This article is meant to be the first of a series which will not provide a direct conclusion on the prospects of a possible stock investment, but (hopefully) many other valuable insights, food for thoughts, questions and inputs for further analysis. We will see how much a close look at financial statements can reveal on a company, its past and future, established and interrupted trends. In my opinion, such an analysis should always be the first thing an investor does, even before looking at the current price and before reading company presentations, as the accounts represent so to say a neutral playing field, where no rhetoric and no smartly arranged charts can influence the observer.
What we should know, however, before looking at the accounts, are some basic facts about the company we are going to analyze.
Walmart (WMT) is an international, US-based retailer that was established in 1962. Since then it has become the largest retailer worldwide by sales and profits and currently serves about 245 million customers every week through its network of almost 11,000 stores around the world and recently has started to sell online, too.
Here are the first basic figures we will look at:
We will also consider the following multi-year table that refers to the previous decade:
At first, the dynamics that are easiest to spot:
- Sales growth has slowed in the past 5 years compared to the previous decade: From 2009 to 2013 sales growth was just 16%, whereas from 2004 to 2008 sales grew by 48% and from 1998 to 2002 sales more than doubled. So there is an evident trend.
- Equity grew at the same rates as sales over the same periods.
- Comparable sales growth has slowed a lot over the past 12 years. Most of Walmart's sales growth evidently comes from the international segment and expansion of the US shop network, as is confirmed by the last lines in the table: In 1998 Walmart operated only 568 shops outside the US; today these units have grown to 6,148!
- Yet, sales is not everything; what ultimately counts is the bottom line: Over the past 5 years net income increased 28%, from 2004 to 2008 it grew by 41% and from 1998 to 2002 net income almost doubled.
- Looking at these figures, we note that in the last years profit grew stronger than sales, whereas in the 5-year periods before it was the other way round.
- What matters even more to shareholders are earnings per share: They grew 50%, 52% and 97% in the above mentioned periods respectively. The takeaway here is that buybacks matter a lot. In the last two 5-year periods, EPS growth was roughly the same (50%), but net income increased much less (28/41%).
- The dividend pay-out ratio increased over time: In 2013 it stood at 32%, in 2008 at 28%, in 2004 at 17% and in 1998 at 18%.
It's time for a first set of questions:
1. Is the reduced sales growth only because of the law of large numbers or even because of stronger competition and/or the Internet?
2. Is there any chance that comparable sales return to stronger growth in the near future? (If there was any, net income would increase enormously.) How can we find out?
The answer to these two questions is in the following statement:
"As we continue to add new stores and clubs in the U.S., we do so with an understanding that additional stores and clubs may take sales away from existing units. We estimate the negative impact on comparable store and club sales as a result of opening new stores and clubs was approximately 0.7% in fiscal 2013 and 0.8% in fiscal 2012." (Source: 2013 Annual Report)
Thus, we should not expect a return to strong growth of comparable sales. At least in the US, Walmart has become so large that new stores will very often cannibalize the already existing ones. Plus, as has recently been recognized by the company itself, there certainly is increased competition and not only from the Internet. Maybe the international segment will boost comparable sales in the future, the global average, however, will most likely not return to the high growth rates previously registered in the USA.
3. What has changed that led to profits growing stronger than sales in the last few years?
4. Will buybacks continue to provide a strong tailwind for EPS growth (or maybe even get stronger)?
We will keep these questions in mind (which can be answered later, after having calculated "Owner Earnings"), while we continue to analyze the rest of the tables:
- LT debt / Total assets remained roughly stable over the whole 16-year period.
- Equity / Total assets decreased, but only slightly (from 41% to 37%).
- This means that the proportion of short-term debt to total assets increased slightly.
- Gross margin increased over time and in the last years it is about stable.
- ROE grew slightly over time, but is basically stable around 20% (a remarkable achievement for such a large business).
The impression here is one of incredible steadiness. We are talking about a fast expanding, huge business and a period that included 2 severe recessions. Could it be that Walmart is not as much managed for increasing earnings as for steady returns on capital?
Until now we have not talked about inventories: Over time they increased strongly and almost every year. This is of course due to the opening of new stores. We can see this also in the cash flow statement:
This is actually very interesting. Because of increasing inventories, operating cash flow and thus even free cash flow shrinks. If we owned the whole business, at the end of the year we would fill our new stores with goods (which would in turn increase our accounts payable), however this is no expenditure, but expansion.
Before we continue to think about cash flows (and, as we will see in the second part, "Owner Earnings"), we take a look at the segmented data table:
This table is extremely useful when it comes to estimate how much of Walmart's capital expenditures goes into growth and how much into maintenance. We can clearly see that in spite of the far smaller store network in the international segment, capital expenditures outside the US are not proportionally smaller than at home. As we know that Walmart adds far less stores in the US than internationally, this is a valuable piece of information. We will estimate more precisely maintenance and growth expenditures in the second part of this analysis.
We can now answer our questions #3 and #4: What has changed that led to profits growing stronger than sales in the last few years? Probably it was the slowing expansion that reduced growth capital expenditures, improved margins and set free additional capital for dividends and buybacks.
Here is another proof for this interpretation from the 2013 Annual Report:
And this is from the 2010 Annual Report:
These statements show that Walmart's expansion actually reduces stated GAAP-Net Income, just because there are some expenses associated with the opening of new stores that have to go in the income statement! And it also shows that these costs have remained stable over the past 3 years and are currently lower than in 2008, while sales increased materially. Thus, the reduced expansion has increased margins.
In the second part we will calculate Walmart's free cash flow and "Owner Earnings" and present another surprising finding.