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Walmart (WMT) reported better-than-expected sales and earnings for Q2. Moreover, free cash flow surged in the first half and Walmart raised its guidance. This implies WMT stock could rise further. It is up over 1.5% in morning trading on Aug. 18 to $158.10.
Walmart said that sales rose 5.7% to $161.63 billion for the quarter, vs. $160.27 billion expected by analysts. This included 6.4% comparable sales growth for stores open in the U.S. for one year or longer.
Moreover, earnings per share (EPS) came in at $1.84 vs. expectations of $1.71 for the quarter. According to the Wall Street Journal, people spent on necessities such as food and Walmart raised its full-year financial outlook. It cited its strong performance during the first half of the year.
Massive Free Cash Flow Growth
Moreover, the large retailer reported that its first-half free cash flow (FCF) skyrocketed to almost $9.0 billion, up from $1.75 billion in the same period a year ago.
FCF is the residual cash flow after all non-cash expenses are taken from sales, including capex spending as well as changes in working capital. FCF is the cash flow that is “free” to be spent on dividends, buybacks, debt-reduction, acquisitions, and cash accumulation.
Moreover, most of the FCF growth occurred during Q2. Figures from Seeking Alpha show that Walmart produced $8.78 billion in FCF in Q2 (i.e., $13,581 billion in cash flow from operations less $4.787 billion in capex spending).
Moreover, its sales for Q2 were $161.2 billion, which means that its FCF margin was 5.45% (i.e., $8.78 billion / $161.2 billion). We can use that to estimate a price target for WMT stock.
Target Price Based on FCF
For example, let's apply this margin to estimates for projected sales. Analysts forecast $637.4 billion for the year ending Jan. 2024 and $661 billion for Jan. 2025. On average that works out to $649.2 billion in sales over the next 12 months.
So, if we apply this recent 5.45% FCF margin against the $649 billion in sales forecast, we can project FCF of $35.4 billion in FCF.
This means that Walmart's FCF can be expected to surge over the next year. That will inevitably lead to a much higher stock price.
For example, at a 5% FCF yield, which is the same as a 20x multiple, Walmart could have a $708 billion market cap (i.e., 20 x $35.4 billion). That is significantly higher than its present $491.25 billion market cap. Even using a 6.5% yield, which is the same as a 15.38x multiple, Walmart would have a $544.5 billion market cap.
This is 10.8% higher than its present market capitalization.
That implies that WMT stock could rise at least 10.8% from today's price of $158.10, or a target price of $175.17 per share. And, as shown above, using a 20x FCF multiple, the stock could rise significantly higher than that target price.
Short Out-of-the-Money Puts
One way to conservatively play this is to sell short out-of-the-money (OTM) put options. This allows an investor, especially those that already own WMT shares, to collect extra income and potentially lower their buy-in cost.
For example, the Sept. 1, 2023, expiration put option chain shows that the $150 strike price puts trade for 37 cents. That means a short-seller of those puts can make an extra 25 basis points (i.e., 0.25%) with just 2 weeks until expiration.
That works out to an annualized yield of 6.4% if this same trade is repeated 26x a year. Moreover, investors can short the $152.50 strike price for higher income, if they believe that WMT stock won't fall by 3.5% to this strike price.
But, even if this does happen, the investor can potentially lower their buy-in cost with an exercise of the short sale trade. This would mean that the cash that has been secured to do the trade would be used to buy 100 shares of WMT at $152.50 per share.
At that point, the investor can then sell short OTM calls and higher strike prices. This could help create income that might reduce any unrealized loss from the exercise of the short sale puts of the stock at the $150 or $152.50 strike price.
The bottom line is that investors can see that WMT is worth substantially more than its present price based on its massive FCF. Selling short OTM puts is one conservative way to play the upside in the stock.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
