Wal-Mart Finally Gets Its Act Together

07/16/2007 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

Jon Markman, editor of Jon Markman’s Strategic Advantage, thinks the retailing giant’s latest turnaround plan may actually work.

As a certain UBS analyst so eloquently put it: "Since the start of the decade, Wal-Mart's (NYSE: WMT) stock has been dead money." How true that is, sadly. And what a come-down from its rocket-like performance of the late 1990s, when WMT shares rose sixfold in three years. Since then, shares have been stuck in terminal ennui around the $50 mark. (The stock closed just above $49 Friday—Editor.)

So, what's the problem? It appears that too much size can be a bad thing. WMT had a good strategy going with the idea of taking big-box shopping to the nth degree. But now that the rural regions of the nation have been saturated, Wal-Mart is having difficulty making new Supercenters near urban areas as profitable as its old ones.

The goal of the [company’s ambitious plans to remodel all of its US stores] plans was to attract more customers with higher incomes to its existing stores. The idea was sound, but it fizzled in practice. Next, WMT lowered prices on generic drugs and baby food in hopes of boosting sales growth. This didn't really work, either.

Now the behemoth is changing its course—again. But this time, I think they're taking the right steps to actually turn the company around, which would ultimately give us higher share prices.

At its June 1st shareholders' meeting, Wal-Mart announced that it would cut down on the construction of new Supercenters. Analysts are expecting the new growth rate to settle in the mid-single digits, which includes conversions of smaller stores to the larger Supercenter format. With capital expenditures scaling back, the incremental free cash flow will be used in a new $15-billion share-buyback program.

Another benefit of this decision will be management's ability to tackle some of the customer service problems weighing on the company's fortunes. Numerous surveys have cited long checkout lines, dirty bathrooms, and messy shelves. Low prices are nice, but shopping needs to be aesthetically pleasing, too, especially if you covet ritzier consumers. The addition of staff and store upgrades will pinch margins in the short term, but it should pay big dividends in brand equity over time.

According to UBS, two-thirds of Americans live within 15 miles of a Wal-Mart. With the store base established, this creates a great opportunity to capture a huge share of customers’ wallets, from electronics to food to fuel. Victory will come as more of its stores are stocked with trendy fashions, sushi and organic produce, are run by more professional associates and managers, and improve their décor and cleanliness.

I think Wal-Mart is on the right path to greater profits, and I am looking for earnings per share growth in the double-digits.  A conservative 17x multiple on my fiscal 2009 EPS estimate of $3.50 points to my 12-month target of $60. That's a 20%-plus move from here. Buy WMT.

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