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What's in Store for Wal-Mart?

Erik Kobayashi-Solomon

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor newsletter. A few weeks ago, I wrote an article about Wal-Mart, the giant retailer, where we stand to gain about 50% profit over about a year's time.

To find more about Wal-Mart, I've invited associate director of the retail team and the coverage analyst for Wal-Mart, Joel Bloomer, to come and talk to us today. Thanks for coming.

Joel Bloomer: Sure.

Kobayashi-Solomon: One of the things that I worry a little bit about Wal-Mart is, a few years ago when they started expanding overseas, I think they kind of flubbed things a little bit. I know their expansion in Germany didn't work out very well. What do you think the risk is that the same kind of thing will happen again?

Bloomer: You're right. They have had some stumbles in the past, and I think Germany is a good example of that. It was about a billion-dollar investment. They were in the market for about eight years and, basically, lost money over that entire period, sold the business in '06 for about a billion-dollar loss, which equates to shareholder value destruction.

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Kobayashi-Solomon: See, this worries me already, because we've got a bullish position on.

Bloomer: The one major lesson that you'd take away from that is that you have to adapt your strategy to the local market. You can't force the local market to adapt to your strategy. And in Germany, they tried to really force what they were doing here over there.

But that's somewhat isolated. Outside of Germany, South Korea didn't go as well, but that was a much smaller venture. Outside of those, it's actually doing pretty well. They've learned their lessons. They know you need to kind of get your toe in, learn the market, grow from there.

Kobayashi-Solomon: And where are their biggest overseas markets right now?

Bloomer: Well, the largest non-U.S. would be--Mexico is a very large market.

Kobayashi-Solomon: Oh, sure.

Bloomer: Canada. So North America's a big piece, in general. Latin America, Brazil, is doing very well, and they're growing pretty quickly there. China's becoming a big piece, and obviously if that continues to go well, that could become a very large piece.

Kobayashi-Solomon: Sure.

Bloomer: Japan, making some strides there.

Kobayashi-Solomon: One thing that you've highlighted in your research, and that I kind of glommed onto, is now they're really trying to consolidate their growth and trying to reduce their capital expenditure budget and boost that free-cash-flow margin. The thing that I worry about is that if you have a company that's worked for years and compensated people for years on expansionary policies, can they really make this paradigm shift and start to produce more cash with the sales that they're generating?

Bloomer: In Wal-Mart's case, I think one thing that gives me comfort around the whole situation is their efficiency, both from an income statement perspective as well as a capital allocation perspective, has always been there. And an overriding goal over the whole period is to be the best retailer, not just the biggest. They become the best by being the biggest, but there's a culture that's always been there.

Kobayashi-Solomon: "Two executives to a hotel room" kind of culture, right?

Bloomer: Yeah. Yeah, exactly. They take cost control to the extreme through the whole process. So some of the international expansion wasn't as great as they had hoped. But for the most part, it's done well. They've allocated that capital well. And what you alluded to in the U.S., they've realized, well, maybe expansion's done, or close to done anyway. So they've pulled back and just make existing stores much more efficient. They find ways to squeeze even more costs out, maybe position themselves to gain share, and do other things with that cash, whether it's international expansion or, hopefully, returning some to shareholders.

One thing about Wal-Mart that's, I think, sometimes overlooked is they're decent with allocating shareholder capital in terms of stock buyback. Or from a dividend perspective, they've been growing the dividend at a pretty healthy clip for a decade. And now that the stock price has been flat for a little bit, you get a yield that's 2%-ish.

And I think going forward, that dividend growth should continue, high single-digit, maybe. It's not hard to add up a 10% total return for a company that I think most people think of as just "It's done. It's grown. It's where it is, and it's going to stay there."

Kobayashi-Solomon: Right. Sure.

Bloomer: I don't know if that's quite the case.

Kobayashi-Solomon: I'm glad you say that. That's really what I'm thinking, that there is kind of a bottom on the share price and that they're pushing up that bottom with the increased cash flow.

Bloomer: Yeah, I think so.

Kobayashi-Solomon: Joel, thanks a lot for coming today. I really appreciate it. And thank you for joining us. Please stop by the OptionInvestor Web site, where we have hundreds of terrific option ideas based on Morningstar's fundamental research.