The article I wrote yesterday on Wal-Mart (WMT) has had a controversial reception, to say the least. Just about every point I made has come under siege from one direction or another - while I expected that my valuation target would get some decidedly negative feedback from shorts, I wasn’t ready for the backlash that came from people claiming to be former employees or general activists opposing Wal-Mart moving into their area. I don’t take moral stances with investments though, so I’m going to try to avoid wading into that sinkhole and focus on operational and equity-related issues. I have to wonder what percentage of people are part of the anti-Wal-Mart movement though, given that the company is the nation’s (and world’s) largest retailer with $363 billion in sales. Just an extremely well-publicized and vocal minority? Perhaps…

One common reason I see for selling or avoiding WMT is the argument that an economic downturn will have a negative impact on sales. While I see many valid reasons to be bearish on the economy, you can look for stocks that hold up better than average in a recession. The obvious example that I’ve covered of late is why you should buy American Eagle Outfitters (AEO, Stock Report) rather than another retailer like Abercrombie and Fitch (ANF), because looking at the same-store comparables changes in difficult retail environments clearly shows that Abercrombie desperately needs a healthy economy to grow, whereas American Eagle is more resilient. How does Wal-Mart stack up in this comparison? Consider that from 2001-2003, when real per capita GDP growth in the US average 0.49%, Wal-Mart grew revenues by an average of 10.3% per year; net income averaged a 13% increase - actually above the ten year average of 12.8%. What should you take from this? No, Wal-Mart isn’t likely to run off a string of double-digit growth years (I believe the consensus targets are completely overstated), but the company should do fine regardless of the challenges the retail market faces. Companies do not grow to $360+ billion in sales by sheer chance.

My most pressing concern about Wal-Mart’s business model is the sustainability of its core advantage; namely, the ability to be the lowest-cost provider thanks to massive internal leveraging of store infrastructure. This isn’t a truly unique trait that absolutely cannot be replicated, but it will be very difficult (though possible with enough financing) to approximate Wal-Mart’s scale. Still, a retailer like Target (TGT - which actually operates in an entirely different demographic) had sales of $62 billion in the last year, or about 1/6 of Wal-Mart’s amount, similarly, Costco (COST) had $64 billion in sales. The gap between Wal-Mart and the next-closest competitor is immense; yet WMT trades at a discount to industry and general market multiples, suggesting that there is more risk to the stock. Does this make sense?

I’ve seen suggestions that the reason the market is so down on Wal-Mart is tied to the low same-store comparables. This is certainly a valid point, as comps are checking in around 2%. Still, I have to wonder who buys WMT looking for high comps growth. It takes a lot to move the needle from where it is, and just about any marginal gains should be satisfactory - I have Wal-Mart priced in as being less than a 5% bottom line grower in my valuation model, and I still come up with the stock as being undervalued. This is likely a consequence of having $18 billion in operating cash flow and a 35% cash return on invested capital.

While there are many corporate PR issues surrounding Wal-Mart, financially speaking, the company looks completely sound. With the stock at multi-year lows and trading at historically large discounts to typical multiples, buying WMT with the right time frame and context (not a growth stock, remember?) should yield excellent market-beating returns.

See the original WMT article.