STOCK WATCH


Wal-Mart: Christmas Is Coming

Jeffrey R. Kosnett

The world's largest retail chain's results the past five years aren't the greatest. But the company just announced a positive earnings surprise for the latest quarter. Is that the start of a turnaround?



Talk about financial flotsam: Shares of the world's largest retail chain are 25% below their five-year high, a humiliation matched or surpassed by just five other components of the Dow Jones industrial average, of which Wal-Mart is a member. The stock has had a few good days of late, including a gain of $1.34, or 2.9%, to $47.66 on November 14. But it's hard to make the case that the tide has finally turned for Wal-Mart shareholders.

That's true despite a successful push to sell groceries, the guts to quit some foreign countries where the format didn't work, and a plan to remodel 684 U.S. Wal-Mart stores so they don't look like flea markets. If you visit one of the renovated stores, you'll probably be impressed. The upgrade in appearance is noticeable, yet merchandise prices remain low. Wal-Mart won't wow fashion plates, but it should attract shoppers with more money to spend on electronics, housewares, sporting goods, toys and food. About half the store revamps are finished. By next year, when they're all complete, we'll know if spiffier stores juice the numbers.

That said, Wal-Mart just came out with an unusual quarterly financial report. Sales were soft, which is usually big trouble in retail. But profits, perhaps because of a plan to spend less to build new stores and a more profitable mix of merchandise, exceeded analysts' forecasts with room to spare.

Wal-Mart didn't accompany the earnings release with other comments, but several analysts issued brief statements affirming their opinions that the stock deserves to be in the mid-to-high $50s. It has been nearly three years since Wal-Mart exceeded $55 despite a 14% three-year annualized increase in earnings per share over that period and an even faster dividend growth. If the stock had tracked earnings the past three years, it would be in the $55 to $60 range. What would it take to bring the stock into that range? Here are some possibilities.

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Christmas, with icing. The next quarter, the one that closes in January, regularly accounts for one-third of Wal-Mart's annual profits. Over the prior three quarters, counting the one just released, Wal-Mart (symbol WMT) made $1.97 a share. That means you can reasonably expect $1 or just below a buck for the holiday-shopping quarter. That would just about get the tally to $3 a share for the four trailing quarters. If you apply the currently depressed price-earnings ratio of 17 to $3 of earnings, you get a stock at $51. Or perhaps we learn that lower gas prices really do result in more-confident consumers opening up their purses and wallets, and sales and earnings come in higher than expected. So perhaps investors decide to upgrade Wal-Mart's P/E ratio to 18. That suggests the possibility of a $54 stock next February, when Wal-Mart delivers fourth-quarter results. And if 2007 is at least as good a year as 2006, perhaps the stock doesn't stop there.

Brazil, China and Japan. This stock doesn't only hinge on what happens here. These three countries, plus Mexico, are all vital to Wal-Mart now that it has quit Germany, is lagging in Britain and is disinclined to try elsewhere in Europe. China, where Wal-Mart plans rapid expansion, is a rapidly growing nation of consumers. Consider this Wal-Mart's China card. Success in China could help rejuvenate Wal-Mart's growth.

Fixing Sam's. One of Wal-Mart's less-publicized problems is how Costco has clobbered Sam's Club. Wal-Mart is talking about smaller and more efficient domestic stores with closely "edited" selections, which suggests that it might de-emphasize Sam's. That would probably encourage investors.

Staying out of the headlines. It is a mystery what part of the stock's travails is due to the company's unpopularity with some local governments, unions and liberal activist organizations. Certainly, some of Wal-Mart's alleged gaffes have been howlers, such as sending e-mails that hinted that store managers were being rewarded for weeding out older, better-paid non-management employees. But Wal-Mart is starting to win some of the PR battles -- witness the growing number of commentators who laud Wal-Mart's contributions to lowering inflation and offering job and advancement opportunities to people with little work experience. If Wal-Mart has been trading at a discount because of "headline risk," it may be due for some relief on this score. When that comes or what it means for the stock price, no one can anticipate. But the odds are that Wal-Mart shareholders will eventually benefit from a change in public perception. That won't come a moment too soon.




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