Walmart's liquidity ratios and financial position in 2006

Financial Analysis of Walmart

WalMart was ranked #1 by Fortune 500 in 2006 and made over $300 billion in sales and over $11 billion net income , in the same year. Considered to be one of the largest private employer in the world, the Wal-Mart's personnel size reached 1,900,000 last year. With these kind of figures, one can have an idea about the size of WalMart's operations, which can be a direct impact on the company's financial figures and ratios.

TOP 5 in 2006

Rank

Company

Revenue ($ millions)

Profits ($ millions)

Wal-Mart Stores

Exxon Mobil

General Motors

Chevron

Conoco Phillips

The company has more than 1,100 discount stores, 1,900 supercenters, 95 neighborhood markets and 575 Sam's club locations in USA and it established strategic presence in 13 foreign markets with 2,750 retail units, reaching over 175 million consumers. Its global expansion has been constant over the last couple of years, with China as one of the markets with the highest potential growth in the future.

Part B Solvency

Debt to Assets is computed as the ratio of total debt to total assets and it shows the percentage of assets that was paid by creditors as opposed to the percentage of assets credited by business owners. Basically, it provides information of the debt load related risk: If this indicator is higher than 1, then the total debt is higher than the total asset. When the debt is very high and is increasing compared to the previous years, it is possible that lenders will refuse future borrowing to such a company. Unlike liquidity ratios, the solvency ratios pay respect to long-term debt, which says to which extent the company's financial commitment is covered from shareholders' investments.

Interest coverage ratio expresses the company's capacity to pay the outstanding debt. The ratio is computed as follows: It is recommended that this ratio has a value higher than 1.5. If a company is generating a small profit before interest and tax (EBIT), after paying the loan expenses, there is little to be divided between shareholders.

It may be possible for a company to have high debts, and yet to be able to cover interest expenses and that is an important detail for lenders. The company has to show that is able to generate enough resources to pay its obligations.

Also, it is possible for a company not to be able to generate a high enough profit to cover the interest expenses in a given period, but to have low debt to asset ratio. In that case, the assets may stand as a guarantee of payment for lenders.

In 2006, the debt to assets ratio at WalMart was 0.225, with a value of 0.198 in 2005. The change in the debt-to-assets ratio shows a small increase in the financial leverage that the company is using. This can be explained by increases both in long-term debts due within a year, as well as in long-term debts with over 1 - year maturities. The latter increase is more significant, amounting 31.6%.

While this increase is not affecting the financial stability of the company, it is indicated that this ratio be kept under control and that the management ensures that the company's total assets can cover, at any given time, the long-term contracted by the company.

At the same time, the interest coverage ratio is 15.8 in 2006 and 17.33 in 2005. There are several conclusions that can be drawn from these values. First of all, the value is significantly higher than the 1.5 value generally recommended. This is not necessarily a negative aspect, indeed it shows that the proportion of interest expense in the total earnings value before interest and taxes is significantly small. This is encouraging, in the sense that the shareholders will have a much larger operational income to use for other purposes than interest expense. On the other hand, it also shows that, despite the increase in long-term debt from 2005 to 2006, the interest expenses remain proportionally small as a segment of operational income.

Part C Profitability

ROA (Return on Assets) measures the management's efficiency in using to use the company's assets to generate earnings. It is expressed as follows:

ROE (Return on Equity) measures the management's efficiency to generate profit with the shareholders money. It is expressed as follows:

Gross profit margin ratio expresses the size of profit derived from sales and can be calculated as follows: In this case, the higher is the ratio, the higher is the profitability. The profit margin can be improved either by reducing the costs of goods sold or by increasing selling prices.

The first two profitability ratios indicate the management efficiency to generate income over the assets and shareholders' equity, whereas the third ratio indicates the company's profit margin to the goods sold. The assets and equity account for more than just the company's sold goods, they also include stocks. Thus, a high gross profit margin, despite showing that the company is capable to generate high profits from the goods sold, it doesn't imply that the company has a high capacity to sell. For an investor or lender it is very important to see that a company has the capacity to sell proportional to its capacity to produce or stock merchandise.

ROA and ROE come to complete this picture. They measure the extent to which net income is generated relatively to the capital employed. Nevertheless, these two indicators alone can't offer a detailed analysis about the sales activity, which generates the largest part of the profit. The image is a general one, of the average profitability of all activities going on in a firm.

The return on assets was 0.134 in 2006 and 0.142 in 2005, a small decrease from 2005 to 2006. For a company the size of WalMart, the value is more than encouraging. Indeed, it virtually shows that approximately 13-14% of the company's total assets are directly translated into generated income.

On the other hand, the company's return on equity amounted to 0.35 in 2006 and a similar value (0.35) in 2005. This values show WalMart as a very profitable company for its shareholders, with 35% of the equity transformed into operational net income.

Finally, the gross profit margin was 29.96% in 2006 and 29.76% in 2005. The values for the gross profit margin sustain the idea that WalMart has been a very profitable company in 2005 and 2006. This can be most likely explained with a policy that combined low costs and, as such, the capacity to provide low prices to the customers, insisting on a high volume - low cost policy, and a policy of global expansion into new potentially profitable markets. This was able to guarantee the company a steady and sustainable growth, encouraging a constant profitability over this period of time.

Further more, the company is well-known for its principles of improving its performances and attempting to be more efficient in everything it does. Throughout its existence, the American retailer has focused on implementing information technology techniques in almost all its activities as the common belief was that automatization drives lower costs, lower prices, lower inventory, shorter delivery time and so on. Following these principles religiously, Wal-Mart has become one of the most efficient players in the entire American market, not just in its industry. Efficiency then was logically driving higher productivity rates and increased profitability for the shareholders.

Part D Company Report

The American retail market is dominated by 3 major players: Wal-Mart, Target and Kmart (see table 2). In 2005, the WalMart's market share was 8.82% increasing 0.2% from the previous year and consolidating its leader position on the U.S. market. As we can see from the figures below, WalMart's market share is around 7 times greater than its two nearest competitors, Target and Kmart. The company's position on the market comes to sustain the arguments in favor of its profitability.

Further more, all sources in the industry generally sustain the idea that WalMart remains one of the most solid and profitable businesses in any industry. The strong financial figures previously analyze clearly reflect this. Any potential legal or ethical problems that WalMart may have, along with risks associated to the global expansion, are not likely to affect its position on the market.

Table 2 - U.S. Retail Industry ($ millions)

Source: U.S. Census Bureau, companies' corporate websites