Monthly Archives: February 2011

FPA Crescent Fund Q4 2010 Letter

FPA is out with their Q4 2010 letter and, as usual, it is worth carefully reading. Steve Romick is a great investor with a fabulous record. I have great admiration for his disciplined and thoughtful investing process.

Here is his thesis on Wal-Mart.

Wal-Mart (WMT) seems anomalous in a world where stocks have rebounded so dramatically from the stock market’s 2009 bottom. Wal-Mart’s stock averaged $48.59 in February 2009 (We are using the average in the month its price hit bottom, as it seems more relevant since it is only the rare circumstance and good fortune that allows one to accumulate a position on the day the market decides to price a stock at a low). At that price, it traded at a TTM and Forward P/E of 14.5 and 13.0x, respectively. Wal-Mart closed 2010 at $53.93 per share – more dear in price but cheaper in valuation – trading at a lower TTM and Forward P/E of 13.3 and 12.1x, respectively.

With more than 8,000 stores in 15 countries, in excess of 2 million employees, and more than 200 million customers each week, most everyone has heard of Wal-Mart. And yet, it seems relatively ignored by investors – a big change from a decade ago, when the market deemed its growth expansive enough to justify it trading ~40x earnings (both trailing forward). Investors may be disappointed in its stock price over the last decade, but we don’t feel there’s much to complain about as far as its revenues and earnings growth go. Revenues grew at a 9.4% rate, while earnings per share compounded at 11.5%.

So where does that leave us, and how do you make money in a company that already has revenues exceeding $400 billion and a market capitalization approaching $200 billion? We now feel that Wal-Mart has grown its way (via earnings) into its stock price. We view Wal-Mart as an infinite duration bond with a rising coupon – a “bond-like equity.” We believe Wal-Mart can grow at an acceptable rate well into the future and that the company will pay a fair dividend, as well as opportunistically repurchase shares, which should provide a high single-digit to low double-digit total return over time – not bad in the context of low single-digit interest rates.

We do not know if the above scenario will play out as exhibited, but we take comfort in the following:

  • Revenues have grown 5%, 8% and 9% in the last 3, 5, and 10 years, respectively. More than 25% of Wal-Mart’s sales come from overseas, and we expect foreign economies to continue to grow better than our own. After dividends and share repurchases, we expect there to be additional free cash flow that will be used to drive the top line.
  • Operating margins are unusually stable, ranging between 5.6% and 6.1% over the past decade. Wal-Mart has exhibited tremendous margin stability, in part due to their stated goal of delivering cost savings to their customers in the form of lower prices. By not taking price into margin, we expect they will be able to pass through price increases in an inflationary environment – an advantage vis-à-vis competitors that keep efficiencies for themselves. We also note that extremely high inflation would hurt unit sales.
  • Shares outstanding have declined by an average 2.2% per year since 2001 and have accelerated in recent years. In the first nine months of 2010, shares outstanding declined by 5.4%.
  • The dividend payout ratio has increased in each of the last 10 years, from 17% in 2001 to 29% today.
  • Incremental returns on capital have been quite good as management proudly exhibited in the company’s most recent 10-Q. Return on investment for the trailing twelve month period, adjusted to include rent, increased from 18.4% to 18.6%, and return on assets increased from 8.2% to 8.8%.


FPA Crescent Q4 Investor Conference Call