Corporate Finance Project Wal-Mart Is Term Paper
- Length: 10 pages
- Subject: Business
- Type: Term Paper
- Paper: #25895193
Excerpt from Term Paper :
This is a particularly useful metric for retailers, because the fixed assets are typically the stores and land. The greater the degree to which the retailer can convert the stores and land to sales, the implication is that the retailer is a superior merchandiser. For Wal-Mart, the sales/net fixed assets ratio is 3.25. The RMA for this metric holds that 7.3 is "worst." This indicates that Wal-Mart is doing a relatively poor job by industry standards of converting its fixed assets (buildings and land) into sales.
The fourth profitability ratio is the sales/total assets. This metric takes the sales/net fixed assets ratio and adds back the other forms of assets. The value of this ratio to the creditor is that it provides an indication of the degree to which the firm converts all of its assets into sales. This is also similar to the ROA, except that it focuses on sales rather than profits. For Wal-Mart in FY2011, the sales/total assets ratio was 2.33. The RMA for this metric holds that 1.7 is "worst" and 2.9 is "average." Wal-Mart again underperforms the industry in this measure. This ratio is influenced by the high net fixed assets, but indicates that compared to its industry peers, Wal-Mart is not converting its assets into sales very well. That the company does convert assets into profits (pre-tax ROA) indicates that the company is very profitable in its endeavors and this makes up for the low degree of sales to assets.
The ratio analysis reveals a few things about Wal-Mart. In most categories, the company is either exceeding the industry standards ("best") or is operating around the industry average. For the most part, Wal-Mart operates at a very high level. The one aspect of the ratio analysis that is cause for concern is the ability of the company to convert assets to revenues. However, as Wal-Mart does a good job of converting assets to profits, this is not a major cause for concern.
The company has good liquidity ratios.. While the current ratio is not considered to be good, the company's liquidity looks fine when considering the other ratios in balance. The business model emphasizing low levels of inventory is partially to blame for the poor current ratio, and Wal-Mart has operated at this ratio for a couple of years without seeming too concerned about it. The company's receivables and inventories turnover ratios are strong compared with the industry . With such a short cash conversion cycle, Wal-Mart appears to have strong liquidity and is a low default risk. The company earns in EBIT its annual interest expense every month.
Wal-Mart appears to be comfortable with its current capital structure. The company is adding to its long-term liabilities, probably because of the low interest rate environment. Some of the proceeds from this lending are being used for stock buybacks, which improve the market value of the company's stock. These buybacks also reduce the common shares outstanding and the book value of the firm's equity. These moves to increase leverage are deliberate on the part of management, indicating that any increase in the company's debt is something that it desires.
Wal-Mart may not convert assets to revenue, but it converts both assets and equity to profit better than its industry peers. This indicates that the company is profitable. It has good control over its cost structure. That Wal-Mart has a formula for profitability is a good indication of both its financial and operational health. In general, the company's indicators are strong relative to the industry and this indicates that Wal-Mart is a relatively low default risk.
Cash Flow Analysis
Wal-Mart has two main sources of inbound cash flow. The most significant source is income from continuing operations. Most of what Wal-Mart does is financed by its profits. The other significant cash inflow last year came from the issuance of debt. The company issued $11.396 billion in debt, while retiring just $4.080 billion. This escalation in leverage is a deliberate action on the part of management to alter the firm's capital structure. Depreciation being added back from the income statement was the third-largest "source" of funding, although the point is that depreciation is not an actual cash flow. The fourth-largest source was the change in the accounts payable. Wal-Mart stretched its payables in order to finance some operations, but its payables turnover is still rated as average. These inbound cash flows are normal. Wal-Mart used a combination of equity (cash flow from operations) and debt financing for its operations last year. The company increased its long-term borrowing, but not unduly so.
The outbound cash flows are not unusual. The largest outbound cash flow item was the purchase of company stock. This is something that companies will often do at times when their stock price is depressed. The buyback increases the market value of the stock by increasing its scarcity on the markets. By propping up the share price, the company is improving the returns to the shareholders. The second-largest cash outflow was for payments for property and equipment. This is not surprising given the size of Wal-Mart's fixed asset base. The company is also expanding rapidly in a number of key emerging markets. This category of spending is typically considered an investment that should yield future improvements in income. Dividends paid is the third outbound cash category. This is a normal business activity, and helps to increase the return to the shareholders. The fourth-largest category of outbound cash flow is the payment of long-term debt. This is also normal. Some of this debt was rolled into new borrowings, which again is quite normal.
There is nothing unusual about the cash flow statement for Wal-Mart. The shift in capital structure that the company is undertaking is not surprising given the low interest rate environment and the volatility of the stock markets. Wal-Mart is able to build shareholder value while lowering its cost of capital. The company is continuing to invest, which given the profitability of its operations is quite desirable.
Recommendation and Conclusion
The bank should lend to Wal-Mart. The company is the largest retailer in the world, and its metrics are generally solid. The high-volume, low-margin business model is somewhat risky but the company does not have an irresponsible amount of debt. The pros of lending to Wal-Mart rest on the low risk of default. The company has a high times interest earned ratio and a short cash conversion cycle. The company's current ratio is not of serious concern, especially given its low inventory levels. Wal-Mart is also a profitable company and appears to have strong operating efficiency as well, to help maintain cash flow.
There are few drawbacks to lending to Wal-Mart. There is some concern about the high book value of its fixed assets in relation to revenues, but the company's ROA is strong so this can be overlooked somewhat. The debt-net worth ratio is perhaps getting a bit high, but the company is not having any problems servicing this debt. Qualitatively, the company's strong position (#1 or #2) in its industries is cause for optimism. Wal-Mart also have sustainable competitive advantage with its bargaining power and hyper-efficient logistics system. This should result in continued revenue and profit growth. The company's diversification through three main businesses and a number of the world's fastest-growing major economies also is cause for optimism -- Wal-Mart is going to continue to improve its cash flow and that will only make it a better company to which to lend over the coming years. Thus, there is no major risk of default with Wal-Mart and the recommendation therefore it to lend.
BALANCE SHEET INFORMATION1
COMPANY NAME: Wal-Mart
%Common Size 20103
Common Size RMA
Total Current Assets2
Net Fixed Assets
(ONLY PP&E + Land)
(AKA Trade Payables)
Total Current Liabilities2
(It may be negative)
Total Net Worth2
Total Liabilities & Net Worth2
Note: NOT all the accounts off of the financial statement will go on this form. Only the accounts listed are needed for specific analysis are on this form.
Your Totals must equal the company's Totals! (BUT THE ACCOUNTS ON THIS FORM DON'T HAVE
TO ADD UP TO THE TOTAL AMOUNT SINCE NOT ALL ACCOUNTS ARE ON THIS FORM)
This is (each account $ amount divided by the Total Asset $ amount) x 100
(After multiplying by 100 only include one decimal place: ex: 23.4%)
This is the percent change in the dollar amounts. (($ in 2010 - $ in 2009)/$ in 2009) x 100