Walmart Leaps, idea #1

Long leaps expiring January, 2012, $30 strike    Currently trading at $24, vs $54 underlying stock price   Multiples for underlying:   Trading at 15.3x earnings, vs. 7 year average of 20x earnings   Trading at 3x book, never traded this cheap (on average annual basis).  7 year average is 4.2x   .5x p/sales per share, vs .7x p/sales per share, 7 year average   Meanwhile, revenues and margins were stable throughout recession.  How can the market be predicting they're going to go down from here?   Walmart underwent multiple compression as did all risky assets. Yet, it was operationally one of the most successful businesses during the recession.  As multiples of all risky assets and yields of corporate bonds regained ground during market recovery, Walmart did not gain much.  It should have recovered it's old multiple at the very least.  It should be the star of the show instead of a laggard.   Technical Positives:   9 analysts upped their 2011 estimates, vs. 1 analyst lowering estimates.       During the nastiest times of the financial collapse the shares traded at a low of $46, only $8 below current price, 14.8% below current share price.    There are consistently less shares outstanding every year.  11.7% less shares outstanding now than there were 5 years ago, yet revenues, gross profit and net income have increased dramatically.     2004 revenues : $258 billion 2009 revenues:  $403 billion   2004 shares outstanding:  4.3 billion current shares outstanding:  3.8 billion   Stable margins!   The share price is basically the same as it was in 2004.    A lot of good, long-term investors are buying.  Buffett just doubled.  Either Walmart is a coiled spring or, as Mr. Market looks at Walmart, something bad is going to happen to their revenues/operations.    Market fears:   -         channel check product of grocery areas (~30% of revenue) seems to be very "proctor & gamble" like in product mix.   Big name, value added type grocery products that are not healthy and out of fashion.  Will the consumer wake up to healthy eating ideas that don't include value added, heavily branded products like rice-a-roni, potato chips, and soda pop?  Will they wake up out of necessity and start cooking from more basic ingredients (plain rice & salt instead of rice-a-roni,?) -         70% of their products are made in China as reported by some detractors of walmart.  Dollars are leaking out of our country and outward appearance is that the biggest, fattest conduit for the leakage is Walmart.   Zillions of corporations have manufacturing based overseas that profit from the same cheap labor, Walmart is just the distributor.  Amazon sells the same stuff and trades at 40x – 70x earnings, vs. Walmart's 15x earnings.  Everything is made in China . Walmart is the face of this issue.  Walmart has an unsustainable 12,500 mile supply chain. -         Labor issues.  Walmart just settled a $40 million lawsuit in the N.E. for locking employees in the store.  More lawsuits will come?   Can they be material or just psychological?  $40 million per state, 49 states left (at worst) is $1.9 billion.  Walmart sneezes $2 billion.   Fascinating history of walmart litigation.  Apparently Walmart is sued 2-5 times per business day somewhere in the United States .   http://www.wal-martlitigation.com/99verdic.htm   Catalysts   Buybacks and free cashflow Continued interest in value investors Flight to safety Inflation protection Walmart has pricing power and shelfspace to take advantage of alleged "over capacity" in economy.   Why Leaps:   Black scholes option value calculator says that if market volatility doubles, and share price collapses to 52 week low, then calls will go down in value by 19.3% (vs. 14.8% for the underlying).    Market volatility was over 4x higher than it is now during the collapses in share prices last spring & fall, so the value of the calls will likely go down by even less than 19.3%.   Purchasing the underlying stock for cash gives you a 1:1 return.  Purchasing $30 calls for control over the equivalent amount of shares, and keeping the remaining cash on the sidelines, gives you a 1:.58 upside/downside scenario in the above mentioned case.  You will suffer 58% of the loss (but still capture 100%) of the gain if we encounter the same selloff we had last fall, with only half the volatility.     Negatives & Uncertainties:   Walmart has been getting cheaper.  My valuation based on multiples isn't useful in determining a bottom since every year it was cheaper than the previous year. Walmarts dividends are steadily increasing, which is bad for call holders.   Why is the market letting it get cheaper?  When will the bottom be?  Why isn't the market recognizing walmart's overwhelming success during the recession?    Healthcare uncertainty.  My understanding is that it's just as likely to be helpful for walmart, as hurtful.   Great VIC writeup on WMT in Nov, 2009 references underlying real estate value compared to a reit, improving employee base, smart management decisions, and rapidly improving roi compared to comps.