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Wal-Mart: Looking for a catalyst

Generic drugs could help revive growth for the world's largest retail chain.

By Michael Sivy, Money Magazine editor-at-large

NEW YORK (Money) -- In chemistry, a catalyst is a substance that speeds up a reaction - or may be crucial to having it take place at all.

Stocks sometimes need catalysts, too. A company may have all the pieces in place for a major rebound, but need some trigger to attract investors' attention.

Wal-Mart is in just such a situation. Shares of the world's largest retailer are just a few dollars above their five-year lows - and down more than 25 percent from their all-time highs.

In fact, it seems as though Wal-Mart (Charts) should merit a higher price. While the stock has languished, sales are up more than 50 percent over the past four years. And earnings per share are up more than 80 percent.

So why has Wal-Mart's stock declined since 2002 when all the results were rising? The answer: Growth has slowed. Although sales for the first three quarters of this year have risen 12 percent from a year earlier, earnings per share are up only 6 percent.

This profit slowdown is the result of a number of factors - fears of a falloff in consumer spending, high gasoline prices that discouraged trips to the mall, and price competition with rival chain Target (Charts). In addition, Wal-Mart has had some trouble fine-tuning its product mix to attract more affluent shoppers.

The good news in this temporary funk is that Wal-Mart shares are attractively priced. The average stock in the S&P 500 trades at more than 17 times earnings for the current year. Wal-Mart, which has historically sold at a premium, now goes for less than 16 times earnings.

And it looks as though the earnings slowdown won't last long. First of all, Wal-Mart's international business is doing great. Operating income from continuing international operations was up more than 16 percent over the past nine months and more than 18 percent in the most recent quarter.

The key issue is reviving profitability in Wal-Mart's domestic stores. A certain amount of sales growth is baked in the cake. In the coming year, Wal-Mart plans to open more than 600 new outlets worldwide, including a 7 percent increase in domestic floor space. It wouldn't take much of an increase in same-store sales to turn that into double-digit revenue growth.

Generics could do the trick

At some point, investors will recognize that the stock is poised for a rebound. What's needed to speed up that process is a catalyst. And sales of generic drugs may give Wal-Mart just the boost it needs.

The Food and Drug Administration estimates that consumers could save at least $25 billion a year by using generic drugs. Such drugs, which have lost their patent protection, typically sell for only a fraction of the price of newer brand-name drugs.

For many people, the older drugs work just as well as the newer ones. And there is a tremendous potential market for large-scale retail chains that can move volume at very low prices.

This business is made for Wal-Mart (and its rival Target). Both companies offer a growing list of major generic drugs for as little as $4 a prescription. Wal-Mart aims to make such drugs available in all 50 states by early next year.

Not only will generics represent a new profit center, they could also bring consumers into Wal-Mart outlets who have not previously shopped there.

Moreover, a growing list of prescription drugs with sales of more than a billion dollars annually will lose patent protection over the next few years and become available as generics. And government attempts to slow the rate of rising health-care costs will encourage the sale of such products.

Whichever discount retailers take the lead in that business should recover their growth-stock reputation. If Wal-Mart succeeds, its own shares could turn out to be the company's biggest bargain.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.