In the corporate headquarters of retail giant
Wal-Mart (NYSE:
WMT
)
, April 21 was a day of utter fear. That's when
The New York Times
reported that company officials sought to cover up a bribery
investigation in Mexico, which might have soon led to massive fines
and the dismissal of key executives. In subsequent days,shares
started to drift lower as investors tried to gauge the fallout.
That was an unnecessary exercise. The scandal was soon over and
value investors spotted an opening, pushing shares up ever higher
during the course of the summer. Since the scandal broke, Wal-Mart
has added more than $50 billion to its already considerablemarket
value .
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That's the power of owning one of the
World's Greatest Businesses
(we here at StreetAuthoritycall them "WGBs" for short). They're
able to weather practically any kind of storm and yet still somehow
find a way to continue rewarding shareholders in the process.
Yet here's the remarkable thing: Even after impressive gains, this
stock is still undervalued according to one key financial metric.
Thanks to a very tight control over capital spending -- just enough
to keep the global expansion humming -- Wal-Mart is morphing into
one of the greatestfree cash flow stories of our generation.
Roughly two years ago,
I made a case
that shares of Wal-Mart were undervalued on the context of their
free cash flowyield . At the time, Wal-Mart sported a 5.6% free
cash flow yield, which is even higher than the corporatebond yields
that you will find on blue chips like this one. In effect,
Wal-Mart's stocks were more attractively valued than itsbonds .
Well, a few years later, we now have a clearer sense of what
Wal-Mart's free cash flow will look like in fiscal 2013, 2014 and
2015. And it's quite impressive. The company held its annual
meeting withWall Street analysts earlier this month, and
management's blueprints helped clarify these analysts' free cash
flow projections. Here is the average free cash flow projection for
the next few years.
In fiscal (January) 2011, Wal-Mart generated roughly $7
billion in free cash flow. In the currentfiscal year that ends
this coming January, that figure is expected to reach $13
billion. That's a stunning jump in a badeconomy . The keycatalyst
for rising free cash flow has, counter-intuitively, been the
result of price-cutting. Wal-Mart's move to "every day low
prices" (EDLP as the company calls it) has again sharpened the
company's perceived value proposition among customers, which is
leading to steady same-store sales gains.
Now, back to that free cash flow yield. This giant retailer is
now worth $257 billion and if you use fiscal 2014 free cash flow
as a basis, then shares are sporting a free cash flow yield 5.4%
($11.4B / $257B). That's still a comfortably higher yield than
Wal-Mart's bonds, which generallyoffer a yield-to-maturity of
just below 4%.
The key takeaway: Right now you can own shares of one of the
World's Greatest Businesses
at a more attractive price than its bonds. This stock is likely
to keep attracting value investors until the stock price rises up
to the point where the free cash flow yield slips to 4%. This
scenario implies a market value of $350 billion, which suggests
36% upside from here for patient investors.
Yet my investment thesis isn't around how much upside this
stock has. Instead, it's how much downside protection it has. If
themarket gets choppy and investors start selling stocks, then
they're likely to stand by Wal-Mart, thanks to the retailer's
prodigious free cash flow.
Risks to Consider:
Part of Wal-Mart's renewed vigor is due to a slightly more
optimistic consumer. Yet just a few years ago, Wal-Mart felt the
pain of a distressed consumer just as much as other retailers. So
if the U.S. economy slumps badly in 2013, then it will be hard
for this stock to move any higher.
Action to Take -->
You can run this free cash flow exercise with any investment. As
a general rule of thumb, free cash flow yields above 5% represent
solid value, and free cash flow yields above 8% represent
stunning value. What kinds of companies are we talking about?
Well, insurers such as
Aflac (NYSE:
AFL
), MetLife (NYSE:
MET
)
and
Prudential Financial (NYSE:
PRU
)
make the grade, as do
Southwest Airlines (NYSE:
LUV
)
and
SunTrust Banks (NYSE:
STB
)
.
-- David Sterman
P.S. -- StreetAuthority Co-Founder Paul Tracy has put together a
special presentation called The World's 12 Greatest Businesses. You
can learn more about these stocks -- including several names and
ticker symbols -- by visiting this link. Given how these 12 stocks
have beat the market year after year, you won't want to miss it.
Click here to read now.
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of STB in one or more if its "real money" portfolios.