The India and global digital commerce landscapes have henceforth changed forever.
Global retail giant Walmart Inc (NYSE:WMT) has agreed to pay $16 billion for a 77% stake in Flipkart, India’s leading digital commerce firm, a move that not only marks the biggest deal in Walmart’s 50-plus-year history, but also one that points to a potential inflection point in beaten-up Walmart stock.
Walmart stock has dropped from from $110 in late January to right around $83 today, a 25% drop that looks especially bad considering the S&P 500 is down only 4% during that stretch.
Why the big underperformance? And will Flipkart save the day?
In short, Walmart stock got way ahead of itself in 2017 as investors overvalued the company’s e-commerce business. And although Flipkart gives this long-term growth narrative a nice boost, WMT stock isn’t at a point where the fundamentals support a bounce just yet.
All in all, I’m still bearish on WMT stock. But as it drops into the mid $70s, the stock begins to look interesting.
Here’s a deeper look.
Walmart Stock Got Way Ahead of Fundamentals
In plain English, Walmart stock soared in 2017 on expectations that the company was going to ditch its brick-and-mortar struggles and enter the Amazon.com, Inc. (NASDAQ:AMZN) stratosphere.
The company’s digital commerce growth numbers were so big and so consistent, while the digital commerce numbers at Target Corporation (NYSE:TGT) were so much weaker, that investors became convinced that Walmart was starting to follow an Amazon-like growth trajectory in digital commerce.
That didn’t happen. It isn’t happening. Nor will it happen in the future.
The truth is that everyone is finding success in the digital commerce space. As it turns out, the whole digital commerce pie is growing, and Amazon isn’t the only contributor to that growth. Target’s e-commerce business is growing at a healthy rate, as are the e-commerce businesses at essentially every mall-based retailer that has been struggling for so many years.
Walmart’s e-commerce growth rates were just so big last year because its entire retail business is so big. Thus, when the company decided to scale its e-commerce business, growth rates were naturally very large because the company’s reach and distribution is equally as large.
Now, those growth rates are coming up against tough laps, and they are starting to cool off. That is a problem for WMT stock, which in early January, was trading at 25 times forward earnings versus a five-year average forward earnings multiple of 16. Clearly, investors were pricing in astronomical growth to persist. Thus, any slowdown has reasonably resulted in material weakness in shares.
Walmart Stock Is Still Ahead of Fundamentals Today, Even With Flipkart
Unfortunately, Walmart stock still trades at 18 times forward earnings, versus that five-year average of 16. As such, bigger-than-normal growth expectations are still priced in.
Does that make sense? Not really.
This is still a low-growth company. Revenue growth bounced around -1% to 2% for several years. Then, it jumped to 3% last year due to super-charged digital commerce growth. Thus, the digital commerce growth tailwind should result in 2-3% revenue growth per year over the next several years.
Throw in Flipkart, which is small (less than $5 billion in revenues versus $500 billion at WMT) but fast-growing (revenues +50% year-over-year), and revenue growth over the next several years should be something like 4%.
That isn’t much. There also aren’t any big margin drivers going forward. If anything, margins are actually under pressure due to the digital commerce shift and the Flipkart acquisition. Nonetheless, I still think healthy revenue growth and operating leverage will drive operating margins to 4.5% in five years, versus 4.3% to 4.4% currently.
That combination of 4% revenue growth and 4.5% operating margins in five years leads me to believe that WMT can do about $6.90 in earnings per share in five years. A market-average and historical average 16-times forward earnings multiple on that implies a four-year forward price target of $110.
Discounted back by 10% per year, that equates to a present value in the mid $70s.
Bottom Line on WMT Stock
WMT is a low-growth stock that received a high-growth valuation in late 2017/early 2018.
Since then, Walmart stock has been in normalization mode.
This normalization isn’t over just yet. But in the mid $70s, the fundamentals and stock price start to once again line up. At that point, WMT stock looks interesting.
As of this writing, Luke Lango was long AMZN and TGT.