21 December 2010

WMT: Financial Gauge Analysis for the October 2010 Quarter

Walmart (NYSE: WMT) earned $0.95 per diluted share on a GAAP basis in the October-ending third quarter of fiscal 2011, up 16 percent from $0.81 in the same three months of last year. 

A special tax benefit added $0.05 per share to reported earnings in the most recent quarter.

A previous article examined Walmart's Income Statement for the October quarter in some detail.  Excluding the tax benefit, adjusted earnings nearly matched the $0.90 per share we had forecast. 

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for Walmart and the associated financial gauge scores.  The metrics were calculated using data from Walmart's current and historical financial statements, including those in the latest 10-Q report.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

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. 

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.

Walmart's market value is nearly $200 billion, which makes it 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 $11 billion of its shares in the first nine months of the current fiscal year.

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 4400 stores in the U.S. (including Sam's Club) and 4292 in other countries.

Net sales by Walmart U.S. grew 1.1 percent last year, and income continuing operations increased a healthy 8.8 percent, but comparable store sales declined 0.7 percent.  Concerned about slow sales at home, Walmart in 2010 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.

Critics of Wal-Mart abound.

Additional background information about Walmart 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:
  • Overall: 34 of 100 (down from 44)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management31 Oct 201031 Jul 201031 Oct 20095-Yr Avg
Current Ratio0.
LTD to Equity60.0%53.3%49.7%47.8%
Debt/CFO (years)
Inventory/CGS (days)42.440.843.744.8
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)
Working Capital/Revenue-2.4%-2.4%-1.9%-2.1%
Cash Conversion Cycle Time (days)
Gauge Score (0 to 25)1213811

Higher debt ratios cost the Cash Management gauge lost a point.

Walmart's famed efficiency is reflected in its ability to operate consistently with negative Working Capital, which means a Current Ratio below 1 and Current Liabilities in excess of Current Assets.  We would worry about the creditworthiness of a smaller company with this characteristic.  However, for powerhouse Walmart, negative Working Capital is a sign that the company doesn't keep more funds than necessary idling in low-interest bank accounts or sitting on the shelf as inventory.

The short Cash Conversion Cycle Time is also a sign of efficiency in handling cash flow.  Although the cycle time nudged up in the latest quarter, it's still well below its year-earlier value.   A leaner Inventory, now about 42 days, contributes to a falling CCCT.

We would rather see Days of Sales Outstanding trending down, but 3-to-4 days is extremely low.

Walmart has taken advantage of this year's historically low interest rates to raise cash and refinance earlier debt obligations.  The company issued $2 billion of long-term securities in April, $3 billion more in July, about ¥100 billion also in July, and $4.9 billion in October 2010.

On 31 October 2010, Walmart had $7.35 billion in outstanding short-term borrowings, $5.2 billion in long-term debt due within 12 months, and $40.8 billion in other Long-term Debt.  As a percentage of Shareholders' Equity, Long-term debt increased from 50 percent to 60 percent (a 15-year high) in the last year.  Total debt is equivalent to 2 years of the Cash Flow from Operations, which is not excessive for Walmart.

Growth31 Oct 201031 Jul 201031 Oct 20095-Yr Avg
Revenue Growth3.9%3.6%0.1%5.2%
Operating Profit Growth5.4%5.1%4.4%6.1%
CFO Growth3.6%15.3%17.3%9.8%
Net Income Growth13.5%12.1%-1.0%8.0%
Gauge Score (0 to 25)71158
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.

The Growth gauge score lost four points because Cash Flow growth cooled considerable and Revenue slipped relative to Total Assets.

Revenue grew at a hardly robust 4 percent rate during the last four quarters.  Revenue/Assets declined as the debt offerings mentioned above expanded Walmart's Balance Sheet.

Cash Flow from Operations, which has been growing nicely for years, has become a noticeable laggard.  While up 3.6 percent in the last four quarters, CFO is actually slightly down in the nine months ended the October 2010, compared to the nine months ended October 2009.  Walmart, in the 10-Q, attributed the decrease to "increased investment in inventory, partially offset by an increase in accounts payable."

The healthy 13.5-percent Net Income growth rate is commendable given the tepid increase in Revenue.

Profitability31 Oct 201031 Jul 201031 Oct 20095-Yr Avg
Operating Expense/Revenue94.0%94.0%94.3%94.2%
Free Cash Flow/Invested Capital12.4%14.0%12.2%8.5%
Accrual Ratio0.7%-0.1%0.5%2.4%
Gauge Score (0 to 25)101188

The Profitability gauge score gave up a point because weaker Cash Flow from Operations caused the Free Cash Flow ratio to fall and the Accrual Ratio to jump.

Operating Expenses as a percentage of Revenue have been remarkably stable.  Note that our definition of Operating Expenses includes both Cost of Goods Sold and Sales, General, and Administrative expenses.  Items in the latter category grew at a slower pace than Revenue "primarily due to increased labor productivity and organizational changes ... designed to strengthen and streamline our operations."

The earnings-driven Return on Invested Capital has been recently steady at 14 to 16 percent.  On the other hand, the recent weakness in Cash Flow, mentioned above, led to a decrease in the FCF/Invested Capital ratio.  It also led to a rise in the Accrual Ratio, which could be signaling degraded earnings quality.

Walmart's Cash Flow tends to be volatile from quarter to quarter, so we'll have to see if the recent CFO weakness is the start of a trend.

Value31 Oct 201031 Jul 201031 Oct 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)6101110
Share Price ($)$54.17$51.19$49.68-

The combination of a rising share price and a lower rate of growth for Cash Flow from Operations pruned four points from the Value gauge score.

The P/E multiple essentially held steady, as did the Price/Sales ratio.

The EV/CFO ratio is a variation of the P/E multiple.  One difference is that its denominator is Cash Flow instead of earnings.  Weaker Cash Flow, therefore, pushed up the EV/CFO ratio, but the latest value is consistent with its historical range for Walmart.

Overall31 Oct 201031 Jul 201031 Oct 20095-Yr Avg
Gauge Score (0 to 100)34443738

Noteworthy financial changes in Walmart's October quarter included weaker Cash Flow from Operations, caused in part by the company using its cash to build up inventory, and higher debt.  These and other changes caused all four GCFR category gauge scores to decline, with Growth and Value dropping the most.  Since Value is double-weighted, the Overall score fell by more than what might have been expected.  A 34-point score, never wonderful, was especially disappointing because it reversed a minor uptrend.

Full disclosure: Long WMT at time of writing.

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