WMMVF - Wal-Mart de México: Looks Undervalued And Set To Build On A Winning Hand

2023-09-23 01:49:01 ET

Summary

• Walmex is benefiting from ongoing investments in price and assortment, expansion of its eCommerce operations, and growth in ancillary service operations.
• Walmex's second quarter results were healthy, with revenue and EPS meeting expectations and same-store sales comps outperforming the industry average.
• Near-term challenges include a slowdown in Mexico's retail sector and economic uncertainty due to the upcoming presidential election, but Walmex is well-positioned to weather these challenges and capitalize on future growth opportunities.
• At around 15% to 20% below my estimate of fair value, Walmex is well worth a closer look.

Same-store sales comps are normalizing in Mexico, but I don't think that this is the beginning of a more challenging time for leading Mexican retailer Wal-Mart de Mexico (WMMVY)(WMMVF)(WALMEX.MX) (or "Walmex"). Instead, I expect to see the company continuing to benefit from ongoing investments into price and assortment (including private label), ongoing expansion of its eCommerce operations, and ongoing growth in its small but potentially lucrative ancillary service operations.

Trading around 15% to 20% below my estimate of fair value (and about 20%-25% sell-side price targets), Walmex is almost cheap enough that I wonder what it is I'm missing. Inflation is leading to some trading-down among consumers (and decreased spending in general) and there could be some turbulence ahead from the next election cycle, but I believe Walmex is poised to weather these challenges and benefit not only from its internal growth drivers but also what I see as underappreciated growth potential in Mexico's economy from further nearshoring and export growth.

A Quick Look Back

Looking back at Walmex's second quarter, there really wasn't much to pick at in terms of the reported results. Absent an unexpected tax issue in Central America (having to do with a change in the taxable base, I understand), EPS would have grown by about 12% and met sell-side expectations.

Revenue rose a little more than 9%, beating by about 1%, with almost 10% growth in Mexico and 6% growth in Central America. On a same-store basis, sales rose 8.5% in Mexico, outperforming the ANTAD industry average by a comfortable 40bp (after modest underperformance in Q1'23), while Central American same-store comps grew 9.5%.

Walmex already has a price gap relative to its peers (Walmex charges less and strives to be the low-cost retailer), but the company is continuing to invest in price as a way to drive increased market share and customer retention. That largely explains the modest decline in gross margin (down 10bp to 23.3%), with Mexico gross margin down 30bp to 23.1%. EBITDA rose a little less than 9%, with margin down 10bp to 10.2%; EBITDA in the Mexican operations rose more than 9%, with margin down 10bp to 10.5%.

By store concept, Sam's Club was the highest-performing business, followed by Bodega Aurrera (a discount retailer focused more on appliances, electronics, and so on), and Walmart. Walmart Express showed a slight negative comp in the quarter, and was also the weakest of the four in the prior quarter, but I don't think there's anything fundamentally broken here.

Near-Term Challenges And Opportunities

Mexico's Economy - Uncertainty Now, But Better Days Ahead

After seeing a strong post-COVID rebound, sales growth trends are definitely slowing in Mexico's retail sector. Comps (as per ANTAD) improved 6.3% in July but slowed to 3.1% in August, or modestly negative after adjusting for inflation. Trading-down remains a significant driver in the sector as customers try to deal with inflation, but it seems to be impacting rivals like Soriana ( ONZBF ) to a greater extent than Walmex - likely in part due to the ubiquity of Walmex (there's one within 10 minutes of about 90% of the population) and the company's ongoing efforts to lower prices.

Given how tied the economies of the U.S. and Mexico are, a further slowdown in growth does some likely for the remainder of 2023 and 2024, with GDP growth expected to slow to around 2.6% this year and 2.1% next year. On top of that, the Mexican presidential election in mid-2024 is likely to lead to more economic uncertainty and deferrals on capex/investment spending, as companies wait to see how this process sorts out (and what the candidates pledge in their attempts to garner votes).

I expect most of this will be background noise for Walmex, as the company is heavily invested in its discount retailer positioning and focuses on price and consumer necessities - a company like La Comer ( LCMRF ) that targets more affluent customers may have more at risk if the economy weakens more than I expected (and conversely more to gain if the economy proves stronger).

Beyond the next year or so, I remain bullish on Mexico's economic prospect. Nearshoring is likely to drive substantial investments in infrastructure, to say nothing of creating significant numbers of higher-paying export-driven jobs. As that plays out, I expect Walmex to benefit.

Multiple Growth Drivers Worth Watching

I also see numerous company-specific drivers at play here.

While Walmex will likely never stop targeting ever-lower prices for customers, I expect the intensity of some of these pricing and supply actions to wane a bit after this year. Still, I see an ongoing opportunity for the company to continue to increase the share of private label goods sold through its stores, and I likewise still see store expansion opportunities (more for Sam's and Bodega) throughout its footprint.

Another important driver to watch is eCommerce. At present this is only about 5% to 6% of the sales base, as Mexican consumers have been slower to adopt online retail habits, but the company has seen a strong response to its On-Demand service expansion (where customers can order online and pick up in a store in as little as an hour). Net sales from eCommerce grew 21% in the second quarter, with a 25% increase in GMV.

Walmex is also looking to leverage numerous complementary service opportunities to generate more profits from its existing asset and customer bases. Its Walmart Connect advertising service saw mid-teens growth in 2022, and while it's just a fraction of a percent of total revenue now, the number of Campaigns is up 30% year over year and this is high-margin incremental revenue. At the same time, the company continues to grow its Cashi financial services and BAIT prepaid phone and connectivity businesses. BAIT users have increased more than 2-fold this year (to over 6M users) and management is looking to make Cashi an open-loop consumer payments platform that can offer digital wallets, cash-in/cash-out services, and payment transfers (not unlike the Spin platform at FEMSA (FMX)).

All in all, while core store-based retailing will be at the heart of Walmex's business model for a long time to come, management is actively looking to drive increased volumes through existing systems. Efforts in e-commerce better utilize existing logistics infrastructure (including 32 distribution centers and a huge store base) and take advantage of best practices developed competing with Amazon ( AMZN ) in the U.S., and offers a level of pricing and convenience that many Mexican retailers simply can't match. Likewise, efforts like Connect, Cashi, BAIT, and Extended Assortment allow Walmex to better monetize existing customer relationships and offer additional profitable services to customers (like Cashi's payments or Salud's health services) with very low incremental cost and investment.

The Outlook

I do expect Walmex's growth to slow some going forward as there just aren't the store location expansion opportunities that there once were. Still, with value-added services like eCommerce, Connect, Cashi, and BAIT growing, I believe Walmex can still drive 8%-plus long-term annualized growth across the next decade.

I also expect this to be profitable growth. Squeezing substantially more profitably out of the core store-based retailing formats may be more challenging, but add-on opportunities like Connect and eCommerce should offer attractive incremental margins with relatively little spending/investment needed to support that growth beyond promotional efforts. I'm looking for EBITDA margins to improve by about 10bp a year over the next three to five years, and over the long term I think free cash flow margins can climb from around 6% recently (2023 will be a below-average year due to a capex program driven by store remodeling) to around 7.5%, helping drive low double-digit annualized FCF growth.

Discounting those cash flows back, I think Walmex is priced for an attractive low double-digit long-term annualized return and is around 20% undervalued today. I get a similar result with a margin/return-driven EV/EBITDA approach that produces a "fair" forward multiple of 13x and a fair value around 16% higher than today's price. I'd also not that while I don't really like using P/E-based valuation, the shares currently trade a little more than 10% below the trailing mid-term (three to five years) average.

The Bottom Line

I'm actually surprised that Walmex comes out looking as undervalued as it does; I'm perhaps more bullish on Mexico than some, but my estimates for the next couple of years are only slightly (<1%) higher than the sell-side averages. In any case, I think Walmex sets up as a classic "the strong getting stronger" story as the company leverages its considerable advantages in merchandising, logistics, pricing, and so on to drive more revenue and profits from its existing customer base and take even more share from smaller retailers less able to compete on price or breadth and depth of service.

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