Walmart: Simply too expensive (rating downgrade) (NYSE:WMT)

Walmart (NYSE: WMT) has just experienced a terrific share price run, posting a solid +45% total return since January 1, 2024, thanks to better-than-expected operating results and some defensive buying by investors in America’s largest big-box retailer.

However, the valuation is now incredibly stretched, while the expected annual growth rates of +5% in sales and +11% in earnings per share (as forecast by Wall Street for 2024-26) are not exactly stellar. My logical conclusion for investors is that investors should sell or avoid the stock until a more intelligent risk-reward balance emerges. This will likely take some time. As of today, I firmly believe Walmart will be a chronic “underperforming” pick, perhaps for many years to come.

To be honest, I do not have a particularly optimistic or pessimistic opinion about the Stock in 2023-24. My last WMT article was a Buy Review in November 2021 here when the price was below $50. However, after the huge price increases this year, I think it makes sense to lay out the “risk side” of the equation at $76 per share in August. Let’s go through the bearish data points, which revolve almost entirely around valuation.

Overvaluation leaves little room for upside potential

Believe it or not, Walmart has a 20-year high valuation today if we use price-to-earnings ratio (39.6x), sales (0.9x), cash flow (18.2x), and tangible book value (10.8x) as benchmarks. We’re talking a 40% premium to the 10-year average, 60% to the 20-year average, and 120% to the lowest valuation of 2016 (using an average of all 4 fundamental/financial metrics).

Company valuations

Taking into account the changing debt and cash levels, the company’s valuation based on sales (0.97x) is back to 2004 levels, while the ratio to EBITDA (17.6x) represents a new 20-year high. Walmart is clearly far from a cheap buy.

Is Walmart the most expensive company in the major retail group? No, but it has left behind its usual position as one of the cheapest companies in the EV statistics and is now on its way to Costco (COST) and Amazon (AMZN). I’d like to add that I’m pessimistic about these two as well because I’m worried about the ratings. My last pessimistic notes about Costco were here in July and about Amazon a few weeks ago here.

Below you can read how Walmart has gone from being one of the cheapest to one of the most expensive major retail companies on EV multiples since 2016, including other names like Goal (TGT), Dollar Tree (DLTR) and Dollar-General (Director General).

My question is: are low growth rates and low profit margins the kind of business results you want to back up with a top-tier industry rating? Walmart continues to have one of the weakest business structures in the entire group in terms of net profit margin on sales (2.34%).

Lack of free cash flow

When you look at the bottom line, Walmart’s free cash flow yield of 1.94% at a current price of $76 is almost the weakest figure for the actual achievable yield of this large retail group. And that situation is completely reversed from 12 months ago, when Walmart led the way with a 5% FCF yield.

How bad is the FCF situation? Well, the yield on the stock price is languishing at the lowest “relative” yield level compared to prevailing cash investment rates over the past decade. If I can earn 4.5% on a “risk-free” 1-year Treasury note, why would I take the real risks of retail competition and a severe economic recession while pocketing a measly 1.94% for generating excess cash (assuming I own the entire company)? Then consider that WMT’s stock price can theoretically drop by -100%, while cash investments almost guarantee a 100% return on your initial capital.

Looking back in time, the negative relative FCF return of -2.43% versus cash rates is the same abysmal adjusted return seen between 1999 and 2001 and again between 2006 and 2008 (circled in gold below). Both periods were followed by recessions that helped keep Walmart’s stock price under wraps.

The outlier is Walmart’s price increase in 2023-24 with a largely negative real FCF yield. Do you really think this uptrend will continue or will there be a violent reversal to the downside in WMT price next?

Is the dividend yield disappearing?

Another issue I have with Walmart is its paltry 1.07% dividend yield. Surely, it makes more sense for income investors to get 4.5% from a 1-year Treasury bond given the slowing economy. More bad news is that the unusual jump in price has pushed the annual cash dividend payout down from nearly 2% in the summer of 2022 to barely 1% in August 2024.

1.07% is also well below the S&P 500 blue-chip index average of 1.22%. It is essentially the worst return range since the Great Recession of 2009 (not shown). If you discount a few months during the pandemic-induced crash in U.S. stocks in 2020, the relative return story screams “sell” rather than “buy” for long-term stakeholders.

Rating Summary

Using Seeking Alpha’s database and computer sorting system, Walmart was able to Rating of “D-” overall is the kind of setup I generally shy away from. Compared to today’s industry averages, an expanded list of numbers, and WMT’s 5-year history, there’s not much substance to justify your $76 purchase price.

Final thoughts

One has to ask whether buying Walmart stock at a 20-year high makes common sense, given that interest rates remain high and the economy is slowing and may soon be heading into a recession. I could easily argue that Walmart should be valued at a BELOW NORMAL price, given that today’s macroeconomic environment is working against the company’s immediate results.

Well, the management team, the founding Walton family and the board of directors are anything but optimistic about the price trend at $76. This group of knowledgeable insiders has sold large net shares during the rapid price increase.

When you take all the data points on financial overvaluation together and then consider that Walmart’s incredible corporate size makes high growth rates almost impossible, I think the statistical chances of it significantly “outperforming” the S&P 500 index in the future are pretty slim.

If you are making significant gains on your WMT position and would rather protect your shares by selling covered calls or even buying puts, I completely understand. But for the average retail investor who has owned the stock for the past 3-5 years, taking profits is probably the better alternative. Additionally, if you are considering buying a stake, I would prefer that you wait for a lower share price that accurately balances recession and competitive risks with company-wide earnings levels. I fear that Wall Street estimates predicting modest business growth through 2026 may prove to be too optimistic.

What could keep Walmart’s stock price above $70 by 2025? That’s a smart question. You have to believe in soft landings for the economy, alongside a steady decline in interest rates over the next year. This “Goldilocks” scenario is, frankly, now “the” prerequisite for further stock market gains for most large-cap U.S. stocks traded on Wall Street. It’s a similar and scary situation to the end of the original tech bubble of 1999-2000, which also marked the peak of trading for Walmart stock and was only broken to the upside in 2013.

Can you stomach holding Walmart for 13 years until 2037 before you see any meaningful gain (aside from the tiny 1% annual dividend yield)? If the answer is no, you may want to turn your attention to smaller and mid-sized names with solid/acceptable valuations and above-average business growth rates. I write about this subset of positive risk/reward choices every week on Seeking Alpha.

I rate Walmart stock as Sell/Avoid at prices over $60.