Walmart (NYSE:WMT) has produced surging free cash flow (FCF) for the past several quarters. As a result, Walmart stock is very undervalued and its FCF yield is attractive to investors.
In the quarter ending April 30, Walmart generated $5.265 billion in FCF. This was 36% more than its $1.3 billion generated in last year’s fiscal Q1 ending April.
Moreover, in the last 12 months Walmart produced $18.45 billion in FCF, which was 19.6% higher than the $15.45 billion in the same period it made a year earlier. In fact, this amount was 26.8% higher than the 12-month FCF from a quarter earlier.
This is astounding. Walmart is on a roll in terms of FCF. But does the market realize this? Probably not. So far this year, Walmart stock is up just 9.4%. In the last year, it is up almost 20%. That is nice but probably does not reflect the huge gains in FCF power that the company is making each quarter.
Comparison With Amazon
How does this performance stack up against Amazon (NASDAQ:AMZN). Amazon generated $25.96 billion in 12-month FCF for the year ending June 30, according to data from Seeking Alpha. This uses the same definition of FCF as Walmart uses. That number is 46% more than Walmart’s $18.457 billion using the same FCF definition.
But here is the rub. Amazon has a market capitalization of $1.59 trillion. That is the same as $1,590 billion. But Walmart’s market cap is just $368 billion.
In other words, Amazon is valued 4.3 times higher than Walmart by the market. This is despite the fact that the last 12-month FCF is only 46% higher than Walmart’s. So either Amazon is overvalued or Walmart is undervalued, or a combination of both.
Another way to look at this is by using a metric call FCF yield. Compared to its market value, the last 12 months of FCF at Amazon is equal to 1.63%. This is derived by dividing $25.96 billion in 12-month FCF by the AMZN stock market cap of $1,590 billion.
But the same FCF yield with Walmart stock is 5%. This comes from taking its $18.457 billion FCF and dividing it by the market cap of $368 billion. In other words, Walmart provides 3 times higher free cash flow per dollar of market value to investors than Amazon.
FCF Margins at Walmart
Maybe Amazon is worth this higher valuation. Maybe it produces more FCF per dollar of revenue. This is where the comparison gets cloudier. It means that the market might be at least partly right.
Here are the cold hard facts. Walmart makes 66.2% more sales than Amazon. But it makes less FCF than Amazon. So that implies its FCF margin is lower than Amazon. That is true, but the market may have overdone the relative valuations.
Walmart made $534.66 billion in last-12-month sales, compared to Amazon’s $321.78 billion. But since Walmart generated $18.46 billion in last-12-month FCF, its FCF margin is 3.45%. Amazon’s was 8.38%.
In other words, Amazon’s margin was 2.43 times better than Walmart’s FCF margin. But here is the problem in the relative valuation as we showed earlier. Walmart’s FCF yield is 3 times greater than Amazon’s. It should only be 2.43 times higher.
Value Adjusting Walmart Stock
Therefore, either Amazon is too high or Walmart is too low in terms of market valuations. Let’s attribute 50% of the difference to each side. In terms of Walmart, it should, therefore, be 28.5% higher.
This is derived the following way. The difference between 2.43 (Walmart’s FCF premium) and 3 (Amazon’s FCF margin premium) is 0.57. Half of that is 0.285. In other words, Walmart’s valuation should be 28.5% higher, after adjusting for the difference in FCF margins.
That would put Walmart stock at a target price of $169.47 per share, or a market cap of $472.88 billion. This gives it an FCF yield of 3.90%. That is a much more appropriate FCF yield than its prior 6.89% yield. It is valued worse than Amazon’s 1.63% FCF yield, but given its lower FCF margin, it is appropriate.
What To Do With Walmart Shares
Will the market realize this discrepancy in valuations? Maybe. But it will take some time. Therefore, I advise most investors should average cost into Walmart stock over time.
Eventually, the market will realize that Walmart’s higher FCF yield is too high, despite its lower FCF margins than Amazon. As the company continues to generate large amounts of FCF this will become more apparent.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. He runs the Total Yield Value Guide which you can review here.
