Business fundamentals and organizational principles

¶ … Target Corporation and Wal-Mart Stores, Inc.

The companies being analyzed are Target Corporation and Wal-Mart Stores, Inc. They are general merchandise retailers. They compete in the large-store general merchandise market, especially in the discount store segment and the U.S. geographic market.

Target Corporation's Store Brands in multiple formats are Target, Super Target, Mervyn's, Marshall Field's, Target Direct and Target Visa. Target operates 1409 stores in 47 states in the United States and is currently the No.3 discount retailer in the U.S. market.

Wal-Mart Stores, Inc. has several Store Brands: Wal-Mart currently operates 2295 Wal-Mart Discount Stores; 1521 Supercenters; 564 Sam's Clubs and 34 Neighbourhood Markets in 9 countries outside the U.S. - Argentina; Brazil; Canada; China; Germany; South Korea; Mexico; Puerto Rico; United Kingdom. Wal-Mart is today the world's largest retailer (and company measured by revenue) and occupies the No.1 position in the U.S. General Merchandise Retail Market.

In regard to investment decisions:

Wal-Mart Stores, Inc. is a better investment than Target Corporation. The reasons for this judgement comprise of a mix of financial and qualitative criteria. The judgement has also been arrived at by taking several of the criteria used in conjunction with each other.

Financial criteria that assumed significance in the judgement are: Company Performances in relation to each other, the Industry and the S&P Index; Management Effectiveness as measured by the Return on Equity, Return on Assets and Return on Investment; Debt Equity Ratio; Segment Performance and Inventory Turnover.

Qualitative judgement has been applied through an understanding of market position; factoring in of a strategic viewpoint on market expansion; and assessing the current strategic direction announced by both companies.

Compared to the S&P 500, Target Corporation is a good investment. This judgement has been arrived at by using the following criteria:

Comparing performance against the S&P 500 Index using measures such as Market Capitalization; Price/Volume; Total Returns; Financials and Valuation Criteria. It is important to mention here that a judgement has been arrived at from a long-term position and therefore any current volatility in share price relative to the S&P 500 index has been ignored.

Qualitative judgement was applied by referring back to the overall analysis conducted to answer the question of which company is a better investment.

Compared to the S&P 500, Wal-Mart is also a good investment. This judgement has been arrived using the same criteria and approach as described in 2.2 above.

In regard to lending decisions

Wal-Mart is a better borrower than Target Corporation, using the following reasons:

An assessment of financial criteria that directly affect a company's ability to service debt such as Times Interest Earned Ratio; Cash Flow; Debt Equity Ratio; Financial Leverage and Price/Cash Flow.

Market perception as reflected in Ratings by institutions such as S&

Compared to the S&P 500, Target Corporation is a good borrower. The criteria used to arrive at this conclusion are:

Comparison with S&P on criteria such as Price/Cash Flow, Investment Grade Ratings, Debt Equity Ratio

Compared to the S&P 500, Wal-Mart is also a good borrower and has excellent ratings. This is indicated by using the same measures as described above.

I would lend Target Corporation $1 billion at 2-3% higher than prevailing market rates of interest under the following conditions

Secured Loan

Option to exercise part conversion to equity

Premium of 1% on Loan balance in case of defaults would lend Wal-Mart $10 billion at prevailing market rates under the same conditions as above.

In regard to decisions as a place where I would be employed, I would choose Wal-Mart over Target Corporation. The reasons based on which I arrived at this decision are as follows:

Reputation as employer

Career Prospects

Overview of Target Corporation and Wal-Mart Stores, Inc.

Target Corporation's Store Brands in multiple formats are Target, Super Target, Mervyn's, Marshall Field's, Target Direct and Target Visa.

Target operates 1409 stores in 47 states in the United States and is currently the No.3 discount retailer in the U.S. market.

Target Corporation has in the last 5-6 years successfully pursued an aggressive growth strategy leading to increased penetration in existing territory through the opening of more stores as well as expansion into new markets.

Target has been following a conscious strategy of positioning itself as a premium discount brand (cheap chic) and focusing heavily on driving its value added service businesses such as the Target Visa and online arm branded Target Direct. The company has entered into a tie-up with Amazon.com with the objective of expanding its online presence and growing its ecommerce. Target aims at straddling different consumer segments through positioning Target as premium discount and Mervyn's and Marshall's as moderate price to full service department stores. The company is also placing a great deal of emphasis on its Super Target Stores (competing head on with Wal-Mart's Supercenters) but since the performance of these large format grocery stores is not reported separately by the company, it is difficult to gauge the contribution of this line of business within the ambit of Target Store performance.

Target has also achieved impressive growth in market share, revenues and net income accounting for the stock having come into such limelight on the bourses.

Wal-Mart Stores, Inc. has several Store Brands: Wal-Mart currently operates 2295 Wal-Mart Discount Stores; 1521 Supercenters; 564 Sam's Clubs and 34 Neighbourhood Markets in 9 countries outside the U.S.

Wal-Mart's markets include Argentina; Brazil; Canada; China; Germany; South Korea; Mexico; Puerto Rico; United Kingdom and the United States.

Wal-Mart is today the world's largest retailer (and company measured by revenue) and occupies the No.1 position in the U.S. General Merchandise Retail Market.

Wal-Mart's revenue for FY 2002 was $218 billion. Wal-Mart has, since its inception, built its entire business on one simple principle and that is to offer the lowest prices. Today, the company has extended that tried and tested principle to all kinds of merchandise including consumer electronics and household appliances to groceries stocked by Wal-Mart Stores, Supercenters, Sam's Club and neighbourhood markets. Furthermore, the company is following the same philosophy in its international markets.

Wal-Mart has also been very consistent in managing its business well, which reflects on the shareholder value it has delivered down the years and its current position in the stock markets. Little wonder then that Wal-Mart features so frequently in the top 10 among Fortune's Most Admired Companies in America.

Investment Decisions

Wal-Mart Stores, Inc. is a better investment than Target Corporation. The reasons for this judgement comprise of a mix of financial and qualitative criteria. The judgement has also been arrived at by taking several of the criteria used in conjunction with each other.

Criteria # 1: Comparison of Performance vs. Industry

This criterion is valid for comparing these two companies because it effectively measures performance of each against an overall industry background.

It is important to assess whether a company's performance is better than or at least in line with industry growth, in order to get a measure of how well the companies are being able to gauge consumer trends, spot opportunities, manage resources to maximize potential and profits.

In this connection, it is important to note that while both Wal-Mart and Target are clearly growing share (Wal-Mart's market share has increased to approximately 13% of the overall U.S. market), Target's heavy focus on the grocery segment (Super Target) will take it head on into Wal-Mart territory where it may not be able to effectively match Wal-Mart prices. Although it is true that currently Target is being able to generate higher margins through it's mid-price and premium discount strategy, this may not hold true with larger contribution to sales coming from Super Target Stores. Currently around 80% of company revenue is from the main Target brand. Whereas Wal-Mart Stores constitute 63.8% of overall sales. Wal-Mart is also growing its business through increased same-store sales of 6% in 2002 as compared to Target's same-store sales increase of 2.7%. Clearly, measuring relative performance to Industry and each other, Wal-Mart comes through as the better performer since it is gaining share from competition.

Criteria # 2: Comparison of stock performance to the industry and the S&P 500.

This will also be a valuable input into assessing investment prospects, as it will reveal how good the performance is against capital market performance norms.

Such an assessment will help determine which company is the better investment since the S&P 500 Index comprises of the economy's best performing stocks and therefore this will serve as an effective benchmark

The Price/Volume graph comparing Wal-Mart and Target stock to the S&P 500 clearly shows that while both stocks are at a higher level than the S&P Index, the Wal-Mart stock is the more heavily traded, an indication of higher investor confidence.

Data on the same graph sheet also shows that both Wal-Mart and Target outperformed the S&P Index and Industry in the area of Total Returns over a 5-year period. It must be remembered that FY 2000 was a bad year for the retail industry on the whole, when looking at the figures. However, when comparing the Total Returns of Wal-Mart to that of Target, it is apparent that Wal-Mart has delivered higher returns over 1997-2002.

FY2002 is likely to see both Wal-Mart and Target improve on their Total Returns performance against both Industry and the S&P 500 given the already announced improvements in Q1 earnings reports.

The market capitalization of both Wal-Mart (247,132.1) and Target (37519.1) are well above the S&P 500 average of 19,717.5.

On the parameter of Financials, both Target and Wal-Mart compare favorably with the S&P 500 Index. However, it is very clear that Wal-Mart is by far the stronger company as compared to both Target as well as the S&P 500 performance. Wal-Mart's Revenue Growth (% 3 years) stands at 16.5 as compared to Target at 9.2 and the S&P Index at 15.4. Target Corporation does outperform both Wal-Mart and the S&P 500 Index on EPS but suffers in comparison on all other scores such as Revenue Growth, Return on Equity and Debt Equity Ratio. Wal-Mart outperforms on both counts of Return on Equity (19.0) and Debt to Equity Ratio (0.5).

A look at the valuation ratios of Wal-Mart and Target, measured against S&P 500 performance also reveals the relative strength of Wal-Mart which has a higher PE of 37.3 vs. Target's 27.6 and a 5-year average PE of 40.1 against Target's 25.8. The Valuation Chart also reflects Wal-Mart's stronger PEG Ratio of 2.3, which meets the norm of 'excellent'. Target's PEG is 1.6 which is also good but shows relative weakness to Wal-Mart. Wal-Mart has also rewarded its shareholders through 21.4% Dividend growth over 5 years - far higher than Target's 7.5% and the S&P 500 average of 0.2%

The above comparisons helps in investment decisions since it is a clear indicator that the management of a company can accurately read and anticipate consumer trends, cater to emerging new tastes and thereby keep growing market share, revenue and income (through effective management of costs and inventory turnover). For it is this constant creation of wealth and thereby shareholder value that has an impact on stock prices and demand for company stock. A company's past performance is a good measure of its ability to continue to tap future growth opportunities.

Criteria # 3: Management Effectiveness

This criterion is valid for comparing these two companies because comparison of performance in the areas of Return on Equity, Return on Assets and Return on Investment indicates which company is better managed.

Criterion

Wal-Mart

Target

Management Effectiveness

Return on Equity (TTM)

Return on Assets (TTM)

Return on Investment (TTM)

Comparison of the above figures will reveal which company is better equipped to tap future potential and opportunities in a manner designed to maximize market share and profitability.

The figures in the table above show that the difference between Wal-Mart's figures and that of Target's is not dramatically different. In other words, Target is also a well managed company but the above figures lean towards Wal-Mart being the better investment

Criteria # 4: Long-Term Debt Equity Ratio

This criterion is valid for comparing these two companies because it is a company's Long-Term Debt Equity Ratio that measures the amount of assets being provided by creditors for each $ of assets being provided by owners.

The use of the LT Debt Equity Ratio helps in determining whether Wal-Mart or Target is the better investment because the higher a company's LT Debt Equity Ratio, the higher it is financially leveraged raising the need to question its ability to service debt, fund future growth plans and distribute earnings among its shareholders.

On this criterion, Wal-Mart is significantly better placed than Target with a LT Debt Equity Ratio (MRQ) of 0.53 as compared to Target's 1.03.

Criteria # 5: Segment Analysis

This criterion is valid for comparing the two companies because both operate in multiple retail formats and therefore it would be important to examine the health and future prospects of the various segments contributing to their business.

Segment Analysis helps to determine investment viability because weak segments or loss making segments can have a negative impact on the overall profitability of the company as well as affect ability to further invest in profitable growth areas.

This criteria shows that Wal-Mart is seeing healthy growth in each of its retail formats, be it Sam's Club or Supercenters or Neighbourhood Markets whereas an analysis of Target Corporation's sales and revenue growth from Mervyn's and Marshall Field's does raise some questions as to the future of these segments. FY 2002 saw each of Wal-Mart's business segments deliver year-on-year growth of net sales whereas both Mervyn's and Marshall Field's have actually seen a decline in net sales over FY2000. It is also significant that a little over 80% of Target Corporation's revenues comes from Target whereas Wal-Mart stores contribute around 63.80% to the total. Given that each of Wal-Mart's business segments are in better health and are showing good growth prospects, as compared to Target - on this criterion too Wal-Mart is the choice of investment.

Criteria # 6: Market Expansion

This criterion is valid for comparing the two companies because they are operating in a mature industry in a mature economy.

A look at the scope and nature of expansion plans will help in assessing future outlook and prospects.

In Target's case, given that its operations are only within the United States, it will primarily depend on market share gains from competition for growth whereas Wal-Mart has already made a presence in 9 countries outside the U.S. with plans to enter the tenth - Japan.

This indicates that Wal-Mart's prospects for growth are better: always providing that the Company manages to replicate its successful business model in the U.S. elsewhere in the world and a look at the performance of its International Division so far seems to indicate that it has done so.

Criteria # 7: Inventory Turnover

This is an important criterion especially when evaluating two large-scale players in an industry with known low margins.

The company's Inventory Turnover reflects its ability to efficiently manage its supply lines and equally move the inventory out of its stores as a sale.

In this area too, Wal-Mart scores with an impressive 7.79 (for its giant size) as against Target's 3.13. Wal-Mart's ability to move large amounts of merchandise is also reflected in its Average Sale Period of 46.85 as compared to Target's 116.61. The Inventory Turnover and Average Sale Period figures have been calculated from the last Annual Reports of the companies.

It must be mentioned though that Target is working towards improving its Inventory Turnover by investing in Information Technology to improve supply chain management on the one hand while introducing concepts like chip cards to customize promotions to individual customers on the other. But the results of these efforts have yet to accrue and reflect in measurable performance.

To conclude, though Target Corporation has put in an incredible performance in recent years, Wal-Mart is the better investment.

Compared to the S&P 500, Target Corporation is a good investment. The reasons for this judgement are:

Criteria: Comparison of all standard performance norms

The criteria are valid because they show the relative performance of Target stock vis-a-vis the S&P 500 Index.

The comparison will help answer the question of whether Target Corporation is a good investment since the S&P 500 Index serves as a benchmark for good performance.

Target's performance vis-a-vis the S&P 500 has already been established earlier in this paper (6.1.2). The only additional points to be made are: Currently Target's Beta is 1.15 indicating higher price volatility relative to the S&P. However, since it is the company's long-term prospects that are being evaluated here, this factor has been ignored.

Secondly, although Target's Year End Dividend Yield has been lower than the S&P 500 over the same 5-year period, it has to be viewed from the perspective that since the S&P 500 Index is made up of stocks across various sectors, dividend performance should be weighed against retail industry average especially considering that the discount segment of the retail industry works on thin margins.

Finally, it is important to consider that Target Stock Performance compares favorably to that of the S&P 500 Index though it may be trailing the index on certain parameters. Viewed from that angle, and the fact that the stock does outperform the S&P Index in areas like Total Returns and Dividend growth over a 5-year period, the conclusion is that Target Corporation is a good investment prospect. Having said that, as an investor, it would be key to keep a careful watch on the company's Debt Equity Ratio, which needs to be improved.

Compared to the S&P 500, Wal-Mart is a good investment. The reasons for this judgement are:

The reasons for the above judgement have already been comprehensively covered earlier in this paper under point 6.1.2. A point of additional interest though is the fact that Wal-Mart is among the top 10 weighted S&P 500 stocks.

In regard to lending decisions

Wal-Mart is a better borrower than Target Corporation. The reasons for this judgement are:

Criteria # 1: Long-Term Debt Equity Ratio

This criterion is valid for comparing these two companies because it is a company's Long-Term Debt Equity Ratio that measures the amount of assets being provided by creditors for each $ of assets being provided by owners.

The use of the LT Debt Equity Ratio helps in determining whether Wal-Mart or Target is the better borrower because the higher a company's LT Debt Equity Ratio, the higher it is financially leveraged raising the need to question its ability to service debt.

On this criterion, Wal-Mart is significantly better placed than Target with a LT Debt Equity Ratio (MRQ) of 0.53 as compared to Target's 1.03.

Criteria # 2: Financial Leverage

This criterion is valid because it shows a company's ability to finance its debt.

By studying a company's Degree of Operating Leverage (DOL) and Degree of Combined Leverage (DCL), a judgement on the company's risk rating can be arrived at.

A comparison of Wal-Mart's and Target's Financial Leverage shows that Wal-Mart is a better borrower since its DOL is 0.45 vs. Target's 1.3 and its DCL is 0.41 vs. Target's DCL of 1.16. Clearly Wal-Mart, as a borrower, presents a lower risk.

Criteria # 3: Cash Flow

Cash Flow is critical to a company's ability to service its existing business, pay back debt and still be able to generate cash to, for example, distribute as dividends.

Cash Flow, as a measure, helps determine a company's ability to pay back borrowed funds on time.

Comparing the cash flow of Wal-Mart to that of Target shows that Target has a higher cash flow though it is important to bear in mind that Target's operations are comparatively on a lower scale to that of Wal-Mart. Given Wal-Mart's sheer size (cash in 2002 was $2,161 million), excellent credit ratings and past profitability - the company's ability to finance either short-term or long-term debt does not really come into question. However, the same cannot be said of Target whose Long-Term Debt Equity Ratio is high enough to cause concern. A lot will depend on Target's ability to continue to grow profitability and reduce its debt over time.

Criteria # 4: Times Interest Earned Ratio

This ratio is the most common measure used to evaluate the ability of a borrower to provide protection to a long-term creditor and is therefore valid here.