Wal-Mart Financial Statement Analysis

The Paul Merage School of Business at UC Irvine Financial Statement Analysis & Reporting Earnings Quality and Asset Analysis friendship WALMART Kian BolooriHee Jun ChungDaejune Min 1. Qualitative Analysis for the environment and the fraternity (1) INDUSTRY ANALYSIS Walmart is in the send away retailer labor. This industry started in the 1950s, grew in the 1960s, and matured in the 1970s. With exception to a moderate harvest-home period in the 1990s, the industry had remained stagnant since the 1970s. Today, three major players in the industry argon Walmart, address and Costco.The assure of the dismiss retail industry is best understood through the Porters Five Forces synopsis. * Competition HIGH Competition among discount retailers resembles that of an oligopoly in that Costco, Target and Walmart hold a vast majority of the market share. In past decades, competition among the firms was minimized because they each targeted a different market segment. For example, Target po re on full(prenominal)er end neighborhoods while Walmart focused on rural locations. However, as the firms began to grow, they had to expand beyond their original targeted segments.As such(prenominal), the firms started competing in the same locations, which escalate competition. This condition remains a dominant issue in the discount retail industry. * Barrier to New Entrants MEDIUM-HIGH Un homogeneous another(prenominal)(a) industries, the discount retailer industry does not require a particular set of technical knowledge for new entrants. However, the major players in the market have established strong procurement and distri exactlyion exculpateworks that prevent new entrants from easily establishing their own. As such, new entrants would find it difficult to establish procurement and istribution networks while bounding cost competitive with those of Walmart, Costco and Target. * talk terms Power of Buyers LOWMEDIUM Buyers have different levels of power depending on their location. In rural areas, buyers have slight power. There is usu completelyy maven discount retailer for each rural region. As such, that retailer has a virtual monopoly in that region, which allow it to increase prices, and thus increase margins. On the other hand, buyers in suburban and urban markets mess easily switch between discount retail competitors as a result, each discount retailer must keep its prices competitive in those markets. Bargaining Power of Suppliers LOW Suppliers to discount retailers hold little to no power. When the major discount retailers initiate relationships with new suppliers, they typically supplicate contracts for the new suppliers whole inventory. As a result, the suppliers become entirely reliant on the discount retailer for their business. The discount retailer then leverages this reliance by demanding dispirit prices on the inventory. As a result, suppliers typically have to sell their inventory at low prices that result in weensy profit mar gins for them and lower inventory be for discount retailers. Threat of Substitutes LOW Current existing substitutes to discount retailers include supermarkets, traditional retailers, and boutique shops. However discount retailers are fit to leverage their strong distribution networks to offer lower prices than many of the substitutes. As a result, discount retailers are able retain business despite the world of substitutes. (2) ECONOMIC CONDITIONS The fact that there are fewer opportunities to expand in the United States has made it difficult for discount retailers to continue growing profits.In fact, discount retailers attempts to enter new markets have resulted in community resistance. In Watts, CA, community members successfully lobbied to prevent Walmart from opening a new store in the neighborhood. contempt these challenges, discount retailers have found new opportunities to increase profits. For one, discount retailers have started converting their stores into supercenters . These supercenters feature traditional discount retail products and grocery store products in one location. Also, discount retailers have begun expanding their international ope symmetryns.For example, Walmart has partnered with companies in South Africa, China, and Brazil in order to expand into those markets. These opportunities have already proven profitable and continue to be a focus for the major discount retail firms. (3) WALMART STRATEGY Walmarts business strategy is to keep costs low and pass the savings oermatch to the customers. Walmart accomplishes this strategy through several means. First, Walmart cuts costs in its procurement channels. Walmart cuts out the manufacturers representatives and works with suppliers directly.In doing so, Walmart saves 3-4% on costs. Also, Walmart is able to use its IT networks to instal sure the fraternity orders the right about of inventory from suppliers so that the Walmart stores experience neither overstock nor stock-out. Second, W almart keeps its labor costs low. Walmart maintains a frugal culture for all employees. For example, executives at the telephoner are prohibited from accepting meals and gifts from third parties. Additionally, Walmart provides store workers with wages and benefits that are below those given by competitors.Third, Walmart invests in ways to cut distribution costs. For example, Walmart know the large-scale cross-docking to transfer merchandise directly from inbound trucks to store-bound trucks without storing the good in its distribution centers. Through these innovations, Walmart has been able to save 3-4% on its distribution costs. Through these means, Walmart has significantly lower its costs when compared to competitors. This point of difference helped Walmart grow to become the leading discount retailer in the world. . Quantitative Analysis for the company and the peers (1) CASHFLOW ANALYSIS From financial year 2007 to fiscal year 2010, Walmart recorded unharmed growth in bot h sales and net income however, net increase in hard bullion and cash equivalents does not have the same growth pattern. Net cash scarper is the aggregate of cash flow from operations (chief financial officer), cash flow from investiture activities (CFI), and cash flow from financing activities (CFF). As is expected, chief financial officer does apparent movement positive in correlation with the increases to sales and income.On the other hand, CFI and CFF experienced sharp decreases. gibe to the common- size of it statement of cash flow, net CFI portion out of net CFO shows a generally decreasing trend during the period (-71%, -76%, -46%, -44%, respectively for 2007, 2008, 2009, 2010), on the other hand, the portion of net CFI increase constantly (-25%, -36%, -43%, -54%, respectively for 2007, 2008, 2009, 2010), which implies that War-Mart has become paying equal attention to investment for the future growth and shareholder value recently.Having solid CFO, Walmart had cash for investing and financing without borrowing a short-term debt As a result, while Walmart experienced 9% growth in sales and 13% increase in net income in 2008 compared to the previous year, net cash decreased almost 400%. Target shows a similar cash flow pattern to that of Walmart. Target has been reducing investment level and focusing more on shareholder return and the debt repayment. On the other hand, Costco has been managing the cash flexibly over the past four years in order to meet the firms drives for investment.Costco still concentrates on investing activities, which can be evidence by the portion of net CFI (-72% of net CFO in 2010). According to 10-K of the year 2010, Costco opened 13 new warehouses in 2010, which was directly related to the capacious negative CFI. For Walmart, the accounting alteration accruals, which is measured as the gap between net income and CFO, is at 40%. The accounting adjustment accruals are one of index fingers for dinero quality. While 40% is significant, it is smaller than that of Walmarts competitors. Changes to true assets and current liabilities have a large impact on the accounting adjustment accruals.For instance, Walmart had accounts due increased by $297 mil in 2010, which negatively impacts on cash flow, but its inventory decreased by $2,213 mil in the same fiscal year, which had a positive influence on cash flow from operations. Despite these changes, CFO has still maintained a growth trend. Consequently, Walmart shows a steady upward trend of free cash flow, which is the difference between CFO and big(p) expenditures, during the past four years ($4. 6 bil, $5. 7 bil, $11. 6 bil, $14. 1 bil, respectively for 2007, 2008, 2009, 2010). The cash spent on CFI went to purchase of PPE in order to expand current operations.The firm used to invest approximately 80% of CFO in PP&E in 2007 and 2008, however decreased the investment to 45% level recently. A significant level of CFF went to shareholder return, includ ing dividends and share buybacks (e. g. $11. 4mil or 77% of net income in 2010). As such, Walmart appears to provide value to its shareholders. Similarly, Target and Costco also invested highly in PP&E and return more than 70% of net profit to investors. To sum up, we can see a certain pattern in cash flows of the three firms as follows, which shows that Walmart, Costco and Target are matured and generating healthy cash flow. Walmart Target Costco accretion (NI/CFO) 58% (Gap 42%) 54% (gap 46%) 53% (gap 47%) CFO Positive,Constantly Growing Positive,Growing Trend Positive,Growing Trend CFI Negative (for PP&E) Negative (for PP&E) Negative (for PP&E and short-term investments) CFF Negative (for shareholder returns) Negativeexcept in 2007 ($7. 6mil long-term debt in 2007) Negative (for shareholder returns) One cause of concern from Walmarts cash flow is a contradiction in terms between Walmarts growth strategy and CFF.The high levels of dividends that Walmart gives its shareholders may limit the amount of cash the company has for expansion. CFO has remained high enough to divvy up CFI, but this might not always be the case. As a result, Walmart may have to cut the amount of dividends it pays if it wants to continue growth during a period when CFO is decreasing. (2) EARNING QUALITY ANALYSIS Walmarts earnings have been positive and growing each fiscal year from 2008-2010. The increase in earnings is primarily collect to the fact that revenue had also increased in that timeframe. There has been a 7. 5% increase in revenue from 2008 to 2009 and a 0. 95% increase in revenue from 2009 to 2010. A large majority of Walmarts revenues come from its core operationsthe net sales of products that Walmart had procured from suppliers and sold at its retail locations. The Net gross sales figure is computed as the sales less sales tax and estimated sales returns. Less than 1% of full revenue is based on membership revenue. social status revenue is from customers who purchase yearly Sams Club memberships. There are several important features regarding the relationship between Net Income and CFO.First, the Net Income and CFO both trend positive, growing at a comparable rate. Second, CFO is larger than Net Income each year. This is primarily due to the adjustment to depreciation and amortization. Third, the adjustment due to an increase in accounts due is fairly constant, and is not a significant portion of the total CFO. These features suggest that the Net Income is a good indicator of cash inflow from operations, which would be expected from a company that collects cash at point of sale. Walmart recognizes revenue at point of sale when customers purchase products at the retail locations.Walmart recognizes revenue from gift cards only when the gift card is redeemed. Walmart recognizes revenue from services when the company performs the service however, revenue from services is a small portion of total net sales. For membership, Walmart recognizes the rev enue over the period of the membership. For example, if a membership cost $120 upfront, then $10 revenue would be acknowledge each month of the 12-month membership. Until its recognized, the cash collected is accounts as a li index (Deferred Membership Revenue). Expenses are divided into various categories.Cost of sales is all costs related to the attainment and transport of inventory. Any money received from suppliers, such as reimbursements for markdowns, is reduced from the cost of sales figure. Furthermore, Walmart does not include its costs of distribution facilities in its cost of sales, which can make its gross profit seem disproportionally stronger than its competitors. However, these costs can be found within SGA. SGA, Advertising and Pre-Opening costs are all recognized the same period that they are spent. Walmart does not seem to participate in any earnings management.The small account receivable account suggests that sales can be seem in cash inflow, meaning there is li ttle chance that Walmart fabricated sales figures. Furthermore, Walmart did not make any significant changes to its depreciation cycles and PPE purchase patterns, which suggests that Walmart did not try to inflate its earnings to disguise unfavorable in operation(p) performance. (3) RATIO ANALYSIS Financial ratios are a measurement of the companys overall health. In general, the financial ratios of a company are compared with those of its major competitors (cross-sectional and trend analysis) and to the companys antecedent periods (trend analysis). positivity Ratio The ability to generate profit on capital invested is a key determinant of a companys overall value. Profitability is the net results of a number of policies and decisions. Here, the key ratios, ROCE and ROA, were calculated to judge the profitability in general. Return-on-assets (ROA) has been increased to 9. 6% in 2010 from 8. 4% in 2007 (See adjoin 10-2). This high ratio indicates that Walmart generated high income with given level of its assets. Return-on-capital employed (ROCE) has also increased to 21. 3% in 2010, from 19. 1% in 2007 (See exhibit 10-1).Compared to the competitors, Walmart has the highest ROA and ROCE, which illustrates that Walmart is the most profitable company in its industry. * Activity Ratio Activity ratio measures how efficiently a company utilizes its assets. These ratios are analyzed as indicators of ongoing operational performances on other words, how effectively a company uses its assets. Walmarts inventory disturbance in days was 40 days in 2010, which is a modest improvement from 45 days in 2007 (See exhibit 11-1). The lower memory days of the inventory indicates that Walmart has made progress over the period in terms of inventory management.Considering the gross revenue growth, which increased over the periods, Walmart has effectively managed its inventory, avoiding any shortage or inadequate inventory levels. Walmart continued to set their goods in fairly lo w price in order to have its inventory move faster. Even though inventory turnover ratio of Walmart is less than that of Costco, Walmarts improvement in its inventory turnover is better than that of Costco or Target. Additionally, account payable turnover gradually increased from 9. 9 days to 10. 22 days (See exhibit 11-1).The longer period of holding the Account payable indicated it has made good use of available credit facilities. * Liquidity Ratio (Short-Term) A liquid asset is one that trades in an prompt market and can be quickly converted to cash. A firms liquid state position determines whether a firm has enough resources to meet its current obligations. Walmarts current ratio deteriorated from 0. 9 in 2007 to 0. 87 2010 but then is improving from 2010 to 2011 exceeding 0. 88 in 2009 level. Also quick ratio and cash ratio improved from 2009 to 2010 (see exhibit 12-1).Nevertheless, it can be a negative sign for the company to have a current ratio less than 2. 0 and a quick r atio less than 1. 0. In fact, Walmarts current ratio and quick ratio are lower than that of Costco and Target. A lower ratio indicates less liquidity, implying a greater reliance on operating cash flow and outside financing to meet short-term obligation. However, a reason for the troubling liquidity ratios is that Walmart has been using its cash for fixed assets as part of its effort to expand. As such, Walmart can generate cash by slowing growth if it has an urgent need to pay off current obligations.Additionally, Walmarts cash conversion cycle was greatly decreased to 4. 8 in 2010 from 8. 5 in 2007 (See exhibit 11-1). It is the shortest operating cycle of its industry. A shorter cash conversion cycle indicates greater liquidity. The short cash conversion cycle implies that Walmart only needs to finance its inventory and accounts receivable for a short period of time. Its cash cycle is optimized, meaning it is able to sell inventory quickly also have less time capital tied up in th e business process thus better for the companys bottom line. * Solvency Ratio (Long-Term)Solvency refers to a companys ability to fulfill its long-term debt obligations. Solvency ratios provide information about the relative amount of debt in the capital structure and the adequacy of earnings and cash flow to cover interest expenses and other fixed charges as they come due. This is important for assessing the risk and return characteristics such as its financial leverage. Walmarts total liabilities-to-assets ratio was 0. 57 in 2010, slightly decreasing from 0. 58 in 2009 and 2008. This means 57% of total asset are financed with debt . Long-term debt-to-equity ratio was 0. 0 in 2010, once more slightly decreased from 0. 52 in 2009 (See exhibit 12-1). This means 50% is the Walmarts capital represented by debt. Although the size of asset and debt far exceeds the size of its competitors, but the ratios did not show significant proportional difference between Walmart and its competitors. Interest coverage ratios, calculated by using EBIT divided by total interest expense, can be viewed as good if the number exceeds 2. 0. For Walmart, the interest coverage ratio was 11. 8 in 2010 that was improved from 10. 5 in 2007 (See exhibit 12-1).This increase indicates that Walmart has become stronger in solvency, offering greater assurance that Walmart can service its debt from operating earnings. As for evidence, Walmarts CFO-to-total liability was calculated to be 54. 5% in 2010, increasing from 48. 4% in 2007 (See exhibit 12-1). This is relatively high compared to its peers such as Costco and Target. 3. Conclusion Based on the aforementioned analysis, including qualitative and quantitative, we would like to conclude that Walmart is a company that can be highly recommended for investors to buy.First, the industry is still attractive when it comes to high barrier to entry, low power of buyers and suppliers, and low scourge of substitution. Also for the company level, Walmar t has differentiated itself successfully by focusing on the lowest price. Second, Walmarts cash flows show a typical pattern for a healthy and matured firm that is, Walmart has a constantly growing positive CFO, a negative CFI for the investment in PPE, and a negative CFF for shareholder returns such as dividend and share repurchase.Also, the strong CFO generates a increasing trend of FCF (Free Cash Flow), which indicates that the company has a potential for flexible cash management whether for the growth investment or shareholder returns. Third, Walmart appears to have quality earning. Further, there are close ties between net income and CFO in other words, both net income and CFO show positive trend and increase at a comparable rate. Also Walmart is engaged in neither manipulating earnings nor making positive changes in accounting methods. Fourth, Walmarts ratios look good.ROA and ROCE are strong when compared to those of Costco and Target. The liquidity ratios are relatively low , but can be addressed if Walmart chooses to retain cash instead of using it on growth. Finally, Walmarts P/E ratio on May 19, 2011 is 11. 5, which is relatively low when compared to that of Walmarts competitors (Target 11. 9, Costco 26. 3). As such, Walmart appears to be undervalued. Ultimately, the analysis on Walmarts financial statements indicates that investors would be well advised to buy Walmarts stocks.