WALMEX HOLD. Have You Looked at P/BV? (12/14/05) CURRENT PRICE: US$5.81/M$62.35 TARGET PRICE: US$5.70/M$65.00

Transcription

1 Latin American Equity Research Mexico City, December 15, 2005 WALMEX Have You Looked at P/BV? Company Report Mexico Retail HOLD Joaquin Ley* Daniela M. Bretthauer* Mexico: Banco Santander Serfin, S.A Brazil: Banco Santander Brasil, S.A. (5255) (5511) (12/14/05) CURRENT PRICE: US$5.81/M$62.35 TARGET PRICE: US$5.70/M$65.00 What s Changed Rating: Unchanged at Hold Price Target: From US$4.95 to US$5.70 EPS Estimates (US$): 05 From 0.20 to From 0.22 to From 0.26 to 0.28 Company Statistics Bloomberg WALMEXV MM 52-Week Range (US$) E P/E Rel to IPC Index (x) E P/E Rel to Retail Sector (x) 1.0 IPC Index (US$) 1,683 3-Yr CAGR (04-07E) 20.8% Market Capitalization (US$ Mn) 25,240 Float (%) 36 3-Mth Avg Daily Vol (US$000) 28,803 Shares Outst (ADR 10:1) 4,343 Net Debt/Equity (x) -0.2 Book Value per Share (US$) 1.13 Estimates and Valuation Ratios E 2006E 2007E Net Earn (NomM$) 7, , , ,537.7 Current EPS Net Earn (US$) , ,237.3 Current EPS P/E (x) P/Sales (x) P/CE (x) FV/EBITDA (x) FV/Sales (x) FCF Yield (%) 1.1% 2.0% 2.5% 3.4% Div per Share (US$) Div Yield (%) 0.7% 1.0% 1.2% 1.4% Sources: Bloomberg, Company Reports, and Santander Investment estimates. Investment Thesis: Since early August (please see Thanks for Shopping Walmex; Downgrading to Hold, August 3, 2005) Walmex s shares have risen 21.8% in U.S. dollars, that is, in line with the 22.6% increase posted by the IPC index over the same period. While we have no doubt that Walmex s results will continue to be positive in coming years, we also believe that the current valuation level is excessive. Walmex trades at a 12MF FV/EBITDA of 14.6 times, above the second positive standard deviation for the last four years average, a level which was not sustainable in the past. Even more important, from a 12MF P/BV approach, Walmex s trades at 4.7 times (all-time high), when we anticipate a return on invested capital of 24.5% 12 months from now. In other words, investors are currently asking for a meager 5.2% return on their equity investment for the next 12 months, a level that does not even match the Mexican risk-free rate, which we expect to be 6.3% by year-end Therefore, it is not only that Walmex s current forward valuation does not consider any equity risk premium, but it reflects almost no country risk. Thus, we believe that the stock s valuation is ahead of itself and that a correction might be on its way. Reasons for Change to Price Target/Estimates: We have increased our 2005, 2006, and 2007 U.S. dollar EBITDA estimates by 4%, 8%, and 9%, respectively, based on: (1) our assumption of a stronger FX rate; (2) the incorporation into our earnings model of the 25 extra stores for the 2005 expansion plan announced last September; and (3) betterthan-expected SSS in recent months. The higher EBITDA estimates, as well as a more aggressive target 12MF FV/EBITDA multiple (11.8 times versus 11.3 times previously) lead us to raise our target price for year-end 2006 to US$5.70 (M$65.00) per share from US$4.95 (M$58.50) previously. We are maintaining our Hold rating on Walmex s shares. Valuation and Risks to Investment Thesis: Our target price is based on a target 12MF P/BV of 4.2 times leading to a return on investment of 6.3% for minority stockholders, assuming a 2007E ROIC of 26.6%. This leads to a target 12MF FV/EBITDA of 11.8 times, almost in line with its last four years average. Risks to our investment thesis include slower-than-expected SSS growth, worse-than-anticipated working capital management, and a narrower-than-expected gross margin. * Employed by a non-us affiliate of Santander Investment Securities, Inc. and is not registered/qualified as a research analyst under NASD rules.

2 Have You Looked at P/BV? With total sales of US$12.6 billion, EBITDA of US$1.1 billion, and net income of US$702 million in 2004, Walmex is the largest Mexican food retailer. At year-end 2004, the company operated 361 self-service stores, 50 department stores, and 284 restaurants for a total selling space of 2,361,000 square meters and 63,000 seats. According to our estimates, Walmex had a market share of 43% within the formal food retail sector in Wal-Mart owns 64% of the total outstanding shares, and the remaining 36% could be considered as free float. VALUATION Despite very sound 3Q05 results, as well as impressive same-store sales (SSS) growth rates posted in recent months, Walmex s shares have not outperformed the IPC index during the second half of Since early August, Walmex s stock price has surged 21.8% in U.S. dollars, in line with the 22.6% performance posted by the IPC index over the same period. In our opinion, this relates to the already high valuation levels reached by the stock. Going forward, we believe that Walmex will manage to continue posting EBITDA growth rates close to 20%. Following our 23% real peso EBITDA growth forecast for 2005, our estimates call for a 20% increase in 2006 and a 17% rise in This is based on an aggressive organic expansion (15% in 2005, 13% in 2006, and 12% in 2007), supported by the low penetration levels (less than 80 square meters per thousand inhabitants) of the food retailing industry in Mexico; improved execution mainly through better logistics (we believe the bulk of the benefits from the cold chain still remain to be seen); and a favorable private consumption environment. In addition, for the medium and longer term, the implementation of the RFID (Radio Frequency Identification) technology, as well as a potential entrance in the consumer finance business could provide further room for growth, in our view. However, we tend to believe that despite the expected future growth, Walmex s current forward valuation has reached an excessive level, and it already reflects, in our opinion, the profit growth rates for at least the next three quarters. Thus, we believe the stock s valuation is actually ahead of itself and that a short term correction should not be ruled out. FORWARD P/BV Walmex s currently trades at a 12-month forward P/BV of 4.7x, which is 45% above its last four years average of 3.3x. This re-rating would appear acceptable if we consider that Walmex s return on invested capital (ROIC) has surged from levels of 17% four years ago to an expected almost 23% by year-end However, we expect Walmex to post a ROIC of 24.5% 12 months from now. While the figure is, in our view, impressive for a food retailer, we believe it does not justify the current forward valuation on a P/BV basis, since minority stockholders, at this level, would be getting a meager 5.2% return on their equity investment. According to the returns implied by the ROIC/PBV in the past, Walmex seems to have always been considered a fixed income instrument, rather than an equity investment since there is no trace of an implied equity risk premium in recent history. However, at current levels, Walmex s forward valuation is reflecting almost no country risk premium (the U.S. 10 Years bond yield currently stands at 4.5%), which we believe is unwarranted. From a fundamental perspective, it is a fact that any equity investment should, at the very least, compensate for the risk-free rate (it should also compensate for the equity risk premium, but that has not been the case in the past for Walmex). We expect the Mexican risk-free rate measured through the yield to maturity of the UMS15 bond to reach 6.3% by yearend Since we are working with a forward multiple, at year-end 2006 we will be making reference to the 2007E ROIC, which is 26.6%. In order to obtain a minimum return of 6.3%, and 2

3 assuming that the ROIC is 26.6%, the maximum forward P/BV we would be willing to pay by year-end 2006 is 4.2x. A target 12MF P/BV of 4.2x derives into a target price of US$5.70 per share (M$65.00) for year-end Figure 1. Walmex Current and YE06 Estimates 12MF P/BV, 12MF ROIC and 12MF Return on Equity for Minority Stockholders Current Estimated 12MF P/BV MF ROIC 24.5% 26.6% 12MF Return on Equity 5.2% 6.3% Source: Santander Investment. Figure 2. Walmex 12MF P/BV versus 12MF Return on Equity Investment (ROIC/PBV) for Minority Stockholders, January 2002 to Date 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% Current 12MF PBV 4.7x Current 12MF Return on Equity 5.2% % 2.0 J-02 A-02 O-02 D-02 A-03 O-03 D-03 J-04 O-04 D-04 F-05 M-05 S-05 D-05 12MF Return on Equity for Minority Stockholders 12MF P/BV Source: Santander Investment. Figure 3. Walmex ROIC, E. Figures in Millions of Constant Pesos as of Dec E 2006E 2007E + Average ST Assets Ex-Cash 10,055 11,014 12,276 12,860 13,969 15,443 17,620 20,007 +Average Net Fixed Assets 34,473 36,764 40,364 43,042 45,956 49,244 54,185 59,149 +Average Deferred Assets Average ST Liabilities Ex-Debt 12,629 14,146 16,041 15,846 17,968 21,155 24,133 27,403 - Average Deferred Liabilities 5,200 5,736 5,884 5,850 5,535 4,646 3,900 3,377 = Average Invested Capital 26,698 27,896 30,716 34,207 36,422 38,887 43,773 48,376 EBIT 4,878 6,105 7,130 8,012 9,840 12,233 14,931 17,556 Cash Tax Rate 27.2% 27.1% 26.8% 35.8% 26.6% 28.5% 27.6% 26.6% NOPLAT 3,549 4,448 5,217 5,140 7,221 8,747 10,817 12,886 ROIC 13.3% 15.9% 17.0% 15.0% 19.8% 22.5% 24.7% 26.6% Sources: Company reports and Santander Investment. FORWARD FV/EBITDA (ARITHMETIC AVERAGE) The year-end 2006 target price we set based on a target 12MF P/BV of 4.2x implies a target 12MF FV/EBITDA multiple of 11.8x. That would be basically in line with the last four years average of 11.7x, and 19% below its current level of 14.6x. The current 12MF FV/EBITDA multiple is already above the second positive standard deviation for the last four years average of 14.2x, a level that was not sustained in the past (please see Figure 4), and as well as in the case of the P/BV, we regard as excessive. 3

4 Have You Looked at P/BV? Figure 4. Walmex 12-Month Forward FV/EBITDA Multiple January 2002 to Date (Arithmetic Average) SD SD 12.9 Average 11.7 Current SD SD J-02 A-02 O-02 D-02 A-03 O-03 D-03 J-04 O-04 D-04 F-05 M-05 S-05 D-05 Sources: Company reports and Santander Investment. One might argue that given the faster EBITDA growth rates as well as the expansion in ROIC, Walmex s target 12MF FV/EBITDA multiple should deserve a premium on its historical valuation. From a growth perspective it might not be that clear, since the EBITDA CAGR for the E period is 18% in real pesos and we estimate 20% for The average ROIC for E is 19.6%, and we expect a 24.7% ROIC for From that perspective, Walmex s target valuation should have a premium on its historical average, and it does not from a FV/EBITDA perspective, but it does on a P/BV basis (remember that our target 12MF P/BV is of 4.2x versus an historical average is 3.3x). The reason is that the expansion in Walmex s ROIC is not only due to a growing EBIT, but also to significant improvement in working capital management, which is not reflected in the EBIT but in the BV through lower equity needs. The improved working capital management, coupled with the share buy backs and dividends, imply that the company s BV has grown at a much slower pace than the operating profit. Therefore, the real re-rating of Walmex s valuation should take place on a P/BV basis rather than on a FV/EBITDA basis. FORWARD FV/EBITDA (MOVING AVERAGE) Nevertheless, our 11.8 times target 12MF FV/EBITDA multiple for year-end 2006 might also imply a premium to its historical average. Instead of calculating the last four years arithmetic average, we can also build a 24 months moving average, in order to soften the effect of the valuation bubble, which occurred in early 2002 (please see Figure 4). In that case, the current 12MF FV/EBITDA average stands at 11.3 times, against which our target represents a 5% premium. 4

5 Figure 5. Walmex 12 Month Forward FV/EBITDA Multiple January 2002 to Date (24 Months Moving Average) Current Average J-02 A-02 O-02 D-02 A-03 O-03 D-03 J-04 O-04 D-04 F-05 M-05 S-05 D-05 Sources: Company reports and Santander Investment. Figure 6. Latin American Retailers Valuation Table, Closing Prices as of December Current Target Mkt EV/EBITDA P/E Company Country Rating Price Price Cap 04 05E 06E 04 05E 06E Alsea Mex Restr 2.45 Restr Comerci* Mex Hold , Cencosud* Chi Buy , D&S Chi Hold , Falabella* Chi Hold , Gigante* Mex Uperf Globex Bra Uperf Guararapes* Bra St. Buy , La Polar* Chi Buy Liverpool* Mex Uperf , L. Americanas Bra Buy , L. Renner* Bra St. Buy Natura* Bra Hold , Pão de Açucar Bra Buy , Ripley* Chi Buy ,605 NA NA Soriana* Mex Hold , Submarino* Bra Buy Walmex* Mex Hold , Average NA not available. Sources: Company reports and Santander Investment estimates. *Year-end 2006 price targets. EARNINGS REVISIONS Figure 7. Walmex Estimates Revisions, 2005E-2007E (U.S. Dollars in Millions a ) 2005E 2006E 2007E Previous Current Change Previous Current Change Previous Current Change Revenue 15,166 15,496 2% 16,406 17,245 5% 18,810 19,699 5% EBITDA 1,396 1,445 4% 1,561 1,691 8% 1,822 1,986 9% Op. Profit 1,099 1,143 4% 1,235 1,360 10% 1,454 1,608 11% Op. Margin 7.2% 7.4% 2% 7.5% 7.9% 5% 7.7% 8.2% 6% Net Income % 957 1,050 10% 1,121 1,237 10% EPS % % % a Except per share data. Sources: Company reports and Santander Investment estimates. 5

6 Have You Looked at P/BV? We are revising our 2005, 2006, and 2007 estimates on the back of several factors: (1) We are including the 25 extra store openings for 2005 announced since last September, which add some 2% of additional selling space; (2) we are also factoring our assumption for a stronger FX rate, which explains almost half of the upward revision of our U.S. dollar estimates; and(3) we are increasing our SSS growth estimate for 2005 from 5.3% to 6.3% on the back of better-thanexpected results in recent months. Positives Fast EBITDA growth rates. Expanding return on invested capital. Strong industry leadership. RFID and consumer finance provide further room for growth in the medium and longer terms. Concerns Valuation likely ahead of itself. Eventual changes to VAT (not foreseen for the short term) would be a negative. MACROECONOMIC ASSUMPTIONS Figure 8. Mexico Select Economic Projections, F F 2006F Real GDP (%) 1.4% 4.4% 3.2% 3.3% CPI Inflation (%) 4.0% 5.2% 3.2% 3.8% US$ Exchange Rate (Year-End) US$ Exchange Rate (Average) Interest Rate (Year-End) 6.0% 8.5% 8.3% 7.3% Interest Rate (Average) 6.2% 6.8% 9.2% 7.7% Fiscal Balance (% of GDP) -0.6% -0.3% -0.2% -0.2% Current Account Balance (% of GDP) -1.4% -1.3% -1.7% -2.0% International Reserves (US$ Bn) Total External Debt (% of GDP) 22.2% 21.2% 20.0% 19.7% Source: Santander Investment historicals and forecasts. RISKS TO INVESTMENT THESIS A poorer-than-expected SSS performance would have a negative impact on our top line growth estimate and would likely erode EBITDA margin following a decrease of the company s operating leverage. This would lower our estimated EBITDA growth, and therefore could have a negative impact on our target price. An unexpected worsening of the company s working capital structure could have a negative impact on both target price and rating. If inventory turns perform worse than expected; and/or payables deteriorate following a potential more aggressive strategy with suppliers, it would likely hurt the whole working capital structure, thus potentially affecting free cash flow generation negatively. We are looking for Walmex s gross margin to remain fairly stable going forward, as any cost benefit is expected to be translated into lower prices for consumers. However, if a massive opening of low gross margin formats (bodegas, clubs), and/or stepped-up competition, as well as deteriorated macroeconomic conditions put pressure on gross margin, consequently negatively affecting EBITDA, returns on investment, and cash flow generation, that could threaten our target price and rating. An unexpected slow down of the expansion plan could also have a negative effect in our estimates. A significant portion of the EBITDA growth we anticipate for the future should come 6

7 from selling floor expansion. If that expansion were to be reduced, our estimates could be negatively affected. Changes to the VAT law could have a negative impact on our estimates and target price. Applying a VAT rate to those products, which currently have a 0% rate might hurt both sales and gross margin. However, changes to the VAT law do not seem to be on the Mexican Congress schedule. 7

8 Have You Looked at P/BV? FINANCIAL STATEMENTS 8 Figure 9. Walmex Income Statement, Balance Sheet, and CF Statement, E (U.S. Dollars in Millions) Income Statement 2004 % 2005E % 2006E % 2007E % Sales 12, , , , Cost of Sales -9, , , , Gross Profit 2, , , , Oper. and Adm. Expenses -1, , , , Operating Profit , , , Depreciation EBITDA 1, , , , Financing Costs Interest Paid Interest Earned Monetary Gain/Loss FX Gain/Loss Other Financial Operations Profit before Taxes , , , Tax Provision Profit after Taxes , , Subsidiaries Extraordinary Items Minority Interest Net Profit , , Balance Sheet 2004 % 2005E % 2006E % 2007E % Assets 6, , , , Short-Term Assets 2, , , , Cash and Equivalents 1, , , , Accounts Receivable Inventories 1, , , , Other Short-Term Assets Long-Term Assets Fixed Assets 4, , , , Deferred Assets Other Assets Liabilities 2, , , , Short-T. Liabilities 1, , , , Suppliers 1, , , , Short-Term Loans Other ST Liabilities Long-Term Loans Deferred Liabilities Other Liabilities Majority Net Worth 4, , , , Net Worth 4, , , , Minority Interest Cash Flow E 2006E 2007E Net Majority Earnings , ,237.3 Non-Cash Items Changes in Working Capital Capital Increases/Dividends Change in Debt Capital Expenditures Net Cash Flow Beginning Treasury 1, , , ,138.6 Ending Treasury 1, , , ,412.1 Sources: Company reports and Santander Investment estimates.

9 Figure 10. Walmex Income Statement, Balance Sheet, and CF Statement, E (Millions of Constant Pesos as of December 2005, CF Statement in Nominal Pesos) Income Statement 2004 % 2005E % 2006E % 2007E % Sales 144, , , , Cost of Sales -114, , , , Gross Profit 30, , , , Oper. and Adm. Expenses -20, , , , Operating Profit 9, , , , Depreciation 2, , , , EBITDA 12, , , , Financing Costs 1, , , , Interest Paid Interest Earned , , Monetary Gain/Loss FX Gain/Loss Other Financial Operations Profit before Taxes 10, , , , Tax Provision -2, , , , Profit after Taxes 8, , , , Subsidiaries Extraordinary Items Minority Interest Net Profit 8, , , , Balance Sheet 2004 % 2005E % 2006E % 2007E % Assets 74, , , , Short-Term Assets 26, , , , Cash and Equivalents 12, , , , Accounts Receivable 2, , , , Inventories 12, , , , Other Short-Term Assets Long-Term Assets Fixed Assets 47, , , , Deferred Assets Other Assets Liabilities 25, , , , Short-T. Liabilities 20, , , , Suppliers 16, , , , Short-Term Loans Other ST Liabilities 3, , , , Long-Term Loans Deferred Liabilities 5, , , , Other Liabilities Majority Net Worth 48, , , , Net Worth 48, , , , Minority Interest Cash Flow E 2006E 2007E Net Majority Earnings 7, , , ,537.7 Non-Cash Items 2, , , ,705.7 Changes in Working Capital , , ,613.6 Capital Increases/Dividends -4, , , ,174.9 Change in Debt Capital Expenditures -5, , , ,468.4 Net Cash Flow , ,213.7 Beginning Treasury 12, , , ,378.6 Ending Treasury 11, , , ,592.3 Sources: Company reports and Santander Investment estimates. 9

10 Have You Looked at P/BV? IMPORTANT DISCLOSURES Walmex 12-Month Relative Performance (U.S. Dollars) Walmex IPC D-04 F-05 M-05 A-05 M-05 A-05 S-05 O-05 N-05 D-05 Sources: Bloomberg and Santander Investment. Walmex Three-Year Stock Performance (U.S. Dollars) B $ /23/02 B $ /2/03 B $ /14/ B $ /5/05 B $ /8/ S-02 D-02 J-03 S-03 D-03 J-04 S-04 D-04 M-05 S-05 Source: Santander Investment. H $ /28/03 B $ /6/03 Walmex (L Axis) B $ /14/04 B $ /15/04 H $ /3/05 IPC (R Axis) 1,700 1,500 1,300 1, Analyst Recommendations and Price Objectives SB: Strong Buy B: Buy H: Hold UP: Underperform S: Sell UR: Under Review 10

11 Key to Investment Codes IMPORTANT DISCLOSURES (CONTINUED) Rating Definition % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months Strong Buy Expected to outperform the local market more than 15%. Buy Expected to outperform the local market 5%-15% % 75.00% Hold Expected to perform within a range of 5% above or below the local market % 20.83% Underperform Expected to underperform the local market 5%-15%. Sell Expected to underperform the local market more than 15% % 4.17% Under Review The numbers above reflect our Latin American universe. For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are 2005 year-end unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53 rd Street, 17 th Floor (Attn: Research Disclosures), New York, NY USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for establishing Argentina recommendations is our forecast of the year-end Argentina IFCI index. For the Andean countries, our benchmark is the simple average of the country risk of each country plus the 10 year U.S. T-Bond yield plus 5.5% of equity risk premium. For additional information about our rating methodology, please call (212) This report has been prepared by Santander Investment Securities Inc. ( SIS ) (a subsidiary of Santander Investment S.A., which is wholly owned by Banco Santander Central Hispano, S.A. ("Santander"), on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This document must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Central Hispano Bolsa, Sociedad de Valores, S.A. (SCH Bolsa), and in the United Kingdom by Santander Central Hispano S.A., London Branch (Santander London), which is regulated by the Financial Services Authority in the conduct of investment business in the UK. This report is not being issued to private customers. SCHI, Santander London, and SCH Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Joaquin Ley and Daniela M. Bretthauer. Grupo Santander receives non-investment banking revenue from the subject company. The information contained herein has been compiled from sources believed to be reliable, but, although all reasonable care has been taken to ensure that the information contained herein is not untrue or misleading, we make no representation that it is accurate or complete and it should not be relied upon as such. All opinions and estimates included herein constitute our judgment as at the date of this report and are subject to change without notice. Any U.S. recipient of this report (other than a registered broker-dealer or a bank acting in a broker-dealer capacity) that would like to effect any transaction in any security discussed herein should contact and place orders in the United States with SIS, which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the U.S. Securities Exchange Act of 1934) for this report and its dissemination in the United States by Santander Investment Securities Inc. All Rights Reserved. 2005