Over the past decade, there has been a significant divergence between Wal-Mart Stores’ experience from a business perspective and the returns experienced by the company’s shareholders. In April, I wrote an article outlining Wal-Mart’s track record over the past ten years and the risks of overpaying for a strong growth record. There are numerous other examples of well known companies that have advanced significantly in terms of business results over the past decade while stockholders received little if any return.
New Position Initiated
A new position in Wal-Mart has been initiated based on a number of factors. Much of the case related to Wal-Mart’s business track record was made in my prior article so I will not repeat all of the factors here. However, a few factors related to this decision are discussed below.
First, as my previous article outlined, Wal-Mart has proven its business model over a long period of time by demonstrating a remarkable ability to grow its top and bottom lines despite already being a very large enterprise ten years ago. During this time frame, store count nearly doubled, gross margins actually improved, and net profit margins remained relatively constant.
Wal-Mart has also made progress attracting middle class and upper-middle class customers who “traded down” to the retailer as consumer confidence plummeted over the past year. Many of these shoppers will not quickly abandon Wal-Mart when the economy recovers given that confidence will be shaky for some time to come and familiarity with the stores could build customer loyalty. Just as the Great Depression created a generation preoccupied with thrift, I anticipate that the current economic dislocation will lead to more appreciation for low prices in the coming years. As the low cost provider, Wal-Mart fills a need that will remain in demand.
Wal-Mart has been criticized recently by its decision to stop reporting monthly sales and sales forecasts. My view is that moving to quarterly reporting is a healthy development that will reduce investor fixation on ultra short term results and trends that can be influenced by numerous factors unrelated to the underlying economics of the business.
Although Wal-Mart’s valuation is now far more reasonable than typical valuations over the past decade, it should be noted that investors purchasing shares at current levels should be satisfied with returns correlating with business results rather than counting on a return to very high multiples of earnings.
Sears Holdings Shares Sold
To make room for Wal-Mart in the portfolio, profits were taken on shares of Sears Holdings after the recent advance in market price. While Sears Holdings is a retailer given its operations of Sears stores in the United States and Canada as well as K-Mart stores, the investment case for Sears Holdings has been related to the value of its real estate assets rather than the value of its declining retail businesses.
Chairman Edward Lampert is attempting to save the retail operations in an attempt to minimize job losses and impacts to local communities served by Sears and K-Mart. However, both retailers are suffering long term declines in business and it is clear that Sears Holdings is unwilling to make dramatic investments in the retail operations.
Bruce Berkowitz of The Fairholme Fund was recently interviewed by Outstanding Investor Digest regarding his investment in Sears Holdings among other topics. Berkowitz conducted an analysis last summer of the property tax assessments for real estate owned by Sears Holdings and came up with a valuation of $80 to $90/share for the real estate alone.
While these valuations may hold up, it is worth noting that much of the real estate is held in mall locations that are experiencing a long term decline as consumers increasingly favor big box store formats. Given that assessments for 2008 were set prior to the recent economic turmoil impacting commercial real estate, it seems prudent to assume that the real estate valuation is quite a bit less than $80/share today. If one further concludes that the retail operations are in a long term runoff, today’s price of $61 for Sears Holdings appears to lack a sufficient margin of safety even if some upside remains.
Disclosure: The author purchased shares of Wal-Mart Stores today at an average price of $49.99 and sold Sears Holdings shares at an average price of $61.05. This article should not be considered a recommendation to buy or sell securities and readers should conduct their own due diligence prior to making any investment decisions. The author has no obligation to update this article in light of changing future circumstances or post an article prior to taking further actions in either security discussed.