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Is the Market too Enthusiastic About Wal-Mart?

John Brick, CFA

Wal-Mart's third-quarter results gave us further clarity on the company's various initiatives within its e-commerce and in-store strategies. The focus remains on its robust 50% e-commerce growth this quarter, which positively affected its U.S. comparable-store sales. The second focal point, in our view, was the low single-digit comparable-store sales increase in food. Management says that this was the strongest number in six years and remains a traffic driver for the firm. In combination, we believe these support Wal-Mart's wide-moat brand-intangible assets and dominant cost advantages.

Despite these healthy top-line results, underlying profitability and valuation leave us more tempered versus the market's reaction. This quarter, the firm posted a 30 basis-point decline in gross margins and a 40 basis-point decline in operating margins. When paired with the firm's fiscal 2019 guidance of only around 5% EPS growth, we see the rise in share price being caused by a rerating in the stock toward 21 times earnings (up from a historical 16 times), rather than being indicative of an improving earnings position. As a result, we will raise our $83 fair value estimate by a low single-digit percentage to incorporate the better than expected third-quarter sales results and the time value of money, but we recommend that investors wait on the sidelines for a better margin of safety before buying in to Wal-Mart.