Why Wal-Mart Stores, Inc. Is a Good Choice for Dividend Investors

By Markets Fool.com

Retail behemoth Wal-Mart is a member of the elite club of Dividend Aristocrats -- companies that have increased dividends for 25 consecutive years or more. With competition increasing in its primary U.S. market, Wal-Mart has struggled to increase sales and earnings in the past few years, but it never stopped raising its dividend.

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Wal-Mart has continuously raised dividend for the past 41 years, which makes it a favorite among investors seeking a tidy dividend income. The stock currently pays a dividend of $1.92 per share per year, for a yield of 2.1%. How did the retailer manage to keep raising its dividend, especially in the current situation, and can it maintain its track record over the coming periods? Let's take a look.

Wal-Mart's dividend: A perspective
In the past 10 fiscal years (Wal-Mart's fiscal year ends in January), the company has increased its dividend at a compounded annual growth rate of approximately 12.3%. Its last announcement was in February last year, when it raised its annual dividend by 2%, to $1.92 per share. The modest increase was bit of a disappointment for investors who are used to bigger increases, but whenever Wal-Mart has offered a single-digit increase in the past 10 years, it's generally followed it up with a generous rise in the next year:

Source: Wal-Mart; chart by author.

Wal-Mart has a low payout ratio, which leaves plenty of room for future dividend increases. Wal-Mart's payout ratio was roughly 39% in the 12 months ending in October 2014, up from about 31% two years prior, according to S&P Capital IQ data. With a payout ratio in the range of 40%, the company can sustain dividends even if there's some earnings volatility.

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Source: 10K; chart by author.

Cash flow generation is strong
In the latest third quarter, Wal-Mart's net operating cash flow increased 72.54% to $3.5 billion over the same period the previous year. The Street reported that this is higher than the industry average cash flow growth rate of 54%. The company generated free cash flow of $7.2 billion in the first three quarters of the year, compared with $3.8 billion in the same period in fiscal year 2014. During this period, it paid $4.6 billion to shareholders through dividends and $1 billion through stock buybacks.

Wal-Mart's strong commitment to return cash to its shareholders stems from its stable cash flow from operations and free cash flow-generating abilities. The company has one of the shortest cash conversion cycles in the industry. The cash conversion cycle is the time a retailer takes to buy goods to put into inventory, sell them, collect payments from customers, and pay off suppliers. And Wal-Mart does all this in less than 18 days. A shorter cycle means cash doesn't remain hung up in working capital and is freed more quickly.

Additionally, Wal-Mart has projected its total capital expenses to be in the range of $11.6 billion to $12.9 billion in fiscal 2016, down from the $12.5 billion to $13 billion projected for fiscal 2015, primarily because of lower investments in brick-and-mortar locations. This definitely is an encouraging sign, as it could leave the company with some extra cash that can be deployed to rewarding investors.

Source: 10K; chart by author.

Wal-Mart's compelling possibilities
Now, let's look at Wal-Mart's future earnings prospects, because that's what will drive future cash flows and the dividends that the company will pay out of it. The retailer has two areas of focus where it's putting effort -- smaller-format stores to compete with dollar stores such as Dollar Generaland Dollar Tree, and online sales.

Both strategies have been successful so far. Wal-Mart's U.S. comps increased 0.5% in the third quarter, aided by a 5.5% comps increase at Neighborhood Market stores, Wal-Mart's small-format outlets. Online sales grew 21% year over year, helped by solid results in key markets such as the U.S., China, Brazil, and Mexico.

During the third-quarter earnings call, Greg Foran, Wal-Mart's U.S. president and CEO, said, "In Q4, we will shift to a heavier mix of small formats, opening over 100 traditional Neighborhood Markets and 70 smaller ones." Wal-Mart's capital expenditure on e-commerce and digital initiatives is expected to be in the range of $1.2 billion to $1.5 billion during fiscal 2016, up from an estimated $1 billion to be spent during fiscal 2015.

Apart from this, Wal-Mart has been aggressively looking to gain traction in the organic food segment, which carries higher margins. The company renewed its partnership with Wild Oats, a leading provider of organic food items, last April.

Even in troubled times, Wal-Mart has rewarded shareholders with tidy dividends and share buybacks. The company's operating discipline and solid cash flow-generating abilities make this possible. As Wal-Mart continues to look for new growth avenues and invest in them, the behemoth remains committed toward investors who bank on it.

The article Why Wal-Mart Stores, Inc. Is a Good Choice for Dividend Investors originally appeared on Fool.com.

ICRA Onlineand Eshna Basu have no position in any stocks mentioned. Nor does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.