Thursday, October 11, 2012

Wal-Mart's Share Repurchases

GuruFocus recently interviewed Steve Romick, the Portfolio Manager of FPA Crescent (FPACX):

According to Morningstar, here's how FPACX has performed recently and, more importantly, over the long haul. Also, here's a link to the Top 25 holdings in the fund.

In the interview, Steve Romick points out that Wal-Mart's (WMT) shares were selling for around $ 50/share last fall and, at the time, a multiple of earnings that was roughly 10 and a half. The stock has rallied almost 50% since then.

Romick also said the following about Wal-Mart:

The margins of Walmart don't move very much over time. In fact, of any company I've ever seen, the rate between the high margin and low operating margin is only 50 basis points. We're talking about an earnings growth that should be pretty close to revenue growth.

Then he later added:

...in addition to that we're getting the benefit of share repurchases. In the last decade they bought back more than 20% of the shares outstanding. It's like a creeping buyout for the largest retailer in the world. And we believed that they would continue to use their free cash flow to repurchase their shares at a rate of 2.5% or so per year. That added to our growth in earnings. And then we said they have a dividend on top of that. We added that to what we thought we could earn. By the time we were all done, we had an expected outcome, assuming no change in the P/E – which at the time was a lot lower than it is today – the expected outcome was going to be in a range of returns of anywhere from, call it 7% to 13%. We felt that we'd rather own this than bonds or cash. And we believed that it would be quite likely that we couldn't lose money, over time.

Back in July of 2011, this Michael Santoli article in Barron's pointed out that investors were effectively selling Wal-Mart back to the Walton family.

Related posts:
Selling Wal-Mart Back to the Walton Family: Part 1 - July 2011
Selling Wal-Mart Back to the Walton Family: Part 2 - July 2011

Well, with the shares having rallied so much, each buyback dollar now goes a whole lot less far. So the higher share price makes future buybacks less wealth enhancing for long-term Wal-Mart investors. The fact that the shares having rallied so much also assures that the process of selling of Wal-Mart back to the Walton family has been slowed.

Buying back the shares is now less effective though hardly ineffective. Shareholders, at least those in it for the long haul, benefit as long as shares are bought when selling below per share intrinsic value.*

The shares may no longer be exceptionally cheap, but they're not particularly expensive either at slightly more than 15 times earnings.

Still, the margin of safety that existed last year is no longer there.

Wal-Mart is as good a recent example as any why no long-term investor should cheer when the stock of a great durable franchise, especially those run by capable capital allocators, has rallied.

Adam

Long position in WMT established at much lower than recent market prices

* As long as the company is financially strong, has no other strategic need for corporate cash, and the necessary investments are being made that maintain, or ideally enhance, the size and strength of its economic moat.
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