Company report: Wal-Mart

Company background Sam Walton founded Wal-Mart in 1962 in Rogers, Arkansas.  The company was built around Sam Walton’s business philosophy of attracting customers with low prices while providing them with good customer service.  Starting from small towns in the South and Midwest of the Unites States, Wal-Mart expanded into the larger cities and eventually worldwide.  Wal-Mart became listed on the New York Stock Exchange on August 25, 1972.

Wal-Mart operates various kinds of retail stores both in the Unites States and internationally.  In the Unites States, Wal-Mart operates under two segments.  The first segment includes the Wal-Mart stores, which encompass discount stores, super centers, and neighborhood markets.  Wal-Mart is also present on the World Wide Web at Walmart.com.  Wal-Mart stores offer a wide variety of products (e.g. shoes, clothes, food, and toys) and services (e.g. photo processing and health and beauty aids) that appeal to the whole family.

The second segment includes the Sam’s Club stores, which include the warehouse membership clubs in the United States and Samsclub.com.  As of July 31, 2005, Wal-Mart operated 1,276 Wal-Mart stores, 1,838 super centers, 92 neighborhood markets, and 556 Sam’s Clubs in the United States.[1]  Internationally, Wal-Mart operates in many countries such as Canada, Brazil, Mexico, and South Korea.

The Walton family is Wal-Mart’s largest shareholder with 40.4% of the company’s outstanding shares.  As of September 30, 2005, the three largest institutions holding Shares of Wal-Mart were Barclays Global Investors Intl. (2.9% of shares outstanding), Fidelity Management & Research Co. (2.4% of shares outstanding), and State Street Global Advisors (1.9% of shares outstanding).  As of June 30, 2005, the mutual funds with the most stake in Wal-Mart were Vanguard 500 Index Fund  (0.8% of shares outstanding), Fidelity Magellan Fund (0.5% of shares outstanding), and Spdr Trust (0.4% of shares outstanding).[2]

Following are a few numbers showing the magnitude of Wal-Mart’s operations.  Wal-Mart counts 1.2 million full-time and part-time associates in the United States and serves 100 million American customers every week.[3]  Worldwide, Wal-Mart counts 1.7 million full-time employees.[4]  Global sales in 2004 reached $285 billion.  In the United States, it is estimated that Wal-Mart sales account for 8% of retail sales (excluding automobiles).[5]  Today, Wal-Mart is the dominant player in the American retail industry and is continuing to expand.  Wal-Mart is known as a major blue chip.

MAJOR FACTORS 1) Valuation (as of December 2, 2005)

A comparative analysis of Wal-Mart’s price ratios shows that Wal-Mart’s valuation is in line with its competitors, industry, and the S&P 500.  A closer look into the P/Sales ratio reveals that Wal-Mart may be undervalued if compared to the S&P 500.  Wal-Mart’s P/Sales ratio (0.67) is less than half the S&P 500 P/Sales ratio (1.50).  This relatively low P/Sales ratio may indicate that investors are expecting lower revenue growth from Wal-Mart and its competitors than from other companies in the S&P 500.

This is understandable due to the retail nature of Wal-Mart’s business, which, in normal circumstances, grows with the opening of new stores and higher sales from existing stores.  The low P/Sales ratio for retail companies is an indication that investors perceive the growth in the retail sales business to be incremental at best.  It is important to indicate that this low ratio is due to the nature of Wal-Mart’s business and not to the fact that investors are bearish on Wal-Mart.

On the other hand, an analysis of the P/BV ratio indicates that the market recognizes Wal-Mart’s ability to leverage its assets more efficiently than the industry benchmark and the S&P 500 to create value.  This can be explained by the fact that companies in the retail industry, contrarily to other industries with heavy machineries and substantial fixed assets, can generate large revenues and profits relative to their asset base.  A comparison of Wal-Mart’s P/BV ratio with that of its competitors shows the positive perception investors have of Wal-Mart’s ability to leverage its assets relative to its competitors.

Table 1: Wal-Mart’s Price Ratios Relative to Competitors, Industry, and S&P 500[6]

Wal-Mart Target Costco Industry S&P 500 P/E 18.9 22.7 22.4 18.2 19.0 Dividend Yield 1.20% 0.70% 0.90% N/A 1.40%[7] P/Sales 0.67 0.96 0.44 0.62 1.50 P/BV 4.19 3.52 2.59 3.68 2.87 As for the comparison of the P/E and P/BV over the past 9 years, it suggests that Wal-Mart’s ratios are getting back to their 1996 levels, before the peak of the stock market bubble at the turn of the millennium.  This movement downward in the valuation of Wal-Mart is not due specifically to significant developments in Wal-Mart’s affairs, but rather to more moderate overall investor optimism and to more conservative valuation methods as well as growth projections.

Table 2: Wal-Mart’s P/E and P/BV[8]

Wal-Mart 1996 1998 2000 2002 2004 Average P/E 19.50 20.80 43.70 34.10 26.30 Average P/BV 3.16 4.82 9.44 7.61 5.32 2) Earnings Growth and Potential

An analysis of Wal-Mart’s operating numbers over the past five years shows sustained growth in both sales and earnings.  It is to be noted that this relatively constant and solid growth is due to same store sales, the opening of new Wal-Mart stores in the United States, and international expansion.  The constancy with which Wal-Mart has grown its sales is indicative of Wal-Mart’s ability to meet its customers’ needs, control its stores’ operations, and plan its global expansion strategy.

Table 3: Wal-Mart’s Sales and Earnings Growth Rates

2002 2003 2004 2005 Sales 13.8% 12.3% 4.8% 11.3% Earnings 6.0% 20.5% 12.6% 13.4% Wal-Mart’s future growth, in addition to coming from traditional areas (mentioned in the previous paragraph), should also stem from Wal-Mart’s larger presence on the Internet.  Contrarily to pure Internet retailers like Amazon.com, WalMart.com’s strategy is two-fold: to increase revenues from on-line sales and to provide support to its existing stores.  WalMart.com provides support to existing stores in many ways.  It helps customers locate existing stores with the “store locator”, prepare for the purchase of more expensive products by providing them with advice and information before they get to the store, and it exhibits the wide range of products that customers can find in Wal-Mart stores.

Because Wal-Mart caters to the middle and low-income segments of the population, providing for many of their basic needs, it is relatively immune from an eventual deceleration of the economy.  In fact, as the erosion of America’s middle class continues, Wal-Mart’s customer base could even expand further.

As is outlined in its 2005 Annual Report, Wal-Mart plans to continue pursuing an aggressive geographical expansion and market coverage.  Wal-Mart plans to open as many as 530 new stores during the next fiscal year (250 super centers, 45 discount stores, 40 Sam’s Club, and 30 neighborhood markets) in the United States.  On the international front, Wal-Mart plans to open as many as 165 new stores.  As it pursues its strategy of expanding its market coverage, Wal-Mart still has many years of solid growth ahead.  It is to be expected, however, that as Wal-Mart reaches a “critical size”, it will see its growth rate decelerate and stabilize unless it decides to engage in the aggressive pursuit of new growth opportunities outside of the retail sector.  This would require Wal-Mart to redefine its mission statement.

3) Special Aspects (Unnoticed by Market)

Because Wal-Mart’s stocks are so widely held and because so many analysts follow the company, it is unlikely that major aspects of Wal-Mart’s business go unnoticed by investors.  It is, however, possible that some of Wal-Mart’s strengths or weaknesses are not being assessed appropriately.  Wal-Mart has developed what can be seen as one of the most sophisticated logistical and supply chain management systems in the retail industry.  This technological and organizational achievement, combined with Wal-Mart’s successful partnership with suppliers worldwide, may be undervalued by the market.  With globalization underway, Wal-Mart is better positioned than many of its competitors worldwide to capture market shares in new emerging mass consumption markets.

4) Financial Condition

Wal-Mart is in healthy financial condition.  Its operating margin is improving at a stable rate, from 22.7% in 2002 to 24.5% in 2005.  Its ROE and ROA are also stable and improving.  Wal-Mart’s debt is under control.  The debt/equity ratio has been steadily declining, from 0.53 in 2002 to 0.48 in 2005.  Wal-Mart generates ample income to cover its interest expenses, with an interest coverage that is improving year over year (14.4 in 2005).

Although asset turnover has been slightly decreasing from 2002 to 2005, it remains at an adequate level.  The decrease in asset turnover is due to Wal-Mart’s substantial investments in property and equipment, which have increased at a faster relative rate than sales.  Investments in properties and equipment were financed partly from retained earnings and partly from debt.

Because of Wal-Mart’s financial strength, it can adequately finance its capital expenditures, and should interest rates rise, it should be able to both cover higher interest payments and reimburse the capital.  Wal-Mart is very successful in maintaining extremely low levels of receivables relative to its level of sales (2005 receivables/sales was 0.006) and is also very successful at churning its inventory (2005 inventory/sales was 0.103).  These numbers are indicative of the sound financial management practices being applied at Wal-Mart, which are key to earning investors’ confidence and trust.

Table 4: Wal-Mart’s Operating Ratios 2002 2003 2004 2005 Operating Margin 22.7% 22.9% 24.0% 24.5% ROE 19.0% 20.4% 20.8% 20.8% ROA 8.0% 8.5% 8.6% 8.5% Debt/Equity 0.53 0.50 0.46 0.48 Current Ratio 1.04 0.93 0.92 0.90 Interest Coverage 9.0 12.8 15.0 14.4 Asset Turnover 2.61 2.58 2.44 2.37 Receivables/Sales 0.009 0.009 0.005 0.006 Inventories/Sales 0.104 0.102 0.104 0.103 6) Market/International Competitiveness

The retail sector is changing due in part to Wal-Mart.  Wal-Mart’s ability to pressure the price of consumer products downward is redefining the reality of the retail industry in the United States and worldwide.  This is the new competitive reality of the mass retail market.

While Wal-Mart continues to gain strength in its current markets, with its state of the art logistical systems and proven ability to expand rapidly into new areas, it is well positioned to make in-roads into other markets.  With the creation and expansion of a middle class in developing countries like China and India, global retail perspectives for Wal-Mart remain optimistic.  While other retail companies may also tap into these opportunities, they do not possess some of Wal-Mart’s key competitive advantages, such as:

-         Enormous bargaining power.

-         State-of-the-art logistics and distribution system.

-         Proven organizational model to open new stores.

-         Strong organizational culture and strong management team experienced in operating in a global context.

While Wal-Mart’s competitors are trying to emulate Wal-Mart in its areas of greatest competitiveness, none of them have reached Wal-Mart’s level of success and efficiency.  Wal-Mart is currently the global market leader in the retail sector and is likely to remain the leader for the foreseeable future.

7) Management

With an impressive track record of growth and profitability, Wal-Mart has one of the most experienced and talented team of managers in corporate America.  Their strategic vision is clear: to provide products at the lowest prices possible in a friendly environment to the largest customer base possible.  This strategic vision has been directly inspired from Wal-Mart’s founder, Sam Walton.

Wal-Mart’s discount pricing philosophy is based on the premise that by cutting its price, it can increase the volume of its sales.  Wal-Mart’s three main pricing philosophies are:

1)      Every Day Low Prices (EDLP): Wal-Mart aims to offer every day low prices (not only during a sale).

2)       Rollback: Whenever it can, such as when it can buy the product at a lower cost, Wal-Mart rolls back its prices.  This is shown to the customers by a Rollback smiley face next to the price.

3)      Special Buy: Even if Wal-Mart tries to offer every day low prices, it sometimes also engages into sales, and when it does, the Special Buy logo is there to indicate to the customer that he or she is getting an “exceptional value”.

In addition to trying to offer the lowest prices possible, Wal-Mart prides itself in providing customers with exceptional service.  To achieve that goal, Wal-Mart developed an established corporate culture of customer service, information sharing, and positivism.

Although Wal-Mart enjoys success with customers, it has strenuous relations with labor unions and some of its U.S. based suppliers.  Wal-Mart believes in a work force that is not unionized, and as such tries at all costs to prevent unions from infiltrating its workplace.  This practice has created an outcry from the labor movement in the United States and many other countries where Wal-Mart operates.  Another issue that has attracted great amounts of public attention is Wal-Mart’s policy of pressuring suppliers into selling their products at ever-lower prices.  Failure to lower prices can result in the supplier losing business from Wal-Mart.

This aggressive stance taken in order to cut costs has lead Wal-Mart to buy a record number of products from developing countries such as China, and has, by the same token, resulted in billions of dollars in lost business for American suppliers.  This situation has raised widespread concerns in the American population and among the political class.  Should these concerns persist and should they translate into widespread movements of contestation, it could adversely affect Wal-Mart’s public image and sales.

Should labor unions succeed in unionizing Wal-Mart stores, it would affect Wal-Mart’s cost structure and bottom-line.  It is to be noted, however, that the labor union issue is one that affects both Wal-Mart and its competitors, and hence should not decrease Wal-Mart’s competitiveness relative to its competitors.

8) Plant and Equipment

As stated previously, Wal-Mart has invested heavily in its distribution centers and supply chain management system.  This has not only allowed Wal-Mart to leverage its international web of suppliers and to efficiently supply its thousands of stores worldwide, it is also of critical importance for Wal-Mart’s fast expansion.  Only with a well-honed logistical system can it expect to open close to 700 new stores worldwide in a single year in order to fuel its aggressive growth.

9) Cost Structure

Wal-Mart currently possesses one of the lowest cost structures in the retail industry.  Because of its size and retail presence, not only can it negotiate for lower prices, should it be dissatisfied with a supplier, it is in position to find another one anywhere in the world.  Should the cost of labor rise in one country, it can move to another one.  Should the price of raw materials rise, that is not a major concern for Wal-Mart, relatively speaking, because it would equally affect Wal-Mart’s competitors.

Should the cost of oil rise, Wal-Mart has the option of purchasing from local suppliers.  It should be mentioned that should overall costs rise, Wal-Mart possesses the ability to transfer the rise in costs to its customers.  Unless a major economic shock occurs, this should safeguard Wal-Mart’s bottom line.

Because Wal-Mart is not a manufacturer, but a distributor and retailer, it should not be adversely affected by changes in productivity, which is more a concern for the manufacturing sector, or by a change in product/technology cycle as long as it keeps abreast of technological developments in logistics, information systems, and supply chain management.

At the current state in its development, continued Wal-Mart expansion is unlikely to result in additional economies of scale.  However, by increasing its market coverage, Wal-Mart can gain more pricing power.

CONCLUSION/RECOMMENDATION I would recommend Wal-Mart as a moderate buy for the following reasons.

Wal-Mart is a well-established company with a proven track record, an effective business model, and an experienced management team.  It is the clear leader in the retail industry sector, both operationally and marketwise.  Its established corporate culture, efficient operations and clear strategic vision provide Wal-Mart with a strong basis for continued growth in existing and new markets.

Wal-Mart is one of the few companies in the United States that is not threatened by a rise in Chinese producing capabilities, but in fact benefiting from it.  In that regard, it is emerging as a winner in the globalization process that is currently underway.

Wal-Mart’s stock is offering the benefits of a defensive stock, while providing the investor with a reasonable growth prospect.  Wal-Mart has a strong balance sheet.  It has the ability to meet all its financial requirements, even in a rising interest rate environment.  Wal-Mart’s retail business, catering to the middle and lower income segments of the population, has a low sensitivity to a downturn in the economy.  As Wal-Mart grows its global retail presence, it will provide a certain level of risk diversification to country-specific economic fluctuations and to currency movements.

As of December 2, 2005, Wal-Mart’s valuation on a P/E basis was in-line with the S&P 500.  Contrary to other companies offering growth prospects, Wal-Mart is paying regular dividends (the trailing twelve-month dividend yield is 1.2%).  While Wal-Mart’s price and performance ratios are in line with its competitors, its operations, financial strength, and business model are superior to its competitors.  Wal-Mart is also more likely to gain market share to the detriment of its competitors, and hence, gain an even greater share of the retail sector market.

Despite bright perspectives ahead for Wal-Mart, it faces challenges and possible threats.  Wal-Mart has to deal with the pressure from labor unions to allow its workforce to unionize.  Wal-Mart also has to deal with movements of public contestations in the United States over the perception that it sends jobs abroad or that its penetration into a local community will destroy existing small shops.

Despite these challenges, Wal-Mart is a moderate buy in light of the strength of its fundamentals and the advantageous risk/reward ratio that holding a position in Wal-Mart offers.

Notes [1] Yahoo Finance, Quotes & Info, Wal-Mart Stores Inc. (WMT).  4 Dec. 2005.  Yahoo.com.  4 Dec. 2005  <http://finance.yahoo.com/q/pr?s=wmt> [2] MSN Money Central, Investing, Wal-Mart Stores, Inc.: Ownership.  4 Dec. 2005.  MSN.com.  4 Dec. 2005  <http://moneycentral.msn.com/investor/invsub/ownership/ownership.asp> [3] “Is Wal-Mart Good for America?”.  PBS.  16 Nov. 2004.  Public Broadcasting Corporation.  4 Dec. 2005  <http://www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/stats.html> [4] Yahoo Finance, Quotes & Info, Wal-Mart Stores Inc. (WMT).  4 Dec. 2005.  Yahoo.com.  4 Dec. 2005  <http://finance.yahoo.com/q/pr?s=wmt> [5] “Is Wal-Mart Good for America?”.  PBS.  16 Nov. 2004.  Public Broadcasting Corporation.  4 Dec. 2005  <http://www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/stats.html> [6] MSN Money Central, Investing, Wal-Mart Stores, Inc.: Key Ratios.  4 Dec. 2005.  MSN.com.  4 Dec. 2005  < http://moneycentral.msn.com/investor/invsub/results/compare.asp?Symbol=WMT> [7] StockSelector.com, S&P 500.  4 Dec. 2005.  StockSelector.com.  4 Dec. 2005  <http://www.stockselector.com/sp500.asp> [8] MSN Money Central, Investing, Wal-Mart Stores, Inc.: Key Ratios.  4 Dec. 2005.  MSN.com.  4 Dec. 2005  < http://moneycentral.msn.com/investor/invsub/results/compare.asp?Symbol=WMT>

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