Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Wal-Mart (WMT) in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess the financial condition of Wal-Mart. The information that I am using for this article comes from Wal-Mart's most recent annual report, which can be found here. Note that this article is not a comprehensive review as to whether Wal-Mart should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
Wal-Mart operates retail stores in various formats under 69 different banners around the world. Their stores sell everything from groceries to health and beauty products to automotive accessories, making them convenient one-stop shops for millions of people. They pride themselves on offering what they call "everyday low prices." The company currently operates 4,625 stores in the United States and 6,148 stores outside the U.S., including 2,353 in Mexico.
The company's operations are divided into three segments. They are Wal-Mart U.S., Wal-Mart International, and Sam's Club. The Wal-Mart U.S. segment accounts for 59% of Wal-Mart's total sales. This segment includes the operations of stores in all 50 states and Puerto Rico, as well as their U.S. retail website, Wal-Mart.com. The Wal-Mart International segment includes operations in 26 other countries. These operations include retail stores, restaurants, and wholesale clubs such as Sam's Club stores that are outside the U.S., along with various retail websites that Wal-Mart uses to do business outside the U.S. Wal-Mart International accounts for 29% of the company's total sales. The Sam's Club segment accounts for 12% of the company's sales, and includes the operations of membership warehouse clubs in the U.S., as well as the website samsclub.com.
Wal-Mart has a market capitalization of $250B and has recorded $469B in sales over the last 12 months. The company has approximately 2.2 million employees, with 1.3 million of those working in the United States.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Jan. 31, 2013, Wal-Mart had $7.78B in cash and cash equivalents. Of this cash, $5.2B is outside the United States, and the company plans to use it to support its liquidity needs in foreign countries. Wal-Mart has no plans to repatriate this cash, as it plans to fund its U.S. operations with operating cash flows and debt.
Over the last 12 months, Wal-Mart paid out $5.36B in dividends, and bought back $7.6B worth of stock. During this time frame, both of these activities were almost entirely covered by the company's free cash flow of $12.7B. Wal-Mart is a member of the S&P 500 Dividend Aristocrats, which means that the company has increased its dividend payout for at least 25 consecutive years. The company still has an authorization to repurchase up to $3.7B worth of stock under its current program. When Wal-Mart repurchases shares, those shares are retired and do not show up on the balance sheet as treasury stock. Over the last three years, Wal-Mart has repurchased nearly 508M shares at an average price of $56.50 per share. That's not bad, given the company's current share price of $76.27 per share.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Wal-Mart's receivables include those from health insurance companies on pharmacy sales, banks for consumer credit and debit card purchases, and consumer financing in the company's international operations.
Wal-Mart had a total of $6.77B in net receivables on its balance sheet, which represents 1.44% of its fiscal 2013 sales of $469B. For fiscal 2012, 1.32% of its sales were booked as receivables, while that percentage was at 1.21% for fiscal 2011.
Due to the fact that receivables currently account for such a small portion of Wal-Mart's sales, I don't see anything to be alarmed about here.
With retail companies like Wal-Mart, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete.
At the end of fiscal 2013, Wal-Mart had $43.8B worth of inventory, which amounts to 9.3% of the company's sales for that year. At the end of fiscal 2012, this level was at 9.1% of sales, while at the end of fiscal 2011, it was at 8.6% of sales. This shows that the company's inventory levels are growing a little bit faster than the revenues. However, I don't see anything here that would indicate boom and bust cycles or the possibility of a large number of their products going obsolete. So, I see nothing to worry about here at this time.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Wal-Mart is 0.83, which is less than ideal, but given that the company has stores all over the world, I don't expect all of the company's operations to come to a grinding halt anytime soon. I would be more concerned if we were dealing with a smaller company whose operations were concentrated in just one or two areas. So, while Wal-Mart's current ratio is less than ideal, I don't see a whole lot to worry about here.
Property, Plant, and Equipment
For retail companies like Wal-Mart to operate, a certain amount of capital expenditure is required. Land has to be bought, stores have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant, and equipment, as companies that constantly have to upgrade and change its facilities to keep up with competition may be at a bit of a disadvantage. However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors.
Right now, Wal-Mart has $117B worth of property, plant, and equipment on its balance sheet. This figure is slightly above the $112B that it reported at the end of fiscal 2012, and the $108B that the company reported at the end of fiscal 2011. In its 10-K filing, the company said that 55% of these assets are in buildings, 25% are in fixtures and equipment, and 15% is in land. The increases that we see here from one year to the next are due to stores that the company has either opened or acquired. Over the last 12 months, Wal-Mart opened or took over 647 stores. In fiscal 2012, they opened or took over more than 1100 stores. In fiscal 2011, the company opened or took over more than 500 stores. This shows that the company is making tremendous efforts toward growing around the world.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case by case basis, as good companies are rarely purchased at or below book value.
Wal-Mart has $20.5B worth of goodwill on its most recent balance sheet, which is inline with the $20.7B that the company reported at the end of fiscal 2012, but higher than the $16.8B that they reported at the end of fiscal 2011. During fiscal 2012, $4.4B in goodwill was added from the acquisitions of 147 Netto food stores in the United Kingdom, and a 51% ownership in Massmart, a South African retailer.
Overall, goodwill accounts for 10.1% of Wal-Mart's total assets of $203B. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed above. As we can see, Wal-Mart is well below this threshold, so I don't see much to worry about here.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers-to-entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = Net Income / Total Assets.
For Wal-Mart, the return on assets would be $15.8B in core earnings over the last 12 months, divided by $203B in total assets. This gives a return on assets for fiscal 2013 of 7.78%, which is decent, especially when considering that a huge asset base of $203B serves as a good barrier-to-entry. I also calculated Wal-Mart's returns on assets over fiscal 2012 and 2011 for comparative purposes. This can be seen in the table below.
Table 1: Consistent Returns On Assets At Wal-Mart
These are good returns on assets that are very consistent. Over the last two years, Wal-Mart's asset base grew from $181B to $203B, while its core earnings grew from $14.4B to $15.8B, showing that the company's earnings are growing along with its asset base, which is what we want to see.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
Wal-Mart has a total of $12.7B in short-term debt, of which $5.59B is original long-term debt that will be maturing within the fiscal year. This large amount of short-term debt concerns me a little bit, especially given that much of the company's free cash flow is currently being devoted to dividends and share repurchases. Given the current low interest rate environment, the company will probably refinance most of this debt out to later years. They might also dig a bit into their small domestic cash position to help pay for some of it.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, Wal-Mart carries $41.4B of long-term debt. This is lower than the $47.1B that it carried one year before, as well as the $43.8B that they carried at the end of fiscal 2011. The company did not issue any long-term debt over the last 12 months, but this may change as the company deals with its short-term debt. Of the company's long-term debt, $13.6B is due over the next five years, while the rest of it isn't due until after fiscal 2018. Some of it isn't due for decades. Interest rates on this debt range from 4.6% to 5.5%.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Wal-Mart over this period is $15.2B. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For Wal-Mart, here is how it looks: $41.4B / $15.2B = 2.72 years
This is a very good number for Wal-Mart, in that it can pay off its long-term debt with an amount that is equal to less than 3 years worth of company earnings. Due to the earnings power of Wal-Mart, I believe that the company's long-term debt, while large, is manageable.
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Wal-Mart stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For Wal-Mart, it looks like this: $121B / $76.3B = 1.59
In the table below, you can see how this ratio has changed over the last couple of years.
Table 2: Debt-To-Equity Ratio At Wal-Mart
Wal-Mart's current debt-to-equity ratio of 1.59 is less than ideal. However, it is right in line with what the company reported in the two prior fiscal years. This means that while the debt-to-equity ratio isn't necessarily what we want, it's not deteriorating either. However, we need to keep an eye on this figure in the years and quarters to come.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks.
The return on equity for Wal-Mart is equal to $15.8B in net income, divided by shareholder equity of $76.3B, which is equal to 20.7%.
To illustrate how the returns on equity of Wal-Mart have changed over the last couple of years, I have created the table below for the return on equity.
Table 3: Returns On Equity At Wal-Mart
The returns on equity at Wal-Mart are very consistent, just like the returns on assets. Over the last two years, the shareholder equity of Wal-Mart has grown from $68.5B to $76.3B. The consistent returns on equity show that management has been able to grow the company's earnings to match the growth in shareholder equity. However, keep in mind that the equity is hampered to an extent by the company's debt. An effort to pay down the company's debt may cause returns on equity to fall due to rising equity positions that the earnings can't keep up with.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Wal-Mart has a very impressive figure of $73.0B. In the table below, you can see how this figure has grown over the last three years. Over this time frame, retained earnings grew by a cumulative 9.6%, which isn't overly impressive, but is what you would expect from a maturing company like Wal-Mart that pays out a lot of dividends and buys back a lot of stock.
Table 4: Retained Earnings At Wal-Mart
After reviewing the most recent balance sheet, there are a few things to like about Wal-Mart's financial condition. For starters, the company has generated strong and consistent returns on assets and equity, showing that management has been able to generate substantial earnings from what they have at their disposal. The company has over $200B in total assets which represents a tremendous barrier-to-entry to any would-be competitors. Where I live, Wal-Mart has a virtual monopoly on many of the things that people need in order to function, as the mom-and-pop stores just can't compete against them. The company's long-term debt, while large, appears to be manageable given the company's earnings power and free cash flow generation.
Things that concern me include the large amount of debt that is coming due within the next 12 months. They will probably need to refinance most of this debt, which will probably increase their long-term debt significantly, unless they decide to put their share buyback program on hold. Their debt-to-equity ratio is also higher than what I prefer, even though it is consistent over the last few years.
While this is not a comprehensive review as to whether Wal-Mart should be bought or sold, I think that its overall financial condition is fair. Investors should not let the company's debt-to-equity ratio alone deter them from buying the company's shares or doing further due diligence.
To learn more about how I analyze financial statements, please visit my new website at this link. It's a new site that I created just for fun, as well as for the purpose of helping others make good financial decisions.
Thanks for reading and I look forward to your comments!