Buy, Sell or Hold: Why Wal-Mart Shares Are No Bargain

Like E.F. Hutton of old, when Wal-Mart Inc. (NYSE: WMT) talks about the state of the markets people listen.

With more than 200 million customers and 10,773 stores in 29 countries, the worldwide retail giant has become the ultimate consumer bellwether-especially in the United States where it accounts for approximately 10% of all non-automotive retail spending.

Unfortunately, here's what Wal-Mart has to say about its customers : They are broke.

According to leaked e-mails from some of the top brass at Wal-Mart, February sales were a "total disaster."

So how is it possible that the world's largest retailer with "everyday low prices" is having trouble getting its customers to buy things?...

Let's break down Wal-Mart's recent sales and the hot issues that now surround its share price.

Earnings Only Tell Part of the Wal-Mart Story

Due in part to the leaked email, Wal-Mart's recently released quarterly earnings report was the most anticipated earnings release in quite some time. That's true even though the quarterly results do not include February sales.

Instead, investors were looking for clues into what drove those e-mail comments.

For the quarter, Wal-Mart earned $5.61 billion, or $1.67 per share, up from $5.19 billion or $1.51 per share a year earlier. And while these earnings may have sounded like good news, the quality of the earnings leaves me doubting.

Here's why.

A lower tax rate than company anticipated for the fourth quarter came in at 27.7% compared to a 30.9% tax rate last year. Wal-Mart credits fiscal 2013 legislative changes, most notably the American Taxpayer Relief Act of 2012, for the favorable effective tax rate.

Revenues also came in a little weaker than expected for the quarter as well. Even though revenue grew by 3.9% to $127.92 billion, it fell short of the consensus expectation of $128.77 billion.

The closely watched same-store sales figures didn't boost investors' spirits either.

Wal-Mart had forecast a U.S. same-store sales increase of 1 to 3 %. But they came in at the bottom of the forecast with a rise of 1 % in the fourth quarter. That was down from a year earlier when U.S. same-store sales grew 1.5 %. To top it off, the company is forecasting flat first quarter same-store sales.

In addition, after four straight quarters of improved U.S. foot-traffic, Wal-Mart reversed course and reported a decline in the current quarter.

Still, after what seems to be lukewarm to negative news for Wal-Mart, the stock price has done very little and is still hovering in the low $70 range. The saving grace for the company's share price seems to be its announcement of a hefty 18 % increase in its annual dividend to $1.88 which will yield nearly 2.7 % at current price levels.

Economic Woes Explain Customer No-Shows

But to really understand Wal-Mart's recent slide in sales you have to understand what's going on in the broader economy.

After all, there is a reason why Wal-Mart's name keeps popping up in Federal Open Market Committee Transcripts. It's a microcosm of economic activity.

As former Fed Board Governor Randall Kroszner once said, Wal-M art officials "effectively know what retail sales are before the numbers are reported because their sales are so highly correlated with overall retail sales."

And as Wal-Mart's forthright U.S. president and CEO, Bill Simon, plainly stated recently, "We continue to monitor economic conditions that can impact our sales, such as rising fuel prices, changes in inflation and the payroll tax increase."

First, rising fuel prices are at the forefront. As of February 18th, AAA reported that gas prices have risen for 32 straight days. The average price for a gallon of regular unleaded gasoline has increased more than 13 % over that period to $3.73. Some regions in California are even seeing gas at $5.00 per gallon.

High gas prices not only impact the Wal-Mart customer - but will also impact Wal-Mart itself as it tops-off the tanks of the Wal-Mart 18-wheelers cruising the highways. You can expect that these added expenses will be passed off to customers in the form of inflation, which also negatively impacts sales.

Finally, Wal-Mart's customers now have a smaller paycheck. Thanks (or no-thanks) to a payroll tax break that expired on December 31, 2012, Americans started to pay 2 % more in payroll taxes. Now, workers earning the national average salary of $41,000 are receiving about $30 less every two weeks.

These trouble spots for Wal-Mart are not one-time events that will blow over in a couple of quarters. These are long-term industry (and global-economy) related items that will not be solved any time soon.

Can Wal-Mart Thrive in This Economy?

There is a school of thought that when the economy suffers, Wal-Mart benefits, as the consumer looks to stretch their dollar by shopping at the low-price leader.

This has been true to some extent in the past but this time around its Wal-Mart's middle-to-lower-income earners that are being squeezed. Higher prices for gas, food and an increase in taxes affect this lower-income customer's bottom line on a percentage basis much more than it would a higher-income wage earner.

In previous economic downturns Wal-Mart benefited from a "trading down" as its main competitors, such as Target (NYSE: TGT) and Costco (NASDAQ: COST), gave up market share while customers shopped for better deals. But in this environment Target and Costco are less vulnerable to the "trading down" effect.

The average annual income for a Wal-Mart customer is approximately $40,000. Meanwhile, it is $64,000 and $96,000 respectively for Target and Costco customers. Consequently, a Wal-Mart customer feels the pain more than others shopping elsewhere.

To sum it up, Wal-Mart is certainly not going anywhere. But it is going to take a lot of positive news in the broader economy before the company becomes a good investment again.

Unfortunately for Wal-Mart, much of what ails the company is out of its control. So, if you trust this economy then, by all means, hold on to your shares.

However, if you are like me and are more than a little concerned about our economic future Wal-Mart is no bargain at these prices. I rate Wal-Mart as a Sell.

About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.

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