Big box retailer Wal-Mart Stores Inc (NYSE:WMT) had a really, really good 2017. WMT stock entered 2017 under $70, and left the year at nearly $100. That is a huge 40%-plus rally for a retail stock that hasn’t been known for delivering out-sized returns recently.
In fact, 2017 was the best year for Walmart stock since 1999. The big rally felt mostly justified. The traditional brick-and-mortar business has a booming e-commerce component that is emerging to be a formidable competitor to Amazon.com, Inc. (NASDAQ:AMZN).
Average ticket is up. So is traffic. Comparable sales growth is consistently positive. Margins are under pressure, but that is mostly because of a surging digital business. Strategic initiatives such as online grocery are playing out well. Earnings growth is ramping up.
Many of those tailwinds will continue in 2018. But those tailwinds aren’t enough to power Walmart stock that much higher in 2018.
In fact, at $100, Walmart stock looks way ahead of itself here. I wouldn’t be surprised to see a material pullback in 2018. Here’s why.
For the past decade, the market has treated Walmart and Target Corporation (NYSE:TGT) as essentially one and the same. They have gone up together, gone down together and traded at a very comparable valuation for the past 10 years.
But 2017 broke that trend in a big way. WMT surged 40% higher. TGT dropped 6% lower.
Moreover, the stark difference in stock performance has created a historic gap in valuation between the two stocks. Over the past several years, both stocks have usually traded at a mid-to-upper teens price-to-earnings multiple (usually 15 to 17) and a high single-digit EBITDA multiple (usually 8).
Today, WMT trades at 26x trailing earnings. TGT stock trades at 14x trailing earnings. WMT stock trades at 11x trailing EBITDA. TGT stock trades at 6x trailing EBITDA.
In other words, WMT stock is more than 80% more expensive than TGT stock. That is a historic high.
Does that valuation discrepancy make sense? Not really.
To say that WMT stock should be nearly twice as expensive as TGT stock because WMT’s operations are currently on fire thanks to a robust digital business while TGT’s operations are struggling seems unnecessarily short-sighted. That thesis lacks scope.
Zoom out. Back in 2014-15, TGT was kicking WMT’s butt. Now, the tide has turned. With time, it will turn again.
That is the nature of the Walmart versus Target competition. These two big box retailers are interlocked in a decades-long competition wherein wins and losses are exchanged with equal frequency.
There will always be Target shoppers (people who prefer a cleaner, relatively higher-end shopping experience). There will always be Walmart shoppers (people who always prefer lower prices).
And then there will always be the rest of us, who don’t really notice a material difference between the two stores and pick one based on whichever is closest.
Yes, right now WMT is kicking TGT’s butt in the e-commerce world, but TGT will bounce back and beef up its digital business. It is only a matter of time before that happens. And because the two stores are essentially interchangeable, a beefed out digital business for TGT means the two companies will once again be on the same playing field.
Consequently, these two stocks should continue to trade at similar valuations. But today, Walmart stock is nearly twice as expensive as Target stock, and that is a problem.
Valuation will remain a serious headwind to WMT heading much higher in 2018.
I wouldn’t be surprised to see WMT stock continue to trade sideways over the next several months, or even fall back some. The narrative in the Walmart versus Target competition will flip in 2018, and by the end of the year, I suspect the two stocks will feature similar valuations.
As of this writing, Luke Lango was long TGT and AMZN.