Walmart valuation

1.0 Executive SummaryIn part 1 of this document we analyze Wal-Mart financial condition and results of operations based primarily on its audited financial statements information from 2009-2013. Wal-Mart overshadows its competitors, with its US retail sales being over three times those of its nearest rival (in FY2013). We attempt to identify what is driving this business model by analyzing the firm’s asset management, capital structure and its ability to generate cash. In doing so we include 2 peer comparisons, namely Costco and Target. 1.1 The company and the industry. Wal-Mart market position.

Wal-Mart is the largest retailer in the world. The company has retail stores worldwide, with 10,773 stores recorded across 27 countries at the end of January 2013. Wal-Mart operates through three business segments, namely Wal-Mart US, Wal-Mart international, and Sam’s Club. The company also operates through various online retail sites including In the US, the company operates as a range of retail formats, including supercenters, discount stores, and neighborhood markets.

The US Hypermarkets and Supercenters Industry comprise large retailers of consumer staples goods. The three key players in the industry include Walmart, Costco and Target. Walmart leads the market with nearly 72% of the market share, but Costco has been able to outpace Walmart and Target’s revenue growth rates over the last few years due to its better customer service.

Walmart and Target have lagged behind in terms of customer satisfaction largely because they pay their employees lower wages compared to Costco, which is a significant demotivating factor. Target operates with the highest margins in the industry, as a higher percentage of its revenues are generated from sales of private label brands as compared to its competitors.

Wal-Mart has established itself as a value retailer by providing low prices for the largest choice. Every Day Low Price (EDLP) is its pricing philosophy under which they price items at a low price every day so that customers trust that prices will not change under frequent promotional activities. Internationally it operates with similar philosophies. In 2002, Wal-Mart ranked at the top of the Fortune 500 list and was named the largest company in the US ranked by total sales and in 2004 was ranked as the largest company in the world. It has remained highly ranked in these lists ever since.

1.2 Maintaining a competitive advantage in the retail industry

Wal-Mart operates in the highly competitive retail industry. Many of these competitors are national, regional or international chains, as well as internet-based retailers and catalog businesses. Through massive economies of scale, Wal-Mart has an advantage over all competitors. It is able to decrease operating expenses by having a large and integrated supply chain. As volume rises for the company, per-unit costs decline and the company is able to pass this savings on to the consumer.

On the other hand, when it comes to dealings with suppliers, due to its massive market share, the company is able to negotiate very favorable terms. Thus keeping purchasing costs low.

The firm’s concentration on cost-control, location of stores, and customer needs were vital to its success. The growth of Wal-Mart has been unprecedented within the industry. Wal-Mart is able to appeal to the budget-conscious consumer. With a large middle class in the U.S. and ever-growing middle classes in many developing countries, this aggressive pricing appeals to a vast majority of the consumer market.

The key drivers for growth can be attributed to five main strategies: advanced technology, company cost controls, low prices, expanding into new retail sectors, and international expansion. (See figure 1-3 in appendix) There has been much comment in recent years regarding the maturity of the company in the US market. Despite revenues increasing, same store sales have been seen to decline in 2010 and 2011. However, the size and scale of Wal-Mart is of advantage to the company. Its dominance within the US market does not look likely to vanish anytime soon.

1.3 US vs International growthUp until 2010, US and international sales followed roughly the same growth pattern with international stores outgrowing US stores by five percentage point in retail value terms. From 2011 international growth saw much stronger recovery than US sales, with a differential of seven points. This is due to several acquisitions (Massmart in Africa and Netto in the UK) that year and reflects the stronger focus on international development to respond to market saturation in the US.

Figure 1. Wal-Mart Inc: Domestic vs International Sales 2007-2012

Source: Marketline

Wal-Mart’s decision to prioritize profits over sales in international markets will lead to fewer new stores and a focus on reducing costs in the existing network. The company will do so by investing in EDLC (Every Day Low Cost)/EDLP (Every Day Low Price) in order to build on stronger foundations for future growth.

The company intends to finance global expansion plans primarily through cash flows from operations and future debt financingsThe company plans to expand by approximately 38 million square feet in FY2014, and according to Bidness Etc’s estimates, this 3.5% increase in retail area will boost net sales by more than 5%. Apart from expanding its total retail area, Walmart also plans to expand its e-commerce capabilities during FY14. It will spend nearly $12.5 billion on its expansion plans during the ongoing fiscal year, which will include capex on stores, logistics, supply chain and e-commerce.

1.4 Sales decompositionWal-Mart is quite stable regarding its costs structure. Cost of sales is every year around 75% of sales, while operating expenses are around 19%. Interest expense moves around 0.45% of sales, and tax expense around 1.75%. Finally, net profit margin is around 3.5%. Compared to target, we can see how its gross margin is higher, but the operating expenses higher. We can assume that compared to Walmart, Target is providing a better experience to the customer, or a more aggressive marketing strategy, compensated by higher prices.

Regarding Costco, we can see how it is the opposite, a lower gross margin, and smaller operating expenses. In this case it is caused by Costco strategy being a wholesale company, selling at discount. In the case of Costco we can see how the interest expense compared to sales is around zero.

This can be explained by its large amount of cash, generating enough interest to cover the interest expense of debt. Figure 2. Financial performance for Wal-Mart Stores Inc, Costco and Target.

1.5 Asset ManagementIn figure 3 we can see how Walmart keeps the asset structure stable over the years, and that some differences exists between Walmart and its peers, especially with Costco.In Walmart evolution we can see how on 2012 there is an increase in goodwill, which indicates that Walmart has been acquiring other companies over that year. Compared to Walmart, Costco keeps around 5 times more cash compared to total assets.

This can be caused because of Costco having future plans of expansion, by capital expenditures, or by merges and acquisitions. Costco has a low percentage of goodwill in their balance sheet, which probably means that it has not invested significantly in merges and acquisitions before.

Looking at Target, we can see how it maintains a lower level of cash. This can be possible because a shorter cash conversion cycle. We can assume that all sales by Target are cash, as it does not have any accounts receivable at the end of the year. Its inventory is also smaller compared to the total assets, but its asset turnover in days is actually higher (57 days for Target compared to 45 for Walmart). Figure 3. Asset composition

The five years average of ROA for Wal-Mart is 8.43% where the sector ROA five year average is 11.1%. This ratio suggests that Wal-Mart is leveraging its assets not as effectively as some of its retailing competitors, however still outperforming its closest peers Costco and Target (Figure 4). From a valuation stance, this ratio is good and as it shows a high level of efficiency, but suggests they could be more efficient.

Figure 4. Return on Assets from 2009-2013

1.6 DuPont AnalysisAlthough the DuPont analysis says nothing about valuation it allows us to find out what drives a company’s return on equity. Of all three companies Wal-Mart has found the right balance between margins and turnover to achievethe highest ROE of the lot (figure 5). Figure 5: Return on Equity from 2009-2013 (Wal-Mart;Costco;Target)

Let’s start by looking at Wal-mart and Target, since both companies operate in similar ways. Wal-Mart ROE is about 21% higher than Target’s, and the DuPont analysis tells us why. Wal-mart’s EBIT margin has averaged around 5.88% over the past 5 years, while Target has maintained a higher 7.47% EBIT margin, 21% larger than that of Wal-mart. (See appendix…)But Wal-mart recovers this deficit in the asset turnover category. While Target sells about 1.51 times assets annually Wal-mart sells about 2.37 times assets annually which is 57% greater than Target. This causes Wal-mart to have a superior ROE.

Turning to Costco, its EBIT margin is the lowest, less than half of Wal-mart’s and a third of Target’s. But the company compensates this by having the highest asset turnover, around 3.39.This all makes sense considering how Costco operates. The company sells its products with very low margins and makes basically all of its profits through membership fees. And since customers typically buy items in bulk Costco is able to achieve a high asset turnover. All of this leads to a lower ROE than both Wal-mart and Target, but this value has been growing steadily as Costco has gotten more efficient.

Summarizing, on one extreme we have Costco, which accepts extremely low margins in exchange for an extremely high asset turnover. On the other extreme we have Target, which has high margins but sacrifices asset turnover. And in the middle stays Wal-mart, which compromises on both fronts and by doing so achieves the best return on equity.

Figure 6: Profit Margin from 2009-2013 (Wal-Mart; Costco; Target)

2 Cash managementIn the next table we present a summary of the cash flow statement of Walmart since 2009 until 2013. From the table we can see how Walmart is generating enough cash to cover all investment activities, and there is still cash to give back to shareholders, in dividends or in treasury buyback. The last two columns are the same information for Costco and Target, for year 2013.

In the information we can see how while the size is different, Target has a similar balance in the cash flows. The operating cash flow is used for both, capital expenditures, and for shareholder remuneration. Regarding Costco, we can see how it is not paying shareholders, but instead raising capital. This cash obtained by Costco is used in capital expenditures, but also a big part is kept in the company. A reason for that could be that Costco is planning to perform acquisitions in the upcoming years. Cash flow


If we analyze the information graphically, in a chart with all numbers in absolute value (in positive), we can see how the cash flow from operations do not change significantly over time, and that increases in capital expenditures (2012) are compensated with a lower remuneration to shareholders.

INCOME STATMENTWMT 2009WMT 2010WMT 2011WMT 2012WMT 2013COST 2013TGT2013Sales100.00%100.00%100.00%100.00%100.00%100.00%100.00%COGS75.48%74.63%74.74%74.98%75.13%87.44%69.62%Gross profit24.52%25.37%25.26%25.02%24.87%12.56%30.38%SG&A expenses18.90%19.50%19.21%19.08%18.94%9.66%23.05%EBIT5.62%5.87%6.05%5.94%5.93%2.90%7.33%Interest Expense0.47%0.46%0.48%0.48%0.44%0.00%1.04%EBT5.15%5.41%5.58%5.46%5.49%2.90%6.29%Income tax1.76%1.75%1.80%1.78%1.70%0.94%2.20%Other0.09%0.15%-0.10%0.17%0.16%0.02%0.00%Net income3.30%3.51%3.89%3.51%3.62%1.94%4.09%


Appendix:Figure 1Total Store numbers FY2002-13

Figure2Total net sales FY2002-13Figure 3Operating profit FY2002-13