Despite Strong Earnings, It’s Tough to Justify Walmart Stock’s Valuation

Walmart (NYSE:WMT) stock beat earnings on August 15. Shares popped from $106.20 to over $113 a piece pre-market. But the good news may not last. The specter of recession has hit the market. The U.S.-China trade war continues to accelerate. With these macro factors in mind, is it the right time to buy WMT stock?

Despite Strong Earnings, It's Tough to Justify Walmart Stock's Valuation
Despite Strong Earnings, It's Tough to Justify Walmart Stock's Valuation

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Investors are digesting the recent earnings report, and making predictions for the next quarter. The recent tariff hikes could materially impact Walmart’s gross margins. Add in an looming recession, and the future performance of Walmart stock could be negative.

Compared to peers such as Target (NYSE:TGT), Walmart appears overvalued. But despite this premium, is the stock a strong opportunity? Let’s have a look.

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After-Earnings Impact

Walmart released earnings yesterday. For the June-end quarter, sales were up 1.8% year-over-year. U.S. sales were up 2.8%, beating expectations. International sales fell 1.1%, due to a strong dollar. Adjusted for currency, net sales were up 3.3%. The company’s U.S. e-commerce business grew an impressive 37%.

Despite a bump in sales, operating income declined 2.9%. This was primarily due to losses at recent Flipkart acquisition. In terms of guidance, Walmart has reduced international net sales growth projections from 5% to ~3-4%. U.S. sales are expected to grow 3% for the year. Flipkart’s losses may cause a slight decrease in operating income for the year. But, excluding Flipkart’s performance, operating income should see a low-to-mid digit percentage increase.

With the company beating expectations, Walmart stock will see a short-term boost. But now attention moves to the second half of 2019. What type of impact will the U.S.-China trade war have on the Walmart stock price? Will the company’s e-commerce strategy pay off? Let’s take a closer look at these factors.

Trade and E-commerce Woes

Two concerns weigh heavily on the Walmart stock price. The first is the U.S.-China trade wars. With relations deteriorating, both countries are pursuing retaliatory action. The U.S. recently announced plans to raise tariffs on Chinese-made electronics and apparel items. But the White House has recently pushed back the tariff hikes until later this year. This could materially affect Walmart’s results in the second half of the year. With increased tariffs, gross margins will likely decline. This would have a negative impact on the Walmart stock price. Investors are anticipating continued growth. But if the tariffs are implemented, delivering said earnings growth could be a challenge.

The second factor that is top of mind is e-commerce. Walmart has made big investments in an attempt to compete with Amazon (NASDAQ:AMZN). Prior to Flipkart, the company acquired Jet.com in 2016. But the deal failed to meet expectations. Walmart gave up on turning Jet.com into a leading brand. Instead, the company has integrated Jet’s infrastructure into its existing e-commerce operations.

The Jet.com deal is a drop in the bucket for Walmart. The company generates about $27 billion in annual operating cash flow. But it could be years before the company succeeds in e-commerce. What does that mean for the Walmart stock price? At the current valuation, WMT stock trades a relatively high valuation. Let’s take a look at Walmart’s valuation relative to peers.

Overvalued Relative to Peers

Walmart stock currently trades at a forward price/earnings (forward P/E) ratio of 21.5. The company’s enterprise value/EBITDA (EV/EBITDA) ratio is 11.6. Compare this to the stock’s closer peer, Target. TGT stock trades at a forward P/E of 14.2, and an EV/EBITDA ratio of 8.3. As I discussed last month, Target shares are undervalued. Despite driving same-store sales growth, investors continue to value TGT at a discount to WMT.

With this in mind, it’s tough to justify the current premium of Walmart stock. While Walmart has substantial international presence, the company’s long-term growth projections are not setting the world on fire. If investor expectations are not met, material downside could be a risk. Shares of WMT stock could trade closer to Target’s valuation in the event of a downturn.

Bottom Line: Avoid Walmart Stock

There’s no doubt that Walmart is a solid business. The company’s market power and cash flow generation is currently stable. But long-term, the company faces many issues. Its e-commerce efforts remain a work-in-progress. With the recent trade war issues, the company’s dependence on imported consumer goods could be its Achilles heel. With Target trading a lower valuation, it is tough to justify the current Walmart stock price.

Investors could gain exposure to the same upside by buying TGT stock. All while getting in at a better valuation point. Investors should avoid WMT stock, and consider TGT if they want exposure to big-box retail.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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