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Using a Value Line Report: Wal-Mart Takes a Blow – May 4, 2012
In the sports world, there are champions that everyone loves and there are those that everyone loves to hate. Wal-Mart Stores (WMT - Free Value Line Research Report for Wal-Mart Stores) would fall into the latter category if it were a sports star. The company has proven itself a capable and dominant player; after all, it is the world’s largest retailer, with over 10,000 stores worldwide (this information can be found in the Business Description). That said, the company has long been accused of destroying so called “mom and pop” stores and for having poor working conditions. So, the company’s success has come despite a large block of the world rooting for failure.
Such a misstep has yet to occur, however, as the company has steadily increased earnings and dividend disbursements year in and year out. In fact, both have increased in every year presented in the Statistical Array, an impressive feat given there have been two recessions since 1996. (Recessions are indicated with grey bars on the Graph.) Still, this industry Goliath’s shares have been largely range bound for a decade, touching $60, or so, and then falling back. Note, however, that the shares barely budged during the two recessions, which is a positive worth remembering.
For all of those who root against Wal-Mart, the big news is the heavy head shot the company took in Mexico. Several executives at the 69%-owned Mexican subsidiary are suspected of orchestrating bribes to public officials in exchange for expediting the issuance of permits needed for retail store expansion. Top managers of its foreign subsidiary, Wal-Mart de Mexico, were said to have made hundreds of cash payments totaling over $24 million to expand its Mexican store base and win market share. Further, they reportedly took steps to conceal the illegal activity from Wal-Mart's worldwide headquarters.
To make matters worse, thanks to a whistle-blowing Walmex lawyer and a 2005 internal investigation by the parent company, now CEO and then head of Wal-Mart International, Mike Duke, was apparently made aware of the matter. He is one of several current Wal-Mart executives alleged to have known about the bribes, but kept quiet. Indeed, an internal unit was sent to Mexico to investigate the claims. They reportedly found reasonable suspicion to believe that Mexican and USA laws had been violated and recommended expanding the investigation. Instead, Wal-Mart executives shut the review down entirely, allegedly in fear of the negative effect the information could have on its business and stock price.
At the end of the day, it is very possible that Wal-Mart employees violated the Foreign Corrupt Practices Act and that the company attempted to cover it up. Value Line analyst Kevin Downing expects this matter to hurt future store expansion efforts, management's credibility and focus, and general investor sentiment toward Wal-Mart—not that the company has ever been viewed in an overly positive light. Fines and management changes are possible, too.
Not surprisingly, the stock fell sharply on the news. This is appropriate based on the potential implications of the issue. Still, companies have survived scandal and missteps before and there is every reason to believe that a company with the size (as the Capital Structure box shows, it has a nearly $2 billion market cap, even after the sell off) and scope (world-wide operations) of Wal-Mart will be able to get back on its feet.
Value Line awards Wal-Mart the highest scores for Financial Strength (A++) and Stock Price Stability (100), as noted in the Ratings box at the bottom right of the report. These two measures are combined to create the Safety Rank, which is found in the Ranks box. Wal-Mart earns the best possible Safety Rank of 1 (Highest). This rank measures the total risk of a stock relative to the approximately 1,700 other stocks. Stocks with high Safety ranks are often associated with large, financially sound companies—like Wal-Mart.
Safety becomes particularly important in periods of stock market downswings. The record of Safety over the years is impressive in the periods when the market is trading lower. This to say that stocks with high Safety ranks generally fall less than the market as a whole when stock prices drop. For example, between June 2008 and March 2009, Rank 1 Safety stocks, as a group, fell 32.5%, while Rank 3 stocks dropped 53.2%. While no one likes to lose money, the nearly 20-percentage-point difference between these two is material. Meanwhile, stocks with a Rank of 5, as a group, fell 67%--more than double the drop of the Safety Rank 1 group. A similar pattern existed in the market drop between October 2007 and January 2008, the 2000-2001 tech meltdown, and the 1987 crash.
So Wal-Mart shares are expected to do better than other stocks in weak markets, but how does one use this information when a company specific event takes place? Such events could include natural disasters, product recalls, and any number of other issues. In the present situation, the issue comes down to how well the company can manage potential mismanagement. To paraphrase Warren Buffett, you want to own a business that an idiot could manage because some day one will. Obviously, that does not apply to Michael Duke—you don’t get to the head of a multinational giant like Wal-Mart unless you are quite sharp. That, however, does not mean he isn’t human and capable of mistakes.
To Wal-Mart’s credit, it has a very large footprint of stores that are visited on a regular basis. Indeed, as the Analyst Comment points out, with a renewed focus on everyday low prices, the company has been able to increase comparable store sales of late. Moreover, although debt makes up 40% of the capital structure (noted in the Capital Structure box), this is well within reasonable levels for its industry and size. Additionally, the retail giant had over $6.5 billion of cash on the balance sheet in January (found in the Current Position box, which is under the Capital Structure box). Operationally, the net profit margin has been fairly steady and so have investor returns (specifically, Return on Total Capital and Return on Shareholder Equity), as shown in the historical portion of the Statistical Array.
On the negative side of the ledger, the bribery issue is material and could affect an important segment of the company—one that has helped drive growth in recent years. Material fines could, in fact, be the lesser evil of the potential outcomes. So, there are material risks that investors need to consider. However, those with a long-term view would do well to keep an eye on Wal-Mart stock, as this problem, which the company is likely to live through to fight another day, could present an interesting buying opportunity.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.