Big Box Retailer Ready for Big Turn

The bottom may have bottomed out in terms of sentiment and stock valuation.  Here’s an option strategy to generate both short term income and longer term gains in this big box blue chip.  

Wal-Mart is far and away the largest retailer in world.  It also one become of the most universally hated; many of its over 2 million employees have long felt exploited.   Its customers  have always had  a loved hate relationship; they were loyal for the low prices but have come to despise the shopping experience and began turning to better run competitors such as Target (TGT)  and or online shopping such as Amazon (AMZN) for convenience and comparable prices.

And lastly, even shareholders which had been richly rewarded for decades, have been complaining and jumping ship.  Over the past six months shares of Wal-Mart have slipped over 20% from their January high.   But the stock put in a key reversal on July 1st holding the important $70 level and have since formed a bullish flag above the long term down trend line.

WMT chart 7.15.15

From a technical standpoint this offers a good risk/reward entry point for establishing a bullish position.

Fundamental Improvement 

Given its massive size of a $240 billion market cap and over $450 billion in annual sales there’s not any one, or even many, things Wal-Mart can do to move the needle over the short term.   But it has taken a host of steps to suggest it is the process of turning this big ship around.

It recently raised the minimum wage and became more willing to let workers exceed 30 hours a week which let them qualify for benefits such as healthcare.  While some of this done out of necessity and public relations it will actually pay off on the bottom line.  Aside from fewer strikes the higher wage will lead to lower turnover.  One the largest costs is bringing finding and training new employees.

One analyst even calculated the wage increase would actually save WMT money through a reduction in theft by employees http://jeffmacke1.tumblr.com/post/121205049853/walmarts-wage-increase-are-workers-stealing-less  .   Again, the numbers themselves are small enough to almost not matter but no one can dispute happier and more productive workers are good for business.

To win back customers Wal-Mart has also taken an aggressive and increasingly innovated tact.  After an increase in complaints about empty shelves the company is making sure it is carrying the right inventory.  It has redoubled its online efforts especially in the gaming and electronic space.  It is being more selective with promotions trying to emphasize loyalty programs instead of just slash and burn sales events.

Shares currently trade at just 14x next year’s earnings, a deep discount Target, Family Dollar or Costco whose p/e ratios are all above 30x forward earnings.

The stock is also offers a 2.85% dividend yield.  As long the 10-year treasury note remains below 2.5%  Wal-Mart’s dividend should act as price support for the stock near the $70 level.

The Trade:  

I want to use an option strategy in which we can replicate that dividend yield by generating short term income premium while also maintaining longer term capital gains potential.

I am using a combination of a sale of near term put spread and the purchase of a longer term call.

Specifically;

-Sell August $72.50 puts

-Buy August $67.50 puts

For $1.05 net credit 

And

-Buy January $75 calls 

For $2.45

The total three strike positon costs a $1.40 net debit. 

The concept here is the sale of the August put spread, which expires August 21st, helps finance the purchase of the January $75 call, which expire 1/15/2016.

Here is what the risk/reward and pertinent stats on the position look like:

WMT bull combo part 2 7.15.15

I think the stock should hold above the $72 level.   I would have an initial price target of $77 a share which would deliver at minimum an 80% return.

— Steve Smith

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About the Author: Steve Smith