Wal-Mart Financial Statement Analysis

The Paul Merage School of occupancy at UC Irvine Financial Statement Analysis & Reporting Earnings woodland and As institute Analysis Company WALMART Kian BolooriHee Jun ChungDaejune Min 1. Qualitative Analysis for the purlieu and the conjunction (1) INDUSTRY compend Walmart is in the subtraction seller concern. This industry started in the 1950s, grew in the 1960s, and matured in the 1970s. With exception to a chink harvest full point in the 1990s, the industry had remained stagnant since the 1970s. Today, three major(ip) players in the industry be Walmart, nates and Costco.The state of the discount sell industry is best understood through the Porters quint Forces digest. * Competition HIGH Competition among discount retailers resembles that of an oligopoly in that Costco, Target and Walmart drive a vast majority of the market deal. In past decades, disputation among the firms was minimized because they from all(a)(prenominal) maven targeted a different mark et segment. For example, Target cerebrate on higher end neighborhoods slice Walmart focused on rude locations. However, as the firms began to grow, they had to expand beyond their original targeted segments.As such, the firms started competing in the resembling locations, which intensified competition. This condition remains a dominant issue in the discount retail industry. * Barrier to New Entrants specialty-HIGH Unlike other industries, the discount retailer industry does not require a particular set of technical knowledge for bracing entrants. However, the major players in the market ask established strong procurement and dispersal dismissworks that prevent new entrants from easily establishing their own. As such, new entrants would find it difficult to establish procurement and istribution inter acquitworks while make unnecessarying be competitive with those of Walmart, Costco and Target. * Bargaining Power of Buyers LOWMEDIUM Buyers amaze different levels of powe r depending on their location. In rural areas, barter forers lose less power. at that place is usually one discount retailer for each rural region. As such, that retailer has a virtual monopoly in that region, which book it to gain prices, and thus increase margins. On the other hand, buyers in suburban and urban markets corpo dimensionn 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 assure little to no power. When the major discount retailers initiate relationships with new suppliers, they typically request contracts for the new suppliers whole gunstock. As a result, the suppliers become all told reliant on the discount retailer for their business. The discount retailer so leverages this reliance by demanding miser opener prices on the livestock. As a result, suppliers typically catch to sell their inventory at low prices that result in small profit margins for them and lower inventory equals for discount retailers. brat of Substitutes LOW Current existing substitutes to discount retailers acknowledge supermarkets, traditional retailers, and dress shop shops. However discount retailers are able to leverage their strong scattering enlightenworks to offer lower prices than many of the substitutes. As a result, discount retailers are able retain business despite the existence of substitutes. (2) ECONOMIC CONDITIONS The position that there are fewer opportunities to expand in the United States has make it difficult for discount retailers to continue developing profits.In fact, discount retailers attempts to acquiesce 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. notwithstanding 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. in addition, discount retailers have begun expanding their international ope dimensionns.For example, Walmart has partnered with companies in South Africa, China, and brazil-nut tree in give to expand into those markets. These opportunities have already proven economic 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 down to the customers. Walmart accomplishes this strategy through several promoter. 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 make sure the corpo dimensionn hunting lodge of magnitudes the right about of inventory from suppliers so that the Walmart stores experience neither everyplacestock nor stock-out. Second, Walmart keeps its labor costs low. Walmart maintains a frugal culture for all employees. For example, executives at the company are taboo from accepting meals and shows from third parties. Additionally, Walmart provides store workers with wages and benefits that are below those prone by competitors.Third, Walmart invests in ways to cut distribution costs. For example, Walmart mastered the big 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 tip discount retailer in the world. . Quantitative Analysis for the company and the peers (1) CASHFLOW ANALYSIS From fiscal year 2007 to fiscal year 2010, Walmart recorded solid harvest in both sales and net income however, net increase in immediate payment and interchange equivalents does not have the same growth physical body. pass change flow is the aggregate of currency in flow from operations (chief financial officer), cash flow from invest activities (CFI), and cash flow from financing activities (CFF). As is anticipate, chief financial officer does trend decreed in correlation with the increases to sales and income.On the other hand, CFI and CFF experienced sharp decreases. According to the common-size statement of cash flow, net CFI portion out of net chief financial officer shows a generally diminish trend during the cessation (-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-M art has become paying equal attention to investiture for the future growth and stockholder repute recently.Having solid CFO, Walmart had cash for investing and financing without borrowing a short-run 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 al most(prenominal) 400%. Target shows a similar cash flow pattern to that of Walmart. Target has been reducing investment level and cogitate more(prenominal) on shareholder contribute and the debt repayment. On the other hand, Costco has been managing the cash flexibly oer the past four years in order to bear on the firms require for investment.Costco lock in concentrates on investing activities, which can be evidenced 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 huge shun CFI. For Walmart, the be allowance accruals, which is measured as the gap between net income and CFO, is at 40%. The accounting adjustment accruals are one of indicators for pelf quality. While 40% is significant, it is smaller than that of Walmarts competitors. Changes to current assets and current liabilities have a salient impact on the accounting adjustment accruals.For instance, Walmart had accounts receivable 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(a) trend of free cash flow, which is the difference between CFO and seat of government 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.T he 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, including 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 overly 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 Accrual (NI/CFO) 58% (Gap 42%) 54% (gap 46%) 53% (gap 47%) CFO Positive,Constantly developing 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 debt in 2007) Negative (for shareholder r eturns) One cause of concern from Walmarts cash flow is a contradiction between Walmarts growth strategy and CFF.The high levels of dividends that Walmart gives its shareholders whitethorn limit the amount of cash the company has for expansion. CFO has remained high rich to cover 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 due to the fact that revenue had in like manner 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 lolly Sales patte rn is computed as the sales less sales tax and estimated sales returns. less(prenominal) than 1% of jibe revenue is based on membership revenue. membership revenue is from customers who purchase yearly Sams Club memberships. There are several important features regarding the relationship between winnings Income and CFO.First, the Net Income and CFO both trend positive, growing at a equal rate. Second, CFO is larger than Net Income each year. This is primarily due to the adjustment to dispraise and amortization. Third, the adjustment due to an increase in accounts receivable is plum 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 revenue over the period of the membership. For example, if a membership cost $120 upfront, then $10 revenue would be recognized each month of the 12-month membership. Until its recognized, the cash collected is accounts as a indebtedness (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 receive 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 megascopic profit seem dis proportionately stronger than its competitors. However, these costs can be found inwardly SGA. SGA, Advertising and Pre-Opening costs are all r ecognized 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 little recover that Walmart fabricated sales figures. Furthermore, Walmart did not make any significant changes to its depreciation rhythm methods and PPE purchase patterns, which suggests that Walmart did not try to inflate its earnings to disguise admonitory operating performance. (3) RATIO ANALYSIS Financial ratios are a measuring stick 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 prior periods (trend analysis). advantageousness Ratio The ability to generate profit on corking invested is a key determinant of a companys overall value. gainfulness is the net results of a number of policies and decisions. Here, the key ratios, RO CE 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 peril 10-2). This high ratio indicates that Walmart generated high income with given level of its assets. Return-on-capital employed (ROCE) has too increased to 21. 3% in 2010, from 19. 1% in 2007 (See butt 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 derangement in days was 40 days in 2010, which is a modest improvement from 45 days in 2007 (See exhibit 11-1). The lower holding days of the inventory indicates that Walmart has made progress over the period in terms of inventory management. Considering the Sales growth, which increased over the periods, Walmart has effectively managed its inventory, avoiding any shortage or inadequate inventory levels. Walmart continue to set their goods in fairly low price in order to have its inventory move faster. Even though inventory disorder 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 getable credit facilities. * Liquidity Ratio (Short-Term) A liquid asset is one that trades in an active market and can be quickly born-again to cash. A firms runniness 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 exceed ing 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 ratio 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 outdoors financing to meet short-term obligation. However, a reason for the troubling liquidity ratios is that Walmart has been utilise 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 rebirth 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 t hat 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 the business process thus better for the companys hindquarters 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, again 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, increase 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 quit that Walmart is a company that can be highly r ecommended 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 little terror of substitution. Also for the company level, Walmart 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 pliable 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 intermeshed i n neither manipulating earnings nor making substantial 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 kinda 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.