dividends per share.

To conclude, the valuation done in this report is subject to considerable error and would not be a reliable

way of recommending investment decisions to clients. I recommend using the Free Cash Flow Method to

value the company and its stock price as it allows for easier comparison of companies with different levels

of debt and is not dependent on company’s payout ratio.


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APPENDIX

Exhibit 1.1 Perpetual Growth Dividend Discount Model Sensitivity Analysis

Exhibit 2.1 Three Stage Dividend Discount Model

2.1% 3.1% 4.1% 5.1% 6.1% 7.1% 8.1% 9.1% 10.1% 11.1% 11.6% 12.1% 12.6

-3.00% 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 11.98$ 10.90$ 10.00$ 9.24$ 8.58$ 8.29$ 8.01$ 7.7$

-2.00% 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 11.98$ 10.90$ 10.00$ 9.24$ 8.90$ 8.58$ 8.2$

-1.00% 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 11.98$ 10.90$ 10.00$ 9.60$ 9.24$ 8.9$

0.00% 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 11.98$ 10.90$ 10.43$ 10.00$ 9.6$

1.00% 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 11.98$ 11.42$ 10.90$ 10.4$

2.00% 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 13.30$ 12.60$ 11.98$ 11.4$

3.00% (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 14.94$ 14.07$ 13.30$ 12.6$

4.00% (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 17.04$ 15.92$ 14.94$ 14.0$

5.0% (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 19.84$ 18.33$ 17.04$ 15.9$

6.00% (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 23.73$ 21.61$ 19.84$ 18.3$

7.00% (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 29.51$ 26.30$ 23.73$ 21.6$

8.00% (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 39.03$ 33.61$ 29.51$ 26.3$

9.00% (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 57.62$ 46.54$ 39.03$ 33.6$

10.00% (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 110.00$ 75.63$ 57.62$ 46.5$11.00% (13.60)$ (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ 1,210.00$ 201.67$ 110.00$ 75.6$

12.00% (12.22)$ (13.60)$ (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (134.44)$ (302.50)$ 1,210.00$ 201.6$

13.00% (11.10)$ (12.22)$ (13.60)$ (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (63.68)$ (86.43)$ (134.44)$ (302.5$

14.00% (10.17)$ (11.10)$ (12.22)$ (13.60)$ (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (41.72)$ (50.42)$ (63.68)$ (86.4$

15.00% (9.38)$ (10.17)$ (11.10)$ (12.22)$ (13.60)$ (15.32)$ (17.54)$ (20.51)$ (24.69)$ (31.03)$ (35.59)$ (41.72)$ (50.4$

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Cost of Equity Capital (Re)

Cost of Capital ( Re ) 7.10% Year Assumtpion EPS EPS Growth Dividend Payout TV PV(Div+TV)

1 4.11 10.40% 1.20 29.30% 1.1

Growth Period (g1) 2 4.53 10.40% 1.33 29.30% 1.1

Growth Years 5 3 5.01 10.40% 1.47 29.30% 1.1Initial Growth Rate of EPS 10.40% 4 5.53 10.40% 1.62 29.30% 1.2

5 6.10 10.40% 1.79 29.30% 1.2

G r o w

t h

Maturity Period (g2) 6 6.70 9.90% 2.05 30.51% 1.3

Payout at Maturity 45.00% 7 7.34 9.40% 2.33 31.72% 1.4

Retention rate at Maturity 55.00% 8 7.99 8.90% 2.63 32.92% 1.5

Growth rate at Maturity 3.91% 9 8.66 8.40% 2.96 34.13% 1.5

10 9.34 7.90% 3.30 35.34% 1.6

Transition Period 11 10.04 7.40% 3.67 36.55% 1.7

Transition years 12 12 10.73 6.90% 4.05 37.75% 1.7

13 11.41 6.40% 4.45 38.96% 1.8

Other Information 14 12.09 5.90% 4.86 40.17% 1.8

Current Fiscal year EPS $3.72 15 12.74 5.40% 5.27 41.38% 1.8

Current Dividend $1.09 16 13.37 4.90% 5.69 42.58% 1.9

Maturity Payout (p2) 45.00% 17 13.96 4.40% 6.11 43.79% 204.2 65.5

Growth + Transition Years 17 18 Maturity 14.50 3.91% 6.53 45.00%

Terminal Value (TV) = div1/(r-g) Share Price $90.05

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wal-mart case write-up f.m

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