27 December 2009

WMT: Financial Gauge Analysis for the October 2009 Quarter

We almost forgot about the third-quarter gauge analysis of Walmart!  By 8 December, when Walmart filed its 10-Q, we had already started to gear up for fourth-quarter results.  The quiet of the holidays was an opportunity to dig down into the to-do list.

In a previous article, we examined Wal-Mart Stores (NYSE: WMT) Income Statement for the third quarter of fiscal 2010 and compared the entries on each line to our "look-ahead" estimates.  Earnings in this period, which ended 31 October 2009, rose from $0.80 to $0.84 per share.

Using the financial statements in the earnings announcement and the more detailed 10-Q, we have now updated our usual set of Cash Management, Growth, Profitability and Value metrics.  This post reports on the metrics and the associated financial gauge scores.

Number 2 on the Fortune 500 list of America's largest corporations, Walmart sold over $400 billion of merchandise last year in its discount stores.  Some background information about Wal-Mart Stores and the business environment in which it is currently operating can be found in the look-ahead.

In summary, Walmart's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management31 Oct 200931 Jul 200931 Oct 20085-Yr Avg
Current Ratio0.
Debt/CFO (years)
Inventory/CGS (days)
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)
Working Capital/Invested Capital-6.7%-8.0%-7.2%-8.2%
Cash Conversion Cycle Time (days)11.310.611.413.1
Gauge Score (0 to 25)3397

It's clear that the Cash Management gauge, as presently formulated, does not give Walmart due credit for its efficient use of cash.  In fact, it penalizes Walmart for its efficiency.   We've been aware of this problem for a while (too long), but we intend to resolve it before companies report their results for the first quarter of calendar year 2010.

The problem results from the scoring algorithm rewarding high levels of Working Capital, which is Current Assets minus Current Liabilities.  Rising Working Capital can be good news for a small or a troubled firm, and it can signify improved creditworthiness.  However, for a financially strong company like Walmart, levels of Working Capital above what is needed to meet day-to-day liquidity requirements is a negative indicator.  Cash tied up in Working Capital is not available to acquire assets with higher returns on investment.

Walmart is an extreme example.  It can rake in profits with negative Working Capital (-$7 billion on 31 October).  This certainly a strength and not a weakness.

Other signs of Walmart's cash efficiency are the extraordinarily few Days of Sales Outstanding and the low Cash Conversion Cycle Time.

We can see that Walmart has been taking advantage of low long-term interest rates because total long-term debt rose from $30.8 billion to $34.4 billion in the last twelve months.  During this same period, short-term debt (commercial paper and maturing long-term securities) declined from $12.7 billion to $9.4 billion. 

Total debt, when compared to Cash Flow from Operations, is actually down.

Growth31 Oct 200931 Jul 200931 Oct 20085-Yr Avg
Revenue growth0.2%1.5%8.8%7.2%
Operating Profit growth5.0%5.2%8.9%6.6%
CFO growth17.3%-7.0%9.9%67.7%
Net Income growth-0.4%-0.5%6.6%6.6%
Gauge Score (0 to 25)51148
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

Walmart has been performing better than other retailers during the recession, but Revenue and Net Income are still essentially flat when assessed on a trailing-year basis.  Revenue/Assets is down slightly.

However, the nascent rebound in Cash Flow from Operations appears very promising.

Profitability31 Oct 200931 Jul 200931 Oct 20085-Yr Avg
Operating Expenses/Revenue94.3%94.3%94.2%94.2%
Free Cash Flow/Invested Capital12.2%10.4%8.9%6.5%
Accrual Ratio0.5%1.5%2.1%3.6%
Gauge Score (0 to 25)86107

It's remarkable that Wal-Mart has been able to keep Operating Expenses so steady given the change in economic conditions.  The Return on Invested Capital has weakened but just barely.

The Free Cash Flow ratio has improved substantially.  The decline in the Accrual Ratio is also considered a positive factor.  Caution is warranted, however, because the Cash Flow results on which these figures depend have been rather volatile in the last couple of years.

Value31 Oct 200931 Jul 200931 Oct 20085-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)119312
Share Price ($)$49.68$49.88$55.81-

Wal-Mart shares price did not change much during the October quarter, but the closing price was down 11 percent from one year earlier.  However, the P/E ratio and EV/CFO ratio are both lower than they had been last year.  This situation -- a lower share price and better valuation metrics -- explains the rise in the Value gauge score.

Overall31 Oct 200931 Jul 200931 Oct 20085-Yr Avg
Gauge Score (0 to 100)32252936

Three of the four category gauges increased during the quarter, and the results for the Cash Management gauge appear spurious for reasons discussed above.  Nevertheless, the score remains below its five year average.

Full disclosure: Long WMT at time of writing.

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