22 February 2007

WMT: Analysis through Jan 2007

Wal-Mart (WMT), based in Bentonville, AR, is the world's largest retailer. It operates the eponymous Wal-Mart Stores and the Sam's Club warehouses. Wal-Mart proudly claims to operate more than 6,700 stores (the eponymous Wal-Mart discount and super-center stores, plus Sam's Club warehouses) and serve more than 175 million customers around the globe each week.

With annual sales over $300 billion, earning it the number 2 rank on the Fortune 500 list of America's largest corporations, Wal-Mart is a major force in the U.S. economy. Wal-Mart's disruptive cost-cutting strategies have revolutionized the marketplace for better and for worse, depending on your point of view. Its visibility and role in advancing globalization have made Wal-Mart a lightning rod for criticism. Wal-Mart transformed retailing by using information technology to manage its supply chain and by pressuring manufacturers to squeeze every penny out of their costs. Rival discounters fell by the wayside, and manufacturers with higher costs suffered mightily. On the other hand, Wal-Mart's discounting is responsible for lower inflation (and thus interest rates), although this effect might not have been reflected fully in the published statistics. However, with the U.S. market now saturated, and the company continuing to slash prices, Wal-Mart's growth (as measured by same-store sales) has shrunk to the low single digits. Target, which appeals to a somewhat more affluent customer base, has been eroding Wal-Mart's market share from above. From below, high gas prices have taken a bite out of the wallets and pocketbooks of Wal-Mart's core customers. The stock price, with a few rare exceptions, has been between $43 and $50 per share since March 2005.

When we analyzed Wal-Mart after the quarter that ended in October 2006, the Overall score was a modest 32 points. At 11 points, Value was the attribute gauge with the highest score. Cash Management was weakest at 4 points.

We have since updated the analysis to incorporate Wal-Mart's financial results for the latest quarter, which was the fourth of fiscal 2007. With data through 31 January 2007, our gauges now display the following scores:

Cash Management. This gauge moved up one point from October to January. The Current Ratio is now 0.90, which is pretty much where it has been this entire decade. (Our scoring system treats more favorably companies with somewhat greater amounts of cash in the till, but Wal-Mart is the master at making do with less). Long-Term Debt/Equity is 44 percent, up 3 percent from the previous quarter, and down from an unusually high debt ratio was 50 percent one year ago. Inventory/Cost of Goods Sold is now 46.4 days. The inventory level (all, of course, finished goods ready for sale) is down from the prior quarter, which is meaningless because retailers always build inventory in the fall to sell during the holiday season. More significant is that the inventory level was a few days less the typical 49-50 day quantity at the end of January. This tells us that the company either became more efficient at managing inventory -- it's already world class -- or it sold more goods at Christmas that it expected. Accounts Receivable/Revenue is 3.0 days, up from 2.7 days in October, but the same as in January 2006. Taking a longer view, this value has been inching up since the summer of 2003. The increase, although small, indicates that the company's customers aren't quite as quick to pay.

Growth. This gauge increased a substantial 5 points from October. Revenue growth is now 11 percent year over year, up from 9 percent a year ago. Net Income growth is 7 percent; down from 10 percent one year ago. The income tax rate didn't change during this period, and, therefore, didn't have a material effect on the Net Income growth rate. CFO growth is a healthier 14 percent, but down from a 17 percent growth rate the year earlier. Revenue/Assets is 229 percent, a few percentage points above recent values. This increase accounted for most of the Growth gauge's rise. A sustained increase in Revenue/Assets would indicate that the company is becoming more efficient at generating sales.

Profitability. This gauge held steady from October's tepid value. ROIC stayed at a moderate 12 percent. It has been in the 12-13 percent range most of this decade. FCF/Equity is 7 percent, up one percent from a year ago. Operating Expenses/Revenue were 95 percent, which is pretty much where they have always been. Gross Margin and SG&A expenses have been remarkably constant. The Accrual Ratio, which we like to be both negative and declining, was constant at +5 percent. The lack of change in this value points to a steady balance between Net Income and CFO.

Value. This gauge, based on the stock price of $47.69 at the quarter's end on 31 January, edged up to a moderate 12 points, compared to 11 and 15 points three and twelve months ago, respectively. The P/E at the end of the quarter was 16.3, similar to recent quarters, but way below the 5-year median of 23.5. The average P/E for the industry is 20.7. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is matches the average P/E (using core operating earnings) for stocks in the S&P 500. WMT's P/E had been at a premium when the company was growing at faster rate. The PEG ratio of 2.3 is indicative of a modestly expensive stock. It has been increasing slowly (i.e., becoming more expensive). The Price/Revenue ratio declined a little to 57 percent. The long-term trend is down, suggests the shares are becoming less expensive. The average Price/Sales for the industry is 77 percent.

The current Overall score of 38 out of 100 points isn't enough to going to excite anyone; this gauge for Wal-Mart has bounced around the 30's for most of the last four years. However, the six-point increase, from 32 to 38 points, in one quarter bears watching as a potential leading indicator of better news to come. The rise in the score reflects the encouraging data in the Wal-Mart's latest results. Sales were healthy, even a bit better than expected, and they were achieved without weakening the Gross Margin. Unsold inventory is not clogging warehouses, suggesting no need for a Spring fire sale. But, more top-line revenue needs to turn into bottom-line earnings to lift the Profitability measures from their present weak state. Should this happen, the Value gauge suggests there is plenty of room for stock price appreciation. The stock market reacted positively to the fourth quarter results because expectations were so low.

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