Wal-Mart and Target are two of the leading retailers in the world. Wal-Mart is one of the world's largest companies and Target is one of its primary competitors. While the both succeed based on similar competencies in logistics and merchandising, there are significant differences between the two that lead to different financial results. Wal-Mart is by far the larger, and this allows it to execute the cost leadership business model more effectively, leveraging economies of scale. Wal-Mart is also more diversified -- it operates internationally while Target does not, is stronger in groceries and has a much stronger online business. The purpose of a financial analysis of these companies is to determine which of the two is stronger financially. The analysis aims to answer the question of how the strategic differences between the two companies translates into differences in financial performance. This information is of particular use to potential investors that have an interest in a retailing business and might therefore benefit from a direct comparison between the two companies.
The economic downturn that began in 2008 and its aftermath have had a significant impact on a number of businesses, and major retailers are no exception. The ability of a firm to weather a financial crisis is an important element in its financial strength. Wal-Mart's revenues did not decline during any fiscal year of the past five, nor did its net income. Wal-Mart saw revenue increase 7.2% in 2009, 0.9% in 2010 and 3.4% in 2011. Wal-Mart profit increased 5.1% in 2009, 7.4% in 2010 and 14% in 2011. That Wal-Mart's profit improved at a faster rate than its revenues is noteworthy. This can be attributable to improvements in its gross profit, reflecting Wal-Mart's ability to leverage its superior pricing power to increase profits even when revenues are all but flatlining.
For Target, the company saw revenue increase each year of the past five, but saw its profits decrease in 2009 and only in 2011 rebound to pre-crisis levels. The company's revenues increased 2.5% in 2009, 0.6% in 2010 and 3.1% in 2011. Target's net income declined 22.2% in 2009, then increased 12.3% in 2010 and 17.3% in 2011. These figures show that Target's profit is more volatile than its revenue, decreasing at a faster rate when times are tough and then increasing at a faster rate when the economy begins to show signs of improvement. The company's gross profit fell in 2009 to 29.5% from 30.1% the previous year, but rebounded to 30.6% by 2011. This indicates that Target perhaps does not have the same strong pricing power as Wal-Mart. This is to be expected, as Target simply does not have the economies of scale in purchasing and distribution that Wal-Mart has.
Ratio analysis is the process of deriving financial ratios from a firm's published financial statements. These ratios are compared across the firm's history, across its industry and across business norms. The ratios provide insight into a number of different elements of the financial condition of the firm -- its liquidity and solvency, its profitability, its investment returns and its operating performance (Loth, 2011). By using this form of analysis, the two firms of Wal-Mart and Target can be compared against one another, despite their vastly different sizes and slightly different businesses. For the investor, this approach is reasonable since in all likelihood only one of these two firms would be chosen for any given portfolio.
The first set of ratios to be calculated is the liquidity ratios. The liquidity ratios measure the ability of the company to meet its financial obligations for the coming year. These obligations are met by converting current assets (those with under one year to cash conversion) to cash. Thus, there are three different liquidity ratios -- the current ratio, the quick ratio and the cash ratio. The current ratio measures the current assets divided by the current liabilities. For Wal-Mart, this was 0.88 for 2011, 0.86 for 2010, 0.88 for 2009 and 0.82 for 2008. This shows that Wal-Mart has experienced a relatively stable current ratio that has seen some improvement over the past few years. The quick ratio for Wal-Mart in 2011 was 0.26 in 2011, 0.27 in 2010 and 0.26 in 2009. The cash ratio for Wal-Mart was 0.13 in 2011, 0.14 in 2010 and 0.13 in 2009. All of Wal-Mart's liquidity ratios are stable, and have been so through the financial crisis. While the ratios are relatively low, this is in part due to Wal-Mart's tight cash conversion cycle and relatively low levels of inventory. The most important factor in the analysis is that Wal-Mart's figures are stable during both moderate and poor economic times.
For Target, the current ratio for 2011 was 1.71, for 2010 it was 1.62 and for 2009 it was 1.66. The quick ratio was 0.95 in 2011, 0.99 in 2010 and 1.02 in 2009. The cash ratio was 0.17 in 2011, 0.19 in 2010 and 0.08 in 2009. There are two main trends within Target's liquidity ratios. The first is that Target's ratios are much better than Wal-Mart's. The company is very liquid, especially in comparison to its larger competitor. The other trend is that Target's current ratio is improving, its quick ratio worsening and its cash ratio in the middle. The cash ratio trend is skewed by an abnormally low cash level in 2009. The other two trends are explained by the fact that inventories have increased as a percentage of current assets. With higher inventory levels, Target's current ratio can increase while its quick ratio weakens, and that is exactly what has happened. For Target, it cannot reasonably be assumed that an improved current ratio is a good thing -- in this case it may reflect lower rates of inventory turnover.
The second set of ratios to be calculated is the solvency ratios, which reflect the firm's capital structure -- its ability to meet its long-term financial obligations. Two solvency ratios worth noting are the debt ratio and the long-term debt-to-equity ratio. Trends are an important mode of analysis here, as firms typically choose D/E ratio targets based on a number of criteria, so higher levels for one firm over another do not necessarily reflect any genuine differences in solvency. For Wal-Mart, the debt ratio in 2011 was 62%, in 2010 it was 58.6% and in 2009 it was 60%. The long-term debt-to-equity ratio was 63.9% in 2011, 51.6% in 2010 and 52.9% in 2009. These figures indicate that Wal-Mart has increased its leverage. The company has taken on over $7 billion in long-term debt in the past year, and this has weakened its solvency ratios. For Target, the debt ratio was 64.5% in 2011, 65.5% in 2010 and 68.9% in 2009. The long-term debt-to-equity ratio in 2011 was 100.7%, in 2010 it was 98.5% and in 2009 it was 127.8%. These figures reflect a decrease in Target's degree of leverage. While the company is growing at a slower pace than is Wal-Mart, Target is also paying down its debt, as evidenced by the reduction in long-term debt in 2010. This reflects well on its long-term solvency.
The next set of ratios is the profitability ratios. These ratios measure the firm's ability to convert revenues into profits. By breaking down the different profitability ratios, it can be better understood the different areas where the firm is having success or difficulty in terms of its profitability. The different profitability ratios are the gross margin, the operating margin and the net margin. For Wal-Mart, the gross margin in 2011 was 24.5% compared with 24.6% in 2010 and 24.0% in 2009. The operating margin was 6.1% in 2011, 5.9% in 2010 and 5.6% in 2009. The net margin was 3.9% in 2011, 3.5% in 2010 and 3.3% in 2009. This figures show improvement each year, as Wal-Mart exerts its pricing power to improve its profitability. It is worth noting that in discount retailing, sometimes margins that are too high indicate that the company is not offering the lowest prices possible -- this is something that could be a strategic disadvantage over time. However, that is not necessary the case, so care should be taken with using profit margins as a proxy for price competitiveness.
In 2011, Target had a gross margin of 30.8%, compare with 30.2% in 2010 and 29.5% in 2009. The company had an operating margin of 6.6% in 2011, 5.9% in 2010 and 5.4% in 2009. Target's net margin in 2011 was 4.3%, compared with 3.8% in 2010 and 3.4% in 2009. These figures show a trend towards improving margins that roughly mirrors that of Wal-Mart. Target has higher margins in general throughout the survey when compared to Wal-Mart. This could arguably be the result of the slight difference in competitive positioning, as Target does position itself as slightly superior in quality to Wal-Mart. However, the difference could simply reflect that Target does a better job of converting revenue into profit.