Investment Valuation
Company Overview
Wal-Mart Stores Inc. (NYSE: WMT) is the largest retailer in the world. They operate in the discount segment of the mass merchandising category of retail, which is the largest segment in the United States and a major segment in a large number of nations. The company competes against firms such as Target, Costco and many other merchandisers in other segments, such as conventional grocery stores. Wal-Mart has approximately two million employees (MSN Moneycentral, 2009) and operates nearly 8000 stores worldwide (2009 Annual Report).
Wal-Mart’s sales totaled $404.9 billion in the latest fiscal year, from which they derived a profit of $13.3 billion. The revenue breaks down to 63.7% from Wal-Mart U.S., 11.7% from Sam’s Club (also U.S.) and 24.6% international. The company is active in a wide range of international markets including Canada, China, Mexico and the United Kingdom.
Of particular note is the success that Wal-Mart has enjoyed in the past year, in the face of the global economic downturn. While consumer spending dropped and many companies, both retailers and manufacturers alike, saw reduced revenues, Wal-Mart did not. The company increased revenues 7.1% is FY 2009. This result has been attributed to the value of Wal-Mart’s discount positioning. Consumers who were previously not Wal-Mart customers turned to the company’s stores as a means of stretching their increasingly thin budgets. Part of Wal-Mart’s strategy going forward to capture these new customers so that they continue to shop at Wal-Mart even when the economic situation improves (Cheng, 2009).
The industry in which Wal-Mart competes is highly competitive. The company has built its success based on many of the skills that its founder, Sam Walton, brought to the firm. Wal-Mart has developed competitive advantages both in merchandising, logistics and the application of information technology in retailing. With respect to the former, Sam Walton was an expert merchandiser, placing the right items in the right part of the store at the right time. Wal-Mart managers today micromanage the layout of their stores and the placement of products within that layout. Wal-Mart’s competencies in logistics allow them to reduce inventory space both in their stores and in their warehouses, lowering costs (Troy, 2003). Lastly, the company has developed strength in IT, such that managers have access to and make use of a constant stream of sales figures. This helps in ordering (inventory reduction) and merchandising. Wal-Mart’s size also gives them a sustainable competitive advantage with respect to purchasing, and they drive down prices paid to suppliers regularly in order to maintain their leadership position in the discount retailing segment. All of this is backed up by a corporate culture that supports finding new ways to reduce costs.
Ratio Analysis (* all ratios from MSN Moneycentral unless otherwise noted).
In general, Wal-Mart’s financials are strong. The company is relatively liquid. Their current ratio is 0.9, up slightly from previous years. The company has maintained a relatively steady quick ratio and cash ratio over three years. Both ratios dipped in 2008 but recovered in 2009 to or near prior levels.
The company maintains steady margins. The gross margin is 23.6% and has varied little in the past three years. This is consistent with the industry-wide margin of 24% (MSN Moneycentral, 2009). The operating margin was 5.6% in 2009, down slightly from previous years. However, the net margin of 3.3% represented an improvement from 2007 levels but was slightly worse than 2008 levels. All told, however, Wal-Mart maintains consistent margins.
The firm has consistently improved its inventory turnover. In 2009 this was 11.62, compared with 10.64 in 2008 and 10.23 in 2007. This consistent improvement shows that the company is turning over merchandise faster and growing inventory more slowly than it is growing sales. Given the economic crisis, it could reasonably be assumed that a retailer would increase its inventory while slowing sales, but this was not the case at Wal-Mart. Receivables turnover has varied, little and at 102.75 is stellar. The company collects receivables nearly immediately. Wal-Mart has steadily improved its asset turnover over the past three years as well. In 2009, asset turnover was 8.19, compared with 7.79 in 2008 and 7.41 in 2007. This improvement shows sales growing faster than assets. This is consistent with increases in same store sales, which is a key measure in retailing. Same store sales in the U.S. increased 3.5% in 2009; 1.6% in 2008 and 2.0% in 2007.
Despite these performance improvements, Wal-Mart’s returns have been on a slight downward trend. The company’s return on equity last year was 21.2%, compared with 21.0% last year but 22.0% in 2007. Similarly, the return on assets was 8.4% in 2009, 8.5% in 2008 and 8.8% in 2007. The slight decrease in returns, when combined with the increase in same store sales and improvements in inventory turnover, can indicate a number of issues. Some possibilities are that new stores are dragging on the performance of the company, which can be attributed in part to international growth, which is sometimes less efficient. New stores may also be cannibalizing existing stores to some degree, and Wal-Mart has addressed this issue by slowing the rate of domestic openings growth (Cheng, 2009).
Wal-Mart’s debt position has remained largely unchanged. The debt ratio has hovered in the 60% range for the past three years. This corresponds to a debt-to-equity ratio in the range of 1.5. There has been limited variability over the past three years.
Wal-Mart’s earnings per share (EPS) have grown steadily over the past three years, a function of steady earnings growth, driven by both same store sales and new stores. The 2009 EPS was 3.36, up from 3.16 in 2008 and 2.93 in 2007. The company has therefore been able to deliver consistent growth to its shareholders. They have even continued to do this in the face of the economic downturn. It has been speculated that the company has gained new customers as a result of consumers “trading down” to Wal-Mart from more expensive, higher-quality stores. This is indicated by the increase in the growth rate for same store sales in fiscal 2009 compared with other years. For its part, the company has anticipated this trend and made changes to its stores to ensure that it attracts more new customers and retains a high percentage of them (Cheng, 2009).
In terms of trend analysis, the company’s ratios are remarkably steady. Wal-Mart is engaged in the same business in which is has operated for years. They have strong control over their pricing, both in terms of purchases and sales. They have strong internal cost controls, a function of the cost-cutting culture that pervades. The levels of debt and margin at which Wal-Mart operates are steady at the levels at which the company wants them to be.
The company has continued to grow at a steady rate in terms of its sales and earnings. The most important of these to investors is the earnings per share. EPS growth was 10.5% in fiscal 2006; 7.35% in 2007; 8.2% in 2008; and 6.0% in 2009. This comes out to an average EPS growth rate of 8.0125%, or roughly 8%. If we extrapolate that for the next three years we can expect Wal-Mart to earn $3.78 per share in fiscal 2010; $4.08 in 2011 and $4.41 in 2012.
Stock Price Analysis
The share price for Wal-Mart as of market close on Friday June 5, 2009 was $51.07. This was significantly lower than the 52-week high but comfortably above the 52-week low. The company has been rangebound since the beginning of January, where it saw a steep drop in the first week. Five years ago the price was $52.76 and the stock has traded lower for much of the interim.
The S&P 500 over the past five years has demonstrated more volatility, riding higher highs from 2005-2008, then seeing a far more precipitous collapse in the second half of 2008. This is consistent with Wal-Mart’s beta, which at 0.20 indicates the firm is far more stable than the S&P 500. Appendix B shows the comparative chart from MSN Moneycentral for Wal-Mart and the S&P 500.
As an investment, Wal-Mart offers stability vs. The market. Part of the source of this stability is the size of Wal-Mart’s operations. They are the 2nd-largest company in the world by revenue and the third-largest by market cap (MSN Moneycentral, 2009). They also offer a hedge in times of economic downturn, since consumers turn to their discount model as a way of stretching their income further. Wal-Mart’s broad product line also helps to insulate them from economic movements.
The most significant question today with respect to investing in Wal-Mart is the valuation that the market currently has for the company. When it became apparent that Wal-Mart was benefiting rather than suffering as a result of the economic crisis, investors drove the stock price up substantially. It eventually fell, a result of somewhat soft numbers this past winter. However, the stock price has since begun to creep upwards again. We have estimated that the EPS will improve to $4.41 in the next three years. The current price for Wal-Mart implies strong growth prospects. The company does have a sound strategy to retain its new customers and refocus growth efforts on less-saturated markets overseas.
In short, while there can be little doubt as to Wal-Mart’s operational excellence, it is not necessarily a great investment. Growth has in recent years been of the slow and steady variety. The company’s present valuation may be symptomatic of its status as a safe haven for investors during tough economic times. This means that the growth implied by its current share price may not be justified. Therefore, while Wal-Mart is a great company to own, it may not be the best investment at its current price and with the market beginning to show signs of recovery. The 0.20 beta and historic low volatility mean that Wal-Mart shareholders will not reap the benefits of market increases. The best use of Wal-Mart in a portfolio would have been as protection last fall from the market declines. Thus, I do not recommend purchasing Wal-Mart now, unless taking a strong bearish view of the recovery from the economic downturn.
Foreign Operations
While three-quarters of Wal-Mart revenues comes from the U.S. market, concerns about cannibalization have convinced the company to shift strategy away from new domestic growth. Wal-Mart is now placing increased emphasis on international markets as a source of new growth. By store numbers, the largest international markets are Mexico (1197 units), Japan (371 units), United Kingdom (358 units), Brazil (345 units), Canada (318 units) and China (243 units). Much of the remaining international operations are in Central and South America (2009 Annual Report).
These figures highlight two key aspects of Wal-Mart’s international expansion strategy. One is that the company is expanding into a variety of international regions. This gives Wal-Mart a hedge against regional economic downturn in any one particular region. However, they also cluster their growth. They have parlayed the success of their Wal-Mex subsidiary into a strong presence in other Latin American markets, for example.
The other key aspect of Wal-Mart’s international expansion strategy is that they are expanding carefully. They have only entered one European market for example. They have stores in China and Japan, but not in other Asian growth markets. This steady strategy of not moving into too many different markets until they have built up share in existing markets has a corollary in their delayed entry into Canada and Mexico, which did not occur until they had attained substantial U.S. presence.
When Wal-Mart reports international operations, they do so on an aggregated basis. They do not provide in their 2009 Annual Report information about one specific international subsidiary. “International” is its own operating division for reporting purposes.
At present, the foreign operations are worth just under 25% of company revenues. Foreign stores are up 32.2% in the past three years. In the U.S., new store growth over the past three years was 6.1% for Wal-Mart stores and just 3.9% for Sam’s Club (2009 Annual Report). Correspondingly, international sales have been increasing in importance. In 2007, international sales accounted for 22.3% of the companies revenues. This increased to 24.1% in 2008, then again to 24.6% in 2009. In both 2008 and 2009, international sales growth was stronger than either domestic Wal-Mart or Sam’s Club sales growth. In 2009, international sales growth was 9.1% and in 2008 it was 17.6%. Domestic growth for those two years was 6.8% and 5.8% respectively. It should be noted that the improvement in the importance of international sales in 2009 was attributable in part to favorable currency exchange rates, which imparted a $4.5 billion gain (Ibid). Nonetheless, Wal-Mart sees its foreign operations as a major source of future income, particularly as the domestic market becomes increasingly saturated.
Global Analysis
The favorable exchange rate helped to mask what was otherwise a slow year for overseas growth in terms of contribution to revenue. However, international growth is still going to be the engine for Wal-Mart going forward. The company has set up an office in Hong Kong with an eye towards managing its Asian expansion, including operations in India, where the company has yet to set up a store.
Clearly, Wal-Mart views global operations as the key to growth in the future. They do not, however, see these operations as a means by which they can hedge against domestic downturn. This is because domestic operations have not experienced a downturn, even in the current economic crisis. Wal-Mart’s position as a discounter helped them to grow in the past year despite the adversity that hurt earnings at many other American companies. If anything, the economic crisis hurt international sales growth as opposed to domestic.
However, given the relative saturation of the U.S. market, there is little doubt that continued growth into China, India and Latin America in particular will drive Wal-Mart’s strategy for years to come. If revenue ever dips in the U.S. Or growth begins to slow significantly, the company is well-positioned to build out international operations to make up the difference. They are continuing to add stores in most of their overseas markets, and have developed models of operating in those markets that leverage Wal-Mart’s competitive advantages in back-end operations to achieve success with different retailing formats. The company’s entry into India, for example, has been as a back-end partner to an Indian retailer. Wal-Mart has opened restaurants in Mexico has part of its expansion strategy. They are finding new ways to leverage international expansion for the long-term well-being of the corporation as a whole.
Works Cited:
Wal-Mart 2009 Annual Report. Retrieved June 7, 2009 from http://walmartstores.com/sites/AnnualReport/2009/
Some financial data and ratios from MSN Moneycentral. Retrieved June 7, 2009 from http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=WMT
Cheng, Adriana. (2009). Wal-Mart needs to prove it’s more than a recession play. Marketwatch. Retrieved June 7, 2009 from http://www.marketwatch.com/story/wal-mart-needs-to-show-legs-beyond-recession-play
Loth, Richard. (n.d.) Financial Ratio Tutorial. Investopedia. Retrieved June 7, 2009 from http://www.investopedia.com/university/ratios/
Troy, Mike. (2003). Competitive advantage lies in systems efficiencies. DSN Retailing Today. Retrieved June 7, 2009 from http://findarticles.com/p/articles/mi_m0FNP/is_11_41/ai_87146180/
Appendix: Ratios
2009
2008
2007
Current ratio
0.9
0.8
0.8
Quick ratio
0.2
0.15
0.2
Cash ratio
0.13
0.09
0.15
Gross Margin
23.60%
23.40%
23.40%
Operating Margin
5.60%
5.80%
5.88%
Net Margin
3.30%
3.36%
3.23%
Inventory Turnover
11.62
10.64
10.23
Receivables Turnover
Asset Turnover
8.19
7.79
7.41
ROE
21.20%
21.00%
22%
ROA
8.40%
8.50%
8.80%
Debt Ratio
60.05%
60.48%
59.38%
Debt-to-Equity Ratio
1.5
1.53
1.46
EPS
3.36
3.16
2.93
Appendix B: Comparative chart Wal-Mart vs. S&P 500
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