17 October 2010

WMT: Look Ahead to October 2010 Quarterly Results

This post describes our model of Wal-Mart's (NYSE: WMT) Income Statement for fiscal 2011's third quarter, which will end on 31 October.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about Walmart and the business environment in which it is currently operating.

Retailing behemoth Wal-Mart Stores, Inc., earned over $14 billion on net sales of $405 billion in fiscal 2010, which concluded last January.  The Revenue figure, along with a drop in energy prices, enabled Walmart to regain from Exxon Mobil (NYSE: XOM) the top position on the Fortune 500 list of America's largest corporations. 

Although the discounter's net sales rose only 1.0 percent in fiscal 2010, income continuing operations increased a healthy 8.8 percent.

A market value of approximately $200 billion, even if this figure is more stable than growing, makes Walmart one of the five most valuable companies in the U.S.

Walmart's board of directors in 2010 approved a new plan to repurchase $15 billion of the company's common shares.  Walmart repurchased $7.1 billion of its shares in the first half of the current fiscal year.

Economies of scale and ruthless efficiencies enable Walmart to sell many products for prices lower than competitors, which include Target (NYSE: TGT), Kohl's (NYSE: KSS), and Sears Holdings (NASDAQ: SHLD).  Walmart is now purchasing more goods directly from manufacturers to reduces its costs.

Critics of Wal-Mart abound.

For financial data reporting, Walmart has three business segments: Walmart U.S., International and Sam’s Club.  Walmart U.S. had net sales of $258 billion in fiscal 2010, or nearly 64 percent of the overall amount.  The International segment had sales of $100 billion (24.7 percent of the total), and sales at Sam's Club amounted to nearly $47 billion.  At last count, Walmart operated 4304 stores in the U.S. (including Sam's Club) and 8416 in other countries.

Net sales by Walmart U.S. grew 1.1 percent last year, but comparable store sales declined 0.7 percent.  Concerned about slow sales at home, Walmart recently replaced the leader of Walmart U.S.

Walmart International has various subsidiaries or joint ventures in Brazil, Canada, China, India, Japan, Mexico, the United Kingdom, and several other countries.   Changes in currency exchange rates had a $9.8 billion unfavorable impact (almost 10 percent) on the International unit's net sales in fiscal 2010.

U.S. retail sales grew for much of the last decade, as shown in the U.S. Census Bureau's Monthly Retail Trade Report.  A severe slump began in mid-2008, which was followed by a modest recovery in 2009 and tepid growth in 2010.   

The Census Bureau estimated U.S. retail and food services sales in September were a seasonally adjusted $367.7 billion, up 0.6 percent (±0.5 percent) from August and up 7.3 percent (±0.7 percent) from September 2009.

Walmart earned $0.97 per diluted share on a GAAP basis in fiscal 2011's second quarter, which ended on 31 July 2010.  Earnings per share were 9 percent greater than the $0.89 Walmart made in last year's July quarter.

We are now ready to look specifically at the October 2010 quarter.

When Walmart reported second-quarter results on 17 August 2010, it provided the following guidance for the August-September-October period:

Earnings Guidance

For the third quarter of this fiscal year, the company forecasts diluted earnings per share from continuing operations attributable to Walmart to range from $0.87 to $0.91, as compared to an as adjusted $0.82 per share last year. The company’s updated full year guidance of $3.95 to $4.05 earnings per share is an increase from the previous range of $3.90 to $4.00 per share. This new guidance assumes that currency exchange rates remain at current levels.

Unfortunately, the guidance is silent on sales expectations, and Walmart no longer issues monthly sales reports.  To estimate the company's quarterly Revenue, we have looked at government reports, competitor news, and seasonal patterns.

Government-collected U.S. retail sales data for the first two months of the current quarter indicate that sales, depending on the category, were up about 5.5 percent when compared to the same two months of 2009.

As a point of comparison, Target (NYSE: TGT) reported net sales in the nine weeks ended 2 October 2010 increased 3.3 percent compared to the equivalent period in 2009.  Comparable-store sales rose a tepid 1.6 percent.

One benchmark is that Walmart's third-quarter sales are typically 1 to 2 percent less than sales in the second quarter of the same year.

Balancing these various items, we have come up with an estimate of $103 billion for Walmart's Revenue in the October quarter.  This value translates into a forecast for 3.6 percent Revenue growth.

For the Gross Margin estimate, we are estimating a 10 basis point improvement over the second quarter's 25.3 percent of Revenue.  The Revenue and Gross Margin estimates lead to a predicted Cost of Goods Sold of (1 - 0.254) * $103 billion = $76.8 billion.

We expect, based on historical results, that Sales, General, and Administrative expenses will be 19.8 percent of Revenue.  Therefore, we expect this item to be 0.198 * $103 billion = $20.4 billion.

Subtracting the estimated costs from the Revenue target, and assuming no special operating charges, yields a $5.77 billion projection for Operating Income.  This figure is 6 percent greater than Operating Income of $5.44 billion in the October 2009 quarter.

We extrapolated past results to estimate net interest expense of $475 million.

If we project a tax rate of 34.5 percent, the provision for income taxes would be $1.83 billion.  We also need to make an adjustment, estimated at $150 million, for the portion of net income attributable to non-controlling interests.

The bottom-line estimate for Net Income is $3.32 billion ($0.90 per share).  In the year-earlier quarter Walmart earned $3.14 billion ($0.81 per share). 

Please click here to see a full-sized, normalized depiction of the projected results next to Wal-Mart's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long WMT at time of writing.  No position in any other company mentioned.

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