02 June 2007

WMT: Financial Analysis through April 2007

We have updated our analysis of Wal-Mart's (WMT)'s financial results for the for the quarter ending on 30 April 2007 to address the data reported to the SEC on Form 10-Q. Our evaluation, adjusted to account for new information, is reported in this post.

Wal-Mart is the world's largest retailer with nearly 6500 stores. With annual sales in excess of $300 billion, Wal-Mart holds the number 2 spot on the Fortune 500 list of America's largest corporations. 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.

Competition, economic factors, and questionable marketing decisions have combined to shrink Wal-Mart's same-store sales growth 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 company is responding by cutting back on plans to open new stores and by offering generic prescriptions drugs for $4.

When we analyzed Wal-Mart after the results from January 2007 became available, the Overall score was a modest 37 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 13 points. Cash Management and Profitability were weakest at 5 points each.

Now, with the available data from the April 2007 quarter, our gauges display the following scores:

Cash Management. This gauge dropped 2 points from 5 points in January. The Current Ratio is now 0.9, which is pretty much where it has been this entire decade. (Our scoring system gives greater rewards to companies with more cash in the till, but Wal-Mart is the master at making do with less). Long-Term Debt/Equity is up to a 49 percent. The debt ratio was 44 percent in January and 47 percent 12 months ago. Inventory/Cost of Goods Sold rose slightly to 48 days from 47 days three months ago, but it is unchanged from April 2006. The steady inventory ratio (all, of course, finished goods ready for sale) hints that sales met expectations. Accounts Receivable are 3.0 days of Revenue, which is somewhat worse than the 2.8-day level one year earlier. It might be indicating the company is finding it more difficult to get its customers to pay their bills.

Growth. This gauge dropped a substantial 10 points from 13 points three months ago. Revenue growth wasn't the reason for the decline. It increased to 10 percent year over year from 9 percent a year ago. Net Income growth, however, slowed to a weak 7 percent from 9 percent a year ago. A 1-percent hike in the income tax rate, from 34 to 35 percent, didn't help. CFO actually declined 3 percent year over year; it was up 13 percent a year ago. Revenue/Assets was steady at 2.26, but below the five-year median of 2.38. The company is not becoming more efficient at generating sales.

Profitability. This gauge dropped 2 points from the prior quarter's 5 points. ROIC slipped to a modest 12 percent from 13 percent a year ago. FCF/Equity edged down to 4 percent from 7 percent. Operating Expenses/Revenue, as always, were 95 percent. The Accrual Ratio, which we like to be both negative and declining, moved in the wrong direction from +5 percent to +6 percent. This tells us that less of the company's Net Income is due to Cash Flow, and, therefore, more is due to changes in non-operational balance sheet accruals.

Value. Wal-Mart's stock price was almost unchanged over the course of the quarter, increasing from $47.69 to $47.92. The Value gauge, based on the latter price, dropped to 10 points, compared to 12 and 16 points three and twelve months ago, respectively. The P/E at the end of the quarter was 16, which is low historically, but little changed from recent quarters. The average P/E for the Retail - Department and Discount industry is a somewhat more expensive 17.5. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is about the same as the average P/E, using core-operating earnings, of stocks in the S&P 500. The days when the Wal-Mart commanded a 30 percent premium to the market multiple seem long ago. No longer a growth company, the current multiple tells us that the market is expecting the company's earnings to grow in line with the average company. The PEG ratio of 2.3 is indicative of an expensive stock, given the weak growth. The Price/Revenue ratio, which is less affected by the one-time factors that cause wide swings in earnings, has stabilized at 0.6. The average Price/Sales for the Retail - D&D industry is 0.7.

Now at a disappointing 23 out of 100 possible points, the Overall gauge has fallen below the 30's, where it had been for the last couple of years. The signs of improvement we thought we saw after January proved to be illusionary.

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