Wal-Mart Stores_ Inc

Wal-Mart Stores, Inc. (WMT) Hold WMT: Competitive and Financial Analysis By: Ryan Hummer February 25, 2006 Company Profile Wal-Mart Stores, Inc. (Wal-Mart) operates retail stores in various formats worldwide. The Company organizes its business into three principal segments: Wal-Mart Stores, SAM'S CLUB and International. The Wal-Mart Stores segment is the largest segment of Wal-Mart's business, accounting for 67.3% sales during the fiscal year ended January 31, 2005 (fiscal 2005). The segment consists of three different retail formats, all of which operate in the United States. The Company's SAM'S CLUB segment consists of membership warehouse clubs that operate in the United States, and accounts for 13% of fiscal 2005 sales. The international segment consists of retail operations in eight countries and Puerto Rico, and generated 19.7% of WalMart's fiscal 2005 sales. In addition, the Company owns an unconsolidated minority interest of approximately 37% of The Seiyu, Ltd., a retailer in Japan. LAST UPDATE: February 25, 2006 SECTOR: INDUSTRY: CONTACT: Consumer Staples Retail 702 Southwest 8th Street Bentonville, AR 72716 (479) 273-4000 (479) 273-4053 www.walmart.com Web: BASIC INFORMATION Current Price: Market Cap (Mil): Shares Outstanding (Mil): Average Volume: 52 Week Low: 52 Week High: Latest Dividend: 60-Month Beta: EPS: P/E: P/E/G Ratio (5-Yr. Expected): P/E (1-Yr. Fwd): P/B: P/S: P/CF: $45.45 $189,260.30 4,163.49 13,698,600 $42.31 $53.49 $0.15 0.85 $2.68 16.95 0.98 13.61 3.58 0.61 9.62 Summary I assign WMT a one-year price target of $46.00 based on its competitive position within the retail industry, current industry trends, and strategy to grow both domestic and international sales. The following are key assumptions underlying my valuation:     There is a strong possibility that consumer spending could slow substantially in the near term as many U.S. consumers have been financing their consumption at least in part by borrowing against the equity in his or her home. Such consumers have refinanced using adjustable rate mortgages. This financial trend combined with the rising interest rate environment will likely slow consumer spending substantially. Present-day low U.S. consumer savings rates could also hamper future consumer spending in the future. Despite WMT’s position as the largest retailer in the world, its latest sales and earnings growth rates (FY2006) have declined dramatically. Sales grew at 9.4% in FY2006 compared to sales growth of 11.3% last year, while earnings growth slowed from 13.4% in FY2005 to 9.4% this past year. The Consumer Staples Sector and Retail industry are fairly valued when considering the sector and industry’s P/E, P/S, P/CF, and P/BV ratios (especially relatively to the S&P 500). Three valuation methods: Free Cash Flow, Dividend Discount Model, and Comparable Valuation Ratio Technique produce consistent values per share to give WMT a one-year price target of $46.00. Company Overview Introduction As of January 31, 2005, WMT operated 1,353 Discount Stores, 1,713 Supercenters, 551 SAM’S CLUBs and 85 Neighborhood Markets in the United States. As of January 31, 2005, the Company operated units in Argentina (11), Brazil (149), Canada (262), Germany (91), South Korea (16), Mexico (679), Puerto Rico (54) and the United Kingdom (282). WMT also operated 43 stores through joint ventures in China as of January 31, 2005. Additionally, WMT recently acquired Seiyu which operates approximately 403 stores throughout Japan and has contributed to WMT’s growing Asian presence. Much of the Company’s international growth in recent years has been due to acquisitions of existing operations in various countries. The three most notable acquisitions include: 1) the Company’s December 2002 purchase of Supermercados Amigo, Inc. (“Amigo”), a supermarket chain located in Puerto Rico with 37 supermarkets at the time of the acquisition; 2) the Company’s February 2004 purchase of Bompreço S.A. Supermercados do Nordeste (“Bompreço”), a supermarket chain in northern Brazil with 118 hypermarkets, supermarkets and minimarkets; and as previously mentioned, Company’s FY2005 acquisition of a 50% stake in Seiyu, a Japanese Retailer with over 403 stores throughout Japan. As of January 31, 2005, the Company employed approximately 1.7 million Associates worldwide, with approximately 1.3 million Associates in the United States and approximately 410,000 Associates in foreign countries. Industry Segments1 WMT is organized into three operating segments: Wal-Mart Stores, SAM’S CLUB, and International. The Wal-Mart Stores segment includes Discount Stores, Supercenters and Neighborhood Markets in the United States as well as Walmart.com. The SAM’S CLUB segment includes the warehouse membership clubs in the United States as well as samsclub.com. The International segment consists of operations in Argentina, Brazil, Canada, China, Germany, Mexico, Puerto Rico, South Korea and the United Kingdom. Each operating segments’ business is somewhat seasonal. Generally, the highest volume of sales occurs in the fourth fiscal quarter, which includes the holiday season, and the lowest volume occurs during the first fiscal quarter. Wal-Mart Stores Segment The Wal-Mart Stores segment had net sales of $191.8 billion, $174.2 billion and $157.1 billion for the fiscal years ended January 31, 2005, 2004, and 2003, respectively. The sales revenue is well diversified throughout the country as no single Discount Store, Supercenter or Neighborhood Market location accounted for as much as 1% of total Company sales or net income during the most recent fiscal year. 1 Wal-Mart Stores, Inc. FY2005 10-K 2 Wal-Mart Discount Stores operate in all 50 states, Supercenters in 45 states and Neighborhood Markets in 14 states. The Discount Stores range in size from 30,000 square feet to 220,000 square feet, with the average size of a Discount Store at approximately 100,000 square feet. Supercenters range in size from 100,000 square feet to 261,000 square feet, with the average size of a Supercenter falling at approximately 187,000 square feet. Neighborhood Markets range in size from 38,000 square feet to 55,000 square feet, with the average size being approximately 43,000 square feet. Wal-Mart Discount Stores and the general merchandise area of Supercenters carry apparel for women, girls, men, boys and infants, domestics, fabrics and notions, stationery and books, shoes, housewares, hardware, electronics, home furnishings, small appliances, automotive accessories, horticulture and accessories, sporting goods, toys, pet food and pet accessories, cameras and supplies, health and beauty aids, pharmaceuticals, jewelry and optical and provide photo processing services. In addition, WMT’s stores offer an assortment of grocery merchandise. The grocery assortment in the Supercenters consists of a full line of grocery items including meat, produce, deli, bakery, dairy, frozen foods and dry grocery. Most of the Discount Stores carry a limited assortment of dry grocery merchandise while a number of the larger Discount Stores in some markets carry a broader assortment of grocery items, including perishable items. Neighborhood Markets are generally organized into departments such as: dry grocery, meat, produce, deli, bakery, dairy, frozen foods, pharmaceuticals, photo processing, health and beauty aids, household chemicals, paper goods, general merchandise and pet supplies. Nationally advertised merchandise accounts for a significant portion of sales in the Wal-Mart Stores segment. WMT also market lines of merchandise under private-label store brands including “Sam’s Choice,” “One Source,” “Great Value,” “Everstart,” “Everactive,” “Ol’ Roy,” “Puritan,” “Equate,” “No Boundaries,” “George,” “Athletic Works” and “Kid Connection.” The Company also markets lines of merchandise under licensed brands, some of which include “Faded Glory,” “General Electric,” “Disney,” “Catalina,” “McDonald’s,” “Mary-Kate and Ashley” and “Starter.” During the fiscal year ended January 31, 2005, sales in Discount Stores and Supercenters (which are subject to seasonal variance) by product category were as follows: PERCENTAGE OF SALES CATEGORY Grocery, candy and tobacco Hardgoods Softgoods and domestics Pharmaceuticals Electronics Health and beauty aids Sporting goods and toys Stationery and books Photo processing Jewelry Shoes 28% 19% 16% 9% 9% 7% 6% 3% 1% 1% 1% 100% 3 SAM’S CLUB Segment The SAM’S CLUB segment had net sales of $37.1 billion, $34.5 billion and $31.7 billion for the fiscal years ended January 31, 2005, 2004 and 2003, respectively. The SAM’s Club segment is also well diversified as no single club location accounted for as much as 1% of total Company sales or net income during the most recent fiscal year. WMT operates SAM’S CLUBs in 48 states. Facility sizes for SAM’S CLUBs generally range between 70,000 and 190,000 square feet, with the average SAM’S CLUB facility at approximately 128,000 square feet. SAM’S CLUB offers bulk displays of brand name merchandise, including hardgoods, some softgoods, institutional-size grocery items, and selected private-label items under the “MEMBER’S MARK,” “BAKERS & CHEFS” and “SAM’S CLUB” brands. Generally, each SAM’S CLUB also carries software, electronics, jewelry, sporting goods, toys, tires, stationery and books. Most clubs have fresh departments, which include bakery, meat, produce, floral and Sam’s Cafe. Additionally, a significant number of its clubs offer photo processing, pharmaceuticals, optical departments and gasoline stations. During the fiscal year ended January 31, 2005, sales in the SAM’S CLUB segment, which are subject to seasonal variance, by product category were as follows: PERCENTAGE OF SALES CATEGORY Food Sundries Hardgoods Service Businesses Softgoods 31% 28% 19% 16% 6% 100% SAM’S CLUBs are membership only, cash-and-carry operations. Limited credit facilities are available, including the “SAM’S Direct” commercial finance program and “Business Revolving Credit” available to qualifying business members. WMT provides “Personal Credit” program available to qualifying club members and accept the Discover Card in all clubs. Credit extended to members under these programs is without recourse to the Company. Typical club members include business owners and operators. Individuals who are not business owners can become “Advantage” members by paying a membership fee. In fiscal 2005, business members paid an annual membership fee of $30 for the primary membership card with a spouse card available at no additional cost. In addition, business members can add up to eight business associates for $30 each. The annual membership fee for an individual “Advantage” member is $35 for the primary membership card with a spouse card available at no additional cost. The SAM’S CLUB PLUS Membership program offers additional benefits and value on services. The annual membership fee for a PLUS Member is $100. 4 International Segment WMT’s International segment is comprised of operations through wholly-owned subsidiaries in Argentina, Canada, Germany, Puerto Rico, South Korea, and the United Kingdom; operations through majority-owned subsidiaries in Brazil and Mexico; and operations through joint ventures in China. Additionally, Wal-Mart has an unconsolidated 37% minority interest in the Japanese retailer, Seiyu (as of FY2005). The International segment’s net sales for the fiscal years ended January 31, 2005, 2004 and 2003, were $56.3 billion, $47.6 billion and $40.8 billion, respectively. Again, the sales are diversified as no single unit accounted for as much as 1% of total Company sales or net income during the most recent fiscal year. Operating formats vary by country, and include Discount Stores in Canada and Puerto Rico; Supercenter s in Argentina, Brazil, China, Germany, South Korea, Mexico, Puerto Rico and the United Kingdom; SAM’S CLUBs in Brazil, Canada, China, Mexico, and Puerto Rico; Superamas (traditional supermarket), Bodegas (combination discount and grocery store), Suburbias (specialty department store) and Vips (restaurant) in Mexico; Todo Dias (combination discount and grocery store) and Balaios (discount food and general merchandise store) in Brazil; Neighborhood Markets (traditional supermarkets) in China; ASDA stores (combination grocery and apparel store) and George stores (apparel store) in the United Kingdom; and Amigo supermarkets in Puerto Rico. The merchandising strategy for the International operating segment is similar to that of WMT’s operations in the United States in terms of the breadth and scope of merchandise offered for sale. While brand name merchandise accounts for a majority of sales, several store brands not found in the United States have been developed to serve customers in the different markets in which the International segment operates. Macro-economic, Sector, and Competitive Analysis Macro-economic Analysis Introduction WMT falls within the consumer staples sector which is typically a defensive or counter-cyclical sector. WMT operates as a discount (food, drug, and merchandise) retail company that is renowned for its ability to offer consumers “every day low prices”. WMT will typically see increased sales during downturns in the economic cycle (and throughout a recession), because consumers divert their spending from luxury goods to consumer staples that are necessary for every-day life. The demand for staples that WMT sells such as groceries, clothing, and pharmaceutical drugs is inelastic, that is consumers will continue to purchase these goods in comparable quantities regardless of the state of the economy. Many consumer staples equities move inversely to the market (S&P 500), and therefore have low market betas (around 0.50). WMT historical stock prices have not displayed the typically negative correlation. On the following page is a stock price chart of WMT compared to the S&P 500 (SP5A) over the past ten years and a regression analysis output: 5 WMT Price Vs. SP5A Price REGRESSION SUMMARY OUTPUT Regression Statistics Multiple R 0.585140785 R Square 0.342389739 Adjusted R Square 0.341125104 Standard Error 0.034424929 Observations 522 ANOVA df Regression Residual Total 1 520 521 SS MS 0.320849671 0.320849671 0.616239367 0.001185076 0.937089038 F 270.7419191 Significance F 2.79716E-49 Intercept WMT Market Beta Coefficients Standard Error t Stat 0.001703865 0.001511081 1.12758022 1.030748765 0.062643364 16.45423712 P-value 0.260017256 2.79716E-49 Lower 95% Upper 95% -0.001264708 0.004672438 0.907683631 1.153813898 Regressing WMT stock price returns against the SP5A price returns shows that WMT’s stock price is positively correlated with the market price movements. The output gives an adjusted R2 of 34.0%, which means the SP5A’s price movements explain 34.0% of WMT’s stock price variation. The regression was performed over a period of ten years and yields a 1.03 (10-year) market beta for WMT. In my analysis throughout this report, I will use the 60-month market beta of 0.85, because using the latest market data should improve the accuracy of my projections. Most equity stocks within the consumer staples sector have 60-month betas well below 0.85 and 10-year betas well below 1.03 (i.e., BUD’s 60-month beta is 0.55). In other words, while typical consumer staple equities move conversely to the market, WMT moves coincidentally with the market. Consumer Spending Since WMT does not exhibit the typical counter-cyclical stock price behavior that most firms within the consumer staples sector exhibit (or is less defensive), adverse shocks to the market will presumably lead WMT’s stock price to fall. One such potential shock that would be detrimental to the retail industry in general is a sudden, unexpected slowdown in consumer spending and consumption. The charts to the right show that consumer spending and consumption has been increasing steadily over time taking into account seasonality. History (see the charts to the right) has shown that it does not pay to bet against the U.S. consumer. On the other hand, there are new factors that have a consequential impact on consumer spending that we must now consider including: Adjustable Rate Mortgages and Consumer Indebtedness and importantly, how the two factors relate and how their affects can potentially slowdown consumer spending in the near future. Adjustable Rate Mortgages (ARMs) provide an alternative for the consumer to finance his or her home and the use of ARMs has grown in popularity throughout the past five years, primarily due to extremely low interest rates. ARM interest rates are typically 6 priced off of financial instruments with shorter maturities that match the length of the initial adjustment period2. Since the U.S. Fed Funds rate reached a low at 1.00% in FY2002, the FED has increased rates a quarter point at a time to where we stand now at 4.50%. This scenario has caused ARM interest costs to rise. Below is a chart 3 that shows the interest rate used to compute interest cost for 1-year ARMs: Since there is evidence that many consumers financed or refinanced their homes with ARMs through the past five years (ARMs accounted for approximately 30% of jumbo mortgages in 3Q05 down from about 40% a year earlier 4), it is reasonable to believe the rising interest rate environment, in which we are currently experiencing, will slow consumer spending. Many analysts are projecting the FED to raise the Fed Funds rate to 4.75% by April of this year, where they expect it to remain at least until July 5. Given that nearly half of all consumer debt and about onequarter of total mortgage debt is currently based on adjustable rates 6, the question is, will this additional expected rate hike be enough to rein in spending, which will intern slow WMT’s sales growth in the U.S.? Furthermore, personal savings as a percentage of disposable personal income has dipped down to negative levels (-0.5% for FY2005: see table7 above and to the right) for the first time since 1933 when the country was struggling to cope with the Great Depression. This data indicates that the U.S. consumer has dipped into his or her savings to fuel consumer spending growth in the past year. Much of this savings may have originated from the consumer borrowing against the equity in his or her home through refinancing with an ARM. When you take this together with the rising interest rate environment, it is very realistic that U.S. consumer spending could slow at a material rate. 2 MortgateDailyNews.com. “Freddie Mac Issues Annual Adjustable Rate Mortgage Survey”. http://www.mortgagenewsdaily.com/172005_Freddie_Mac_Adjustable_Rate_Mortgage_Survey.asp 3 HSA online: http://library.hsh.com 4 Simon, Ruth. “A Trendy Mortgage Falls From Favor”. The Wall Street Journal. November 29, 2005. pg D1 5 http://www.forecasts.org/fedfunds.htm 6 Valueline. Retail Store Industry Report. February 10, 2006 7 U.S. Department of Commerce 7 To further investigate the effects of financial strain on the U.S. consumer and its potential effects on WMT’s sales, I performed a series of regression analyses by regressing WMT’s sales growth to various economic data. The best predictor of WMT’s sales growth with regard to a “consumer debt ratio” was the “Homeowner Financial Obligation Ratio”. The regression results (see chart to the left) did show a negative relationship, this means that as U.S. homeowners augment debt, WMT sales are adversely impacted. Although the inverse relationship between WMT’s qoq Revenue Growth and Homeowner’s Financial Obligation Ratio supports the claim that WMT is not the typically counter-cyclical consumer staple, the R2 is a meager 26%. Out of the various “consumer debt ratios” I used to regress WMT’s sales growth, this was the closest relationship I found (e.g., the highest R2). Sector& Industry Valuation Sector Valuation Since the economy has been in the recovery stage of the economic cycle for the last two to three years, investors have pulled their money out of large-cap consumer staple stocks like WMT and have found opportunity in other sectors, such as energy. With most experts forecasting FY2006 GDP growth in the neighborhood of 3.0%8 the stock market (SP5A) is expected to rise anywhere from 4% to 10%. It is probable that money will continue to flow out of consumer staples into cyclical sectors where opportunity for stock price appreciation may be greater. As a result of people investing in other sectors aside from consumer staples, the consumer staples sector as a whole is approximately fairly-valued based on valuation ratios: P/E, P/S, P/CF, P/BV. Cons Staples P/E Relative to SP5A 1.40 1.20 1.00 0.80 0.60 0.40 P/E 0.80 0.60 0.40 P/S 1.20 1.00 Cons Staples P/S Relative to SP5A 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 2/23/05 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 Cons Staples P/CF Relative to SP5A 2.00 1.60 1.20 0.80 0.40 P/CF 2.40 2.00 1.60 1.20 0.80 0.40 Cons Staples P/BV Relative to SP5A 2/23/05 P/BV 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 2/23/05 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 8 Valueline. Retail Store Industry Report. February 10, 2006. 8 2/23/05 Consumer Staples Relative to SP5A P/E P/S P/CF P/BV High 1.27 0.98 1.54 2.20 Low 0.69 0.50 0.79 1.07 Mean 1.07 0.80 1.26 1.76 Current 1.21 0.74 1.16 1.38 The charts and data above show that the consumer staples index is currently trading at a premium relative to the market (SP5A) when considering each index’s forward P/E ratio. The forward relative P/E ratio of consumer staples index is trading well above its ten-year average of 1.21. When analyzing the other three ratios, we find that the consumer staples index is trading close to its ten-year average. It depends on which valuation ratio the investor considers most valuable, but regardless, this analysis gives us evidence that the consumer staples sector is fairly- to over-valued relative to its long-run (ten-year) average. Industry Valuation WMT operates within the Retail Industry, which is traditionally a difficult industry in which to increase earnings mainly because margins are slim to due intense competition. Other firms that operate within the value-chain, both up-stream (the manufacturer) and down-stream (the consumer) have the power to extract the majority of the value created in the value-chain. Because growth within the retail industry is limited, the market typically assigns lower valuation ratios (P/E, P/S, P/CF, P/BV) to retail firms. Like the consumer staples of which WMT is a part, the retail industry is fairly-valued based on the aforementioned relative valuation ratios: Retail Industry P/E Relative to SP5A 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 0.60 0.50 0.40 P/E 0.30 0.20 0.10 0.00 P/S Retail Industry P/S Relative to SP5A 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 2/23/05 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 Retail Industry P/CF Relative to SP5A 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 P/CF 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 Retail Industry P/BV Relative to SP5A 2/23/05 P/BV 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 2/23/05 2/23/96 2/23/97 2/23/98 2/23/99 2/23/00 2/23/01 2/23/02 2/23/03 2/23/04 Retail Industry Relative to SP5A P/E P/S P/CF P/BV High 4.13 0.48 3.18 1.30 Low 0.97 0.21 0.87 0.58 Mean 1.65 0.34 1.41 0.97 Current 1.39 0.34 1.14 1.02 2/23/05 9 Notice the break in the relative forward P/E ratio chart is the result of not meaningful P/E ratios during that period due to very low earnings (extremely low EPS in the denominator creates very high and, hence, not meaningful P/E ratios). The data shows that the Retail Industry is trading close to its average for all four valuation rations and therefore can be considered fairly-valued. Summary The Consumer Staples Sector and Retail Industry valuations support my valuation of WMT at “HOLD”. If both WMT’s sector and the industry are fairly valued, there is a higher probability that WMT is fairly valued. Competitive Analysis: Five Forces & Current Strategy Five Forces Analysis WMT operates in the retail industry as the preeminent low-cost retailer. WMT’s strategy is built around its pricing philosophy of providing “EDLP- Everyday Low Prices”. WMT’s broad assortment of merchandise that provides one-stop shopping and high in-stock levels provide confidence to customers that WMT will have what they need, and its long operating hours allow customers to shop at their convenience. These qualities provide WTM with an additional competitive advantage. In order to determine whether or not WMT maintains sustainable competitive advantages within the retail industry as a low-cost retailer, it was necessary to conduct a five forces analysis. Barriers To Entry (BTE) Immediate BTEs are relatively low since 1) opening a retail store is relatively low-capital intensive, 2) fixed costs are low, and 3) specific knowledge of operating a retail store is realistically obtainable. Evidence of this typically exists in your local strip mall, where proprietary retail operations are common. On the other hand, when a Wal-Mart store opens in a neighborhood, smaller proprietary retail operations are frequently driven out of business, because WMT has the ability to set prices below the long-run average operating cost of a smaller proprietary retailer. WMT is able to do this because, as the largest retailer in the world, its long-run average operating cost is much lower due to economies of scale it realizes. Supplier Power Supplier power is fairly nonexistent. As the largest retailer in the world, WMT maintains a tremendous amount of buyer power to demand volume discounts from suppliers. In many cases, WMT’s business represents a large percentage of any one supplier’s business, further strengthening WMT’s ability to demand discounts from its suppliers. Supplier power from a human capital standpoint is also very low since most positions within WMT can be classified as unskilled labor positions. Furthermore, WMT does not cater to labor unions and no union is represented in WMT’s business. 10 WMT avoids distribution hold-up by operating its own distribution centers. WMT is well known for its proprietary “pull” inventory management system that allows it to avoid inventory build-up and shortages. This system can help mitigate any supplier power as well. Additionally, during fiscal 2005, approximately 81% of the Wal-Mart Stores segments’ purchases of merchandise were shipped from Wal-Mart’s 99 distribution centers, of which 37 are general merchandise distribution centers, 34 are grocery distribution centers, seven are clothing distribution centers and 16 are specialty distribution centers. The balance of merchandise purchased was shipped directly to stores from suppliers. In addition to serving the Wal-Mart Stores segment, some of the grocery distribution centers also serve the SAM’S CLUB segment for perishable items. Buyer Power The end consumer, WMT’s customer, maintains the ultimate buyer power. WMT’s pricing philosophy is to provide “Everyday Low Prices” to consistently draw consumers who trust WMT will provide the lowest price available and concurrently avoid erratic price changes due to promotional activity. By being the most consistent and lowest cost retailer in the market, WMT business model is appealing to the end consumer. Online shopping also strengthens the end consumers’ buyer power by giving them quick and easy access to pricing information on many comparable goods sold at various retail outlets. To this point, there is not significant evidence that online sales have harmed retail store sales materially. Substitutes A major substitute for shopping at retail stores is shopping online. Trends show that online shopping is growing rapidly year-over-year. WMT does provide online shopping on www.walmart.com and the threat of online shopping cannibalizing sales has not been a significant factor to this point. It is possible that once WMT saturates the market with its retail stores, online shopping could become detrimental to its store sales. Competition Competition is fierce within the retail industry as evidenced by notoriously tight margins: Ave. Gross Margin (Retail Industry/Market: 26.5% vs. 48.3%); Ave. Operating Margin (Retail Industry/Market: 8.5% vs. 12.6%); Ave. Net Margin (Retail Industry/Market: 3.4% vs. 7.0%) 9. WMT competes within many different retail sub-industries: discount, department, drug, variety and specialty stores and supermarkets, many of which are national chains. WMT also compete with other retailers for new store sites. As of January 31, 2005, the Wal-Mart Stores segment ranked first, based on net sales, among all retail department store chains and among all discount department store chains. Summary WMT maintains a strong, sustainable competitive advantage in a highly competitive industry based its lowest-cost, one-stop-shop business model. WMT’s realizes many cost advantages through its tremendous buyer power which is generated by its sheer size (volume of business). Unlike many other Fortune 500 companies, WMT has managed to avoid the problems that labor unions present for earnings growth by strategically avoiding labor unions all together. WMT’s business model works with the end consumers’ 9 Hoovers Online. Available at http://premium.hoovers.com 11 demand for consistent, low-cost retail products and helps to mitigate buyer power. Meanwhile, WMT is consistently able to eliminate competition though setting low prices and subsequently driving competition out of business. Current Strategy10 Wal-Mart has started to drive sales by attracting the “selective customer” – that is, customers that shop at Wal-Mart for basics but do not see it as an alternative for home, apparel or electronics. For example, Metro 7 continues to perform well and Wal-Mart plans to expand the number of stores that carry this brand to 1,500 by September 2006. Wal-Mart has reorganized their field operations to allow an Associate to take ownership and improve customer service. Wal-Mart will change its field organization to better improve the customer experience. This includes changes related to: 1) Store cash office redesign 2) Front-end service 3) Customer needs scheduling 4) Positive associate experience and store manager routines 5) Merchandise flow 6) Increasing customer touch points This structure will enable Wal-Mart to extract more market knowledge from the customer, which should help it improve profitability. As part of the new structure, Wal-Mart announced several changes at its year-beginning meeting, including a completely redesigned compensation program which rewards all store associates based on achieving their individual store goals, including sales and return on inventory. With this planning process, the Company hopes to significantly improve execution and close the gap between strategy and performance. As Wal-Mart makes progress with its in-store process redesign, the Company should continue to see improvements in its cost structure. Wal-Mart is also upgrading existing stores to provide customers with an environment that looks and feels like the Company’s most recent prototypes (similar to the one opened last summer in Rogers, Arkansas). Wal-Mart has undertaken a very aggressive remodel program that will impact 1,800 stores within the next 18 months. This remodel program is being executed by market and will focus on five areas: home, apparel, electronics, food and the restrooms. In 300 stores, Wal-Mart will introduce a new concept for its pharmacies that will have pharmacists more accessible to customers. The Company has a TV ad campaign that illustrates to consumers that they can find what they need at low prices. The Company has also made changes to its printed circular advertisements. The Company is increasing the number of circulars to 23 this year, up from 12 last year, but the overall page count will be reduced (and as a result, the associated expense is not expected to increase). 10 Tang, Charmaine; Weinswig, Deborah. “WMT: 4Q05 EPS Review: Lackluster Sales Saved by SG&A and Gross Margin”. Citigroup. February 21, 2006. 12 Wal-Mart has made significant investments in its marketing organization led by John Fleming. His team now includes Stephen Quinn, Senior Vice President Marketing, formerly Chief Marketing Officer at Frito Lay; Julie Roehm, Senior Vice President of Marketing & Communications, formerly Director of Marketing Chrysler; Robert Atencio, formerly Director of Insight & Consumer strategy for Frito Lay; and Steve Bertschy, Vice President Category Marketing and who formerly was the Senior Vice President and Chief Marketing Officer at Specialty Brands. Another example here Wal-Mart is investing in people is in operations. The Company tries to grow talent internally, and it has developed a detailed selection process to identify the best talent and is providing formal training to build the skills required in these new and expanded roles. Wal-Mart has also complemented its senior leadership teams and operations by offering these new roles to high potential senior executives from other areas of the Company, such as merchandising and logistics. Additionally, the company has also brought in external talent to complement internal promotions. This has been particularly important, as the Company decentralizes its field organization, placing the business units' key leadership teams in the market that they are responsible for. During 4Q05, Wal-Mart continued its international growth through acquisitions. The company acquired the Sonae retail operations in Southern Brazil and increased its ownership of Seiyu to 53%, up from 42% (at 3Q05-end) resulting in the consolidation of Seiyu in Wal-Mart’s financial statements beginning in January 2006. Wal-Mart is now in 15 countries and expects that number to increase. The company acquired 545 new international stores and 50,000 associates in just one week through acquisition. Wal-Mart plans to build or relocate another 220 international stores in 2006. Accounting Analysis It is necessary to conduct an accounting review of WMT’s financial statements before developing projections and a valuation of its current and future operations. There were a few necessary adjustments to make to WMT’s current financial statements in order to paint a more accurate picture of its financial standing. The adjustments were made to WMT’s Balance Sheet and Income Statement to account for its off-balance sheet debt obligations, namely its operating leases and contingency exposures. See Exhibit VI on page 29 for pro forma financial statements that take into account these adjustments. Operating Leases In order to get a more complete picture of WMT’s financial standing by analyzing financial measures such as ROE, it was appropriate to capitalize WMT’s off-balance sheet financing. Off-balance sheet obligations mainly took the form of operating leases. In addition to operating leases mentioned in WMT’s 10 -K, WMT also mentioned that leases amounting to $30M in annual expenses were (at the time) being finalized, but not included in the operating lease table given in its 10-K. On the next page is the operating lease schedule provided in WMT’s 10-K. 13 Fiscal year 2006 2007 2008 2009 2010 Thereafter Total minimum rentals Leases 730 700 626 578 530 5,908 9,072 In order to capitalize the operating leases, I needed to determine the present value of the future total minimum operating rentals. I also added in an additional $30M annually for new leases mentioned in the 10-K. I determined an average annual operating lease expense to be $633M by averaging operating lease expense numbers given from FY2006 to FY2010. The weighted-average effective interest rate on long-term debt was given in the 10-K to be 4.08%. With an average annual operating lease expense of $633M and a total of $9,072, the average life over which the present value of the minimum operating rentals would be amortized was approximately fourteen years ($9,072M/$633M). See graphic below for present value calculations: Average Annual Op. Lease Expense (FY06-FY10) Weighted-Average Effective Interest Rate on LT Debt Projected Off-Balance Sheet Obligations 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Total Operating Leases 730 700 626 578 530 633 633 633 633 633 633 633 633 633 213 $9,072 633 4.08% Additional Proj. Leases 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 $450 Present Value 760.00 701.38 605.58 539.26 477.22 542.68 521.41 500.97 481.33 462.46 444.33 426.92 410.18 394.10 138.82 $7,407 I added the present value of WMT’s operating leases of $7,407M to its FY2006 balance sheet under fixed assets and capital leases. Furthermore, when capitalizing leases, one must not only add the present value of the assets (PV of minimum rent payments) to the balance sheet, but must also account for the affects on the income statement. 14 Operating Lease Capitalization Schedule FY 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Beg. Principal Total Pmt Principal Pmt Interest Pmt Ending Principal Depreciation $7,116 $663 $373 $290 $6,744 $508 $6,744 $663 $388 $275 $6,356 $508 $6,356 $663 $404 $259 $5,952 $508 $5,952 $663 $420 $243 $5,532 $508 $5,532 $663 $437 $226 $5,095 $508 $5,095 $663 $455 $208 $4,640 $508 $4,640 $663 $474 $189 $4,166 $508 $4,166 $663 $493 $170 $3,673 $508 $3,673 $663 $513 $150 $3,160 $508 $3,160 $663 $534 $129 $2,626 $508 $2,626 $663 $556 $107 $2,070 $508 $2,070 $663 $579 $84 $1,491 $508 $1,491 $663 $602 $61 $889 $508 $889 $663 $627 $36 $262 $508 $262 $273 $262 $11 $0 $633 WMT’s annual rent expense, after capitalizing its operating leases, grows to $1,186M annually. This figure is larger than the annual operating lease expense of $730M in FY2006. The expense on the income statement is higher after capitalizing the operating leases because now WMT would have to charge an additional depreciation expense since the assets are now on its balance sheet (see Exhibit VI on page 29 for pro forma balance sheet). Other Concerns Aside from operating leases WMT, does not have many accounting issues of which an investor needs to be aware. The only other minor concerns are potential liabilities which WMT may be subject to pay in the future due to litigation and contingency agreements with affiliates and suppliers. There are currently multiple lawsuits currently being tried in the U.S. court system. WMT was unable to estimate financial impacts of such lawsuits. WMT mentions that it has contracts in place with certain suppliers and affiliates and that, if “unlikely events were to occur,” WMT could be liable to pay out $394M in contingency fees. Specifically, WMT mentions three of these types of contingency contracts, which amounts to the $394M. Financial Analysis In order to accurately assess WMT’s financial health, it was necessary to conduct both a time-series analysis and a cross-sectional analysis of its financial ratios that measure the Company’s: 1) Cash Flow, 2) Profitability, 3) Efficiency, 4) Liquidity and, 5) Leverage. See Exhibit VIII on page 30 for a compilation of WMT’s financial ratios. 15 Cash Flow Time-Series Analysis WMT’s cash flow seems to be healthy and growing (See Exhibit V on page 28 for WMT’s Statement of Cash Flows). WMT’s cash flow from operations (CFO) has seen double-digit growth from FY2002 to FY2006, with one year of negative growth (from FY2004 to FY2005) primarily due to cash outflow in its working capital accounts (mostly due to inventory build-up). From FY2001 to FY2006, Net Income as a percentage of CFO has remained relatively constant ranging from 60% to 68%, aside from FY2004 when NI was 55% of CFO mostly due to slower yoy net earnings growth. Overall cash flow has been positive and fairly steady. Cross-Sectional Analysis Since WMT operations span multiple retail industries, I compared WMT to both the retail drug industry and retail department stores. WMT is in the middle of the pack with regards to Free Cash Flow/Total Cash Flow: Company STEIN MART INCORPORATED FEDERATED DEPARTMENT STORES INC GOTTSCHALKS INCORPORATED PENNEY J C INCORPORATED RITE AID CORPORATION NORDSTROM INCORPORATED LONGS DRUG STORES INCORPORATED DILLARDS INCORPORATED TARGET CORPORATION WAL-MART STORES INCORPORATED WALGREEN COMPANY KOHLS CORPORATION JACOBSON STORES INCORPORATED RETAIL VENTURES INCORPORATED BON-TON STORES INCORPORATED CVS CORPORATION Median Mean Free CF/ Ticker Total CF SMRT 83.56 FD 69.01 GOT 64.33 JCP 63.44 RAD 63.2 JWN 59.29 LDG 49.72 DDS 48.5 TGT 19.71 WMT 14.3 WAG 9.75 KSS 6.13 JCBSQ 5.93 RVI 5.24 BONT -9.08 CVS -47.42 34.11 31.60 FCF is important to investors because it is commonly regarded as the amount of cash generated by operations remaining (after changes in working capital and cap ex) that can be devoted to pay shareholders, both debt-holders and equity-holders. Profitability Time-Series Analysis WMT’s Net Income along with EPS has exhibited double-digit growth since FY2002 until this past year. 16 Earnings Growth (YOY) Diluted net income per common share Net Income 2002 6.4% 6.0% 2003 20.1% 19.2% 2004 15.6% 13.8% 2005 16.4% 13.4% 2006 11.2% 9.4% The major contributor to WMT’s net income growth in the future should be its International segment, which has shown substantially increasing growth in its sales and operating margin. Sales: YOY (QOQ) Growth Wal-Mart Stores Sam's Club International 2002 14.1% 9.7% 10.5% 2003 12.9% 7.8% 15.0% 2004 10.9% 8.9% 16.6% 2005 10.1% 7.5% 18.3% 2006 9.4% 7.2% 11.4% Operating Margin: Operating Margin Wal-Mart Store Operating Margin Sam's Club Margin International Margin 2001 7.9% 3.5% 3.0% 2002 7.3% 3.5% 3.7% 2003 7.5% 3.2% 4.9% 2004 7.4% 3.3% 5.0% 2005 7.4% 3.4% 5.3% 2006 7.3% 3.5% 5.3% Return on Equity (ROE) is an important measure for measuring the return generated on the stockholder’s investment. Below is WMT’s ROE from FY2001 to FY2006. It is broken down into components (using the DuPont Analysis method): ROE Profitability ROE Net Margin Asset Turnover Leverage Ratio 2001 20.1% 3.3% 2.4 2.5 2002 20.1% 3.1% 2.7 2.4 2003 21.4% 3.5% 2.6 2.4 2004 21.8% 3.5% 2.6 2.4 2005 22.1% 3.6% 2.5 2.4 2006 21.9% 3.6% 2.4 2.5 Adjusted 2006 21.5% 3.5% 2.3 2.7 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Cross-Sectional Analysis On the next page is a comparison chart for the retail industry (drug and department stores) that compare yoy revenue and EPS growth (for the past three years). Jan-05 WMT’s ROE has been very consistent over the past five years and has grown slightly. Included in “Adjusted 2006” numbers is the capitalization of operating leases and its effects on WMT’s balance sheet and income statement (which are relatively non-material). The only change has come in asset turnover (decreasing from 2.7 in FY2002 to 2.3 in FY2006) and an increase in leverage ratio. This ROE is to be expected given WMT’s asset growth 25 (mainly through debt financing) from its recent 23 international acquisitions and domestic store 21 growth. WMT’s ten-year average ROE is 21.1%, 19 and in the long-run, assuming a mean-reversion 17 scenario, WMT’s ROE should settle around 15 21.1%. 17 Stock Name BON-TON STORES INCORPORATED CVS CORPORATION KOHLS CORPORATION WALGREEN COMPANY TARGET CORPORATION WAL-MART STORES INCORPORATED NORDSTROM INCORPORATED RETAIL VENTURES INCORPORATED FEDERATED DEPARTMENT STORES INC RITE AID CORPORATION STEIN MART INCORPORATED PENNEY J C INCORPORATED LONGS DRUG STORES INCORPORATED GOTTSCHALKS INCORPORATED DILLARDS INCORPORATED JACOBSON STORES INCORPORATED WAL-MART DE MEXICO SA ADR CL V Mean (not incld. "NM" or "NEG") Median Symbol BONT CVS KSS WAG TGT WMT JWN RVI FD RAD SMRT JCP LDG GOT DDS JCBSQ WMMVY Rev Grw EPS Grw Rate Rate 3yr PTP 3yr PTP 21.7 18.56 15.23 16.32 13.99 9.59 13.43 15.21 11.33 19.61 10.88 14.39 8.9 46.99 5.88 NEG 5.17 8.62 2.39 NMN 2.38 33 1.81 67.15 1.15 4 -0.66 9.77 -2.25 -17.19 -6.09 NEG 8.79 5.525 23.04 15.21 Stock Name NORDSTROM INCORPORATED WAL-MART STORES INCORPORATED PENNEY J C INCORPORATED WALGREEN COMPANY STEIN MART INCORPORATED WAL-MART DE MEXICO SA ADR CL V TARGET CORPORATION CVS CORPORATION KOHLS CORPORATION FEDERATED DEPARTMENT STORES INC LONGS DRUG STORES INCORPORATED BON-TON STORES INCORPORATED GOTTSCHALKS INCORPORATED DILLARDS INCORPORATED RETAIL VENTURES INCORPORATED JACOBSON STORES INCORPORATED RITE AID CORPORATION Mean Median Symbol JWN WMT JCP WAG SMRT WMMVY TGT CVS KSS FD LDG BONT GOT DDS RVI JCBSQ RAD ROE T4Q 26.65 22.17 19.32 18.1 17.76 17.31 17.15 15.3 15.03 10.9 7.48 6.28 4.93 3.89 -22.58 -99.9 NMN 4.99 15.17 The above list is sorted by Revenue Growth and WMT is near the top of the list, but remains below its major competitors in both the retail department store and retail drug industries. It remains in the middle of the pack with regards to EPS growth (a relative measure considering that the calculation depends on weighted-average number of shares outstanding which can be manipulated through share-buyback programs). WMT’s ROE is high compared to the market (13.4% on average 11), but about average for the entire retail industry (20.0%12). Notice that the ROE numbers in the chart above are 4Q05 (in WMT’s case, 4Q06) numbers. Compared to its major competitors, WMT does have a substantially higher ROE. If we again consider a reversion to the mean scenario, we would expect to see WMT’s ROE figure drop to the industry average at about 20.0%. Efficiency Time-Series Analysis WMT’s degree of operational efficiency can be measured by calculating its margins: 1) Gross Margin, 2) Operating Margin, and 3) Net Margin. Gross Margin normally measures how efficiently a firm can produce a product, but in this case since WMT is a retailer, gross margin measures the spread WMT makes on the products it sells. Meanwhile, Operating Margin will measure how efficiently it can bring these products to market. Below is a breakdown of WMT’s margins over time. Margins Gross Margin (% of Net Sales) Operating Margin Wal-Mart Store Operating Margin Sam's Club Margin International Margin Other Total Operating Margin Net Margin 2001 22.4% 7.9% 3.5% 3.0% -0.1% 5.9% 3.3% 2002 22.1% 7.3% 3.5% 3.7% -0.3% 5.4% 3.0% 2003 23.2% 7.5% 3.2% 4.9% -0.6% 5.7% 3.4% 2004 23.4% 7.4% 3.3% 5.0% -0.5% 5.8% 3.5% 2005 23.9% 7.4% 3.4% 5.3% -0.5% 6.0% 3.6% 2006 24.1% 7.3% 3.5% 5.3% -0.5% 5.9% 3.6% 11 12 Hoovers Online. Available at http://premium.hoovers.com/ Hoovers Online. Available at http://premium.hoovers.com/ 18 Each of WMT’s three margins is increasing over time. I would expect all margins to increase at a decreasing rate in the future, aside from WMT’s International Segment’s operating margin. I would expect this to near the Wal-Mart Store Segment’s operating margin of 7.3%. Since WMT’s major sales growth comes from the International Segment (a trend which should continue), it is important that WMT International continue to increase its operating margin. This will be the key factor affecting WMT’s overall earnings growth in the near-future. Cross-Sectional Analysis Below is a chart that compares WMT’s margins to those of its competitors (note, margins are computed five-year averages for each company). WMT stands above average with regards to net margin and EBITDA Margin, which is equivalent to operating margin, but below average when it comes to gross margin. WMT’s margin figures makes sense considering its low-cost retailer strategy -- WMT charges a smaller mark-up, but is more efficient than many of its competitors at bringing products to market, given its aforementioned competitive advantages. WMT’s higher than average operating and net margins make sense given its tremendous, world-leading volume of sales. Gross Margin 5yr Avg 34.18 39.98 34.94 34.09 27.08 22.39 25.89 25.18 35.46 36.44 32.73 25.45 35.13 37.2 23.83 31.33 34.09 EBITDA Margin 5yr Avg 12.92 13.19 10.11 10.3 6.88 7.58 6.47 4.35 6.41 6.19 7.82 3.51 4.34 1.16 1.59 6.85 6.47 Net Prof Marg Adj 5yr Avg 6.31 4.53 3.75 3.61 3.6 3.47 3.09 1.99 1.68 1.56 1.07 1.05 0.58 -0.47 -1.34 -1.58 2.06 1.84 Stock Name KOHLS CORPORATION FEDERATED DEPARTMENT STORES INC TARGET CORPORATION NORDSTROM INCORPORATED WALGREEN COMPANY WAL-MART STORES INCORPORATED CVS CORPORATION STEIN MART INCORPORATED PENNEY J C INCORPORATED BON-TON STORES INCORPORATED DILLARDS INCORPORATED LONGS DRUG STORES INCORPORATED GOTTSCHALKS INCORPORATED RETAIL VENTURES INCORPORATED RITE AID CORPORATION JACOBSON STORES INCORPORATED Mean Median Symbol KSS FD TGT JWN WAG WMT CVS SMRT JCP BONT DDS LDG GOT RVI RAD JCBSQ Liquidity Time-Series Analysis In order to measure WMT’s degree of liquidity or solvency, I used three ratios: 1) Interest Coverage Ratio, 2) Current Ratio, and 3) Quick Ratio. These three ratios will give an investor insight as to any dangers WMT might run into with regard to having cash on hand to service immediate obligations. I calculated the ratios in the following manner: Interest Coverage Ratio (FCF/Interest Expense); Current Ratio (Current Assets/Current Liabilities); Quick Ratio (Cash and Cash Equivalents plus Accounts Receivable/Current Liabilities). 19 Liquidity Interest Coverage Ratio Current Ratio Quick Ratio 2001 15.3 0.92 0.13 2002 15.7 1.02 0.15 2003 24.8 0.93 0.15 2004 31.7 0.91 0.17 2005 28.7 0.90 0.17 2006 28.0 0.90 0.19 Adjusted 2006 22.2 0.89 0.18 WMT, the largest retailer in the world, has plenty of free cash flow to meet its annual, short-term debt obligations. Its interest coverage ratio increased dramatically from FY2001 to FY2006 an account of WMT’s rapidly growing CFO. Despite the fact that adjustments from capitalizing operating leases brings down the interest coverage ratio from 28.0 to 22.2, it is still a high number and it is evident that WMT does not have much solvency risk at this point. Cross-Sectional Analysis WMT ranks absolute last for Current Ratio and Quick Ratio with regards to its peers (See chart to the right). This is not a problem for WMT since it holds $6.4B of cash and its CFO was $17.6B (both figures from FY2006). In my opinion, WMT is doing a good thing by maintaining low liquidity ratios, because it forces management to manage WMT’s cash and cash flows efficiently and provides less freedom to squander cash on investments that will decrease the return to shareholders (ROE). Stock Name KOHLS CORPORATION PENNEY J C INCORPORATED BON-TON STORES INCORPORATED DILLARDS INCORPORATED STEIN MART INCORPORATED GOTTSCHALKS INCORPORATED NORDSTROM INCORPORATED WALGREEN COMPANY RITE AID CORPORATION FEDERATED DEPARTMENT STORES INC TARGET CORPORATION RETAIL VENTURES INCORPORATED CVS CORPORATION LONGS DRUG STORES INCORPORATED JACOBSON STORES INCORPORATED WAL-MART STORES INCORPORATED Mean Median Symbol KSS JCP BONT DDS SMRT GOT JWN WAG RAD FD TGT RVI CVS LDG JCBSQ WMT Current Ratio 2.5 2.44 2.38 2.19 2.19 2.18 1.92 1.86 1.8 1.75 1.69 1.66 1.63 1.51 1.21 0.9 1.86 1.83 Quick Ratio 1.1 1.48 0.66 0.49 0.56 0.15 0.78 0.55 0.39 1 0.89 0.1 0.44 0.46 0.5 0.17 0.61 0.53 Leverage Time-Series Analysis WMT’s leverage ratios were not as high as one would expect. As a result of its reasonable debt structure and plush cash flow from operations, WMT continues to maintain an AA S&P credit rating 13. I analyzed WMT’s: 1) Leverage Ratio, 2) Debt/Equity, and 3) Long-term Debt/Total Capital. Liquidity Leverage Ratio Debt/Equity Debt/Total Capital 2001 2.5 49.9% 28.5% 2002 2.4 53.4% 30.9% 2003 2.4 49.8% 29.7% 2004 2.4 46.1% 28.2% 2005 2.4 47.9% 28.9% 2006 2.5 56.7% 33.2% Adjusted 2006 2.7 70.0% 41.2% 13 Business Week Online. Available at http://research.businessweek.com 20 Here, the affects of capitalizing WMT’s operating leases are profound. Notice that the D/E ratio rises from 56.7% to 70% and D/TC grows from 33.2% to 41.2%. While WMT’s debt ratios are increasing with time, it is not in much danger of being over-levered at its current capital structure. Again, given its vast amounts of cash on hand and CFO, WMT can easily handle the debt service at this point. I would expect WMT’s debt level to continue to grow slightly given its plans for international and domestic expansion, and its recent quest to refurbish over 1,800 of its stores already in existence. LT Debt /Tot Cap 5Yr Avg% 100 59.25 47.44 45.37 45.19 44.48 41.12 36.5 32.76 32.39 23.47 18.96 15.21 11.16 0.14 36.90 36.50 Cross-Sectional Analysis When it comes to the retail industry, WMT maintains a capital structure that puts it in the middle of the pack with regard to its use of debt. Adding in the changes made by capitalizing WMT’s operating leases, its five-year average LTD/TC would most likely increase to approximately 40%. One would also have to capitalize WMT’s competitors’ operating leases and make the necessary adjustments to make an apples-to-apples comparison. Assuming most of WMT’s competitors maintain a comparable percentage of operating leases, WMT would most likely remain near the industry average for LTD/TC. Stock Name RITE AID CORPORATION RETAIL VENTURES INCORPORATED TARGET CORPORATION GOTTSCHALKS INCORPORATED PENNEY J C INCORPORATED NORDSTROM INCORPORATED DILLARDS INCORPORATED FEDERATED DEPARTMENT STORES INC BON-TON STORES INCORPORATED WAL-MART STORES INCORPORATED KOHLS CORPORATION LONGS DRUG STORES INCORPORATED CVS CORPORATION STEIN MART INCORPORATED WALGREEN COMPANY JACOBSON STORES INCORPORATED Mean Median Symbol RAD RVI TGT GOT JCP JWN DDS FD BONT WMT KSS LDG CVS SMRT WAG JCBSQ Valuation Analysis I used three different techniques to value WMT: 1) Free Cash Flow Model, 2) Dividend Discount Model, and 3) Comparable Valuation Ratio technique. Each valuation turns out very similar numbers for a oneyear price target, all of which are in the vicinity of where WMT is trading today ($45.45). The FCF valuation assigns WMT an intrinsic value of $46.73. The DDM model gives WMT an intrinsic value of $44.50. The Comparable Valuation Ratio technique gives WMT an average intrinsic value of $47.20. Considering all three models, I give WMT a one-year target price of $46.00. FCF Valuation Model See Exhibits I, II, and III on pages 24, 25, and 26 for a complete description of the FCF valuation model used, including all major assumptions used in calculating WMT’s intrinsic value of $46.73, which is a 2.8% discount compared to its current price of $45.45. Below is a list of major assumptions that were made:     Discount Rate used was 10%, which is relatively high compared to its computed average cost of capital. Earnings projections were made up to and including FY2015, and afterward, a terminal growth of 5.5% was used to calculate the terminal present value of future cash flows. Changes in working capital would remain consistent and would near zero. Depreciation and Amortization would remain a constant percentage (1.5%) into the future. It has been very consistent, near 1.5% in the past five years. 21   Cap Ex would decrease as a percentage of assets due to decreasing growth prospects. The terminal growth rate coupled with the discount rate would give WMT a terminal intrinsic value to earnings ratio that could be compared with WMT’s present day P/E ratio. Furthermore, I performed a stress test to note the affects of using different discount and terminal growth rates. 5% $258.65 NM NM NM NM 8% $59.07 $75.53 $108.45 $207.20 NM Discount Rate 10% $37.26 $42.94 $51.47 $65.68 $94.11 12% $26.53 $29.17 $32.69 $37.61 $44.99 15% $17.97 $19.06 $20.39 $22.05 $24.18 4% 5% 6% 7% 8% Terminal Value The stress test gives us an idea of what WMT’s intrinsic value would be if our assumptions were different. WMT’s intrinsic value grows as the terminal rate gets bigger and as the discount rate gets smaller. Normally, one would discount the FCFs using the company’s WACC. I computed the WACC for WMT, but it was abnormally low at about 6.8% (See WACC Calculation in Exhibit VII on page 30). I felt 6.8% was too low and does not accurately capture the risk of owning WMT. Discounting WMT’s expected cash flows by its WACC gives WMT a target price of $177, which is a 288% discount. Apparently the market agrees that discounting WMT at its WACC does not account for all risk of owning WMT. Dividend Discount Model The DDM values WMT at $44.50. The DDM discounts expected dividends a stockholder would receive in the future. I kept the discount rate at 10%, but I used a different terminal growth for WMT’s dividends. I assumed dividend growth would be higher than WMT’s FCF growth at 8.3%. I believe this assumption is justified because WMT’s current dividend payout ratio is relatively low (22%). Assuming that WMT is a maturing company, many investors would expect WMT to begin paying out more of its earnings at a higher payout rate (30%+). Below is a graphic that contains the DDM valuation and assumptions. DDM 2003 2004 2005 2006 2007 2008 2009 2010 Termimal ================ =============== =============== =============== =============== =============== =============== =============== =============== Dividends Per Share yoy % Change 0.30 0.36 20.0% 0.52 44.4% 0.60 15.4% 0.69 15.0% 0.79 15.0% 0.91 15.0% 1.05 15.0% 66.85 Terminal Growth Rate Discount Rate PV of Expected Divs. Per Share PV of FCF 8.3% 10.0% $44.50 To arrive at the $44.40 valuation, I assumed WMT’s dividend would grow at 15% for each of the next four years, and at a terminal 8.3% afterwards. 22 Comparable Valuation Ratio Technique The Comparable Valuation Ratio technique produced an average intrinsic value for WMT of $47.20. Since I wanted to determine a one-year price target, I assumed WMT would trade at the same levels that it currently is trading at with regard to P/E-1year forward, P/S, P/CF, and P/BV. Using this method to determine a 5-year (or longer price target), one would use long-term “mean” or “median” data for the firm’s P/E, P/S, P/CF and P/BV. Using my earnings, sales, book value and cash flow estimates for FY2007, I determined projected EPS, Sales per Share, Cash Flow per Share, and Book Value per Share. Next, I used that data to compute WMT’s intrinsic value today. The major assumption that I made here is that WMT would be trading at its current multiples one year from now. This scenario will mostly likely not be the case. See the graphs below for a historical range of WMT’s valuation ratios. Currently, WMT is trading at low multiples, and in Comparable Valuation Ratios the long-run, an investor should expect Price/"X" Current Expected "X" per Share Implied Value P/E-1yr Fwd 13.61 3.08 41.89 to see a reversion to the mean for each P/S 0.61 86.88 53.00 ratio. It is also important to consider P/CF 9.62 4.63 44.50 WMT’s relative (to SP5A) valuation P/BV 3.58 13.80 49.40 ratio range, which shows that WMT is Average $47.20 trading at normal valuation multiples Discount (Premium) 3.8% (See Exhibit IX on page 31). Notice with this more imprecise methodology for valuing a firm’s shares, there is a wider value per share range. The range in this case is from $41.89 (using the P/E ratio and EPS estimate for FY2007) to $53.00 (using the P/S ratio and Sales per share estimate for FY2007). Given the impreciseness of this method, the average implied price is $47.20 (averaging all four implied price figures from the above chart). This number is still very consistent with the figures generated by the other two valuation methodologies. WMT P/E (1-Yr Forward) 60 50 40 30 20 10 0 1 0.5 0 2.5 2 1.5 WMT P/S 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2005 WMT P/CF 50 45 40 35 30 25 20 15 10 5 0 14 12 10 8 6 4 2 0 WMT P/BV 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 Summary All three valuation models provide a consistent one-year forward valuation of WMT’s firm value per share that I averaged to get $46.00 per share. I have taken into account all data mentioned in this report concerning the consumer staples sector, the retail industry, and WMT’s firm-specific competitive advantages to develop specific sales growth estimates, cost estimates, and earnings estimates for the coming years. 2/23/2006 2/23/2006 23 Exhibit I: Pro Forma Income Statement (Amounts in millions except per share data) Fiscal years ended January 31, Revenues: Wal-Mart Stores Sam's Club International Other Net sales Other income, net Total Revenue Costs and expenses: Cost of sales Operating, selling, general and administrative expenses Operating Income: Wal-Mart Stores Sam's Club International Other Operating income Interest: Debt Capital leases Interest income Interest, net Income from continuing operations before income taxes and minority interest Provision for income taxes: Current Deferred Total Provision for Taxes Income from continuing operations before minority interest Minority interest Income from continuing operations Income from discontinued operation, net of tax 2001 2002 2003 Actual 2004 01/31/2005 2005 04/30/2005 07/31/2005 10/31/2005 01/31/2006 2006 4/30/2006E 7/31/2006E Projected 10/31/2006E 1/31/2007E 2007E 2008E 121,889 26,798 32,100 10,542 191,329 1,787 $193,116 139,131 29,395 35,485 13,788 217,799 1,873 $219,672 157,120 31,702 40,794 229,616 1,961 $231,577 174,220 34,537 47,572 256,329 2,352 $258,681 243,656 198,747 44,909 42,133 7,976 11,958 62,067 469 $62,536 191,826 37,119 56,277 285,222 2,767 $287,989 47,641 9,155 14,112 70,908 772 $71,680 51,809 9,969 15,033 76,811 709 $77,520 50,243 10,019 15,174 75,436 817 $76,253 60,218 10,655 18,400 89,273 854 $90,127 209,911 39,798 62,719 312,428 3,152 $315,580 51,929 9,704 15,805 77,438 811 $78,249 57,249 10,567 16,837 84,653 744 $85,397 55,016 10,821 17,450 83,287 858 $84,145 66,842 11,721 27,600 106,162 897 $107,059 231,036 42,812 77,693 351,541 3,310 $354,850 251,829 45,809 93,231 390,869 165 $391,035 150,255 31,550 171,562 36,173 178,299 39,983 48,447 9,667 219,793 51,105 54,571 13,168 58,787 14,054 57,988 14,216 69,045 15,222 240,391 56,660 59,240 14,645 64,760 15,856 64,131 15,016 81,214 19,506 269,345 65,022 295,888 71,968 9,600 942 949 (196) $11,311 10,200 1,028 1,305 (617) $11,937 11,840 1,023 1,998 (1,290) $13,295 12,916 1,126 2,370 (1,387) $15,025 3,552 272 774 (176) $4,422 14,163 1,280 2,988 (1,340) $17,091 3,307 295 667 (328) $3,941 3,992 371 750 (434) $4,679 3,312 342 797 (402) $4,049 4,714 377 1,116 (347) $5,860 15,325 1,385 3,330 (1,511) $18,529 3,635 330 790 (391) $4,364 4,007 359 842 (427) $4,782 4,126 368 925 (421) $4,998 5,013 398 1,463 (535) $6,339 16,782 1,456 4,020 (1,774) $20,483 18,635 1,558 4,941 (1,955) $23,179 1,104 279 (188) 1,195 10,116 1,083 274 (171) 1,186 10,751 799 260 (132) 927 12,368 729 267 (164) 832 14,193 86 80 (31) 135 4,287 934 253 (201) 986 16,105 199 53 (52) 200 3,741 301 60 (59) 302 4,377 348 60 (59) 349 3,700 324 76 (78) 322 5,538 1,172 249 (248) 1,173 17,356 235 78 (78) 235 4,129 256 85 (85) 256 4,525 252 84 (84) 252 4,746 321 107 (107) 321 6,018 1,065 355 (355) 1,065 19,418 1,173 391 (391) 1,173 22,006 3,350 342 3,692 6,424 (129) 6,295 3,712 185 3,897 6,854 (183) 6,671 3,883 474 4,357 8,011 (193) 7,818 137 4,941 177 5,118 9,075 (214) 8,861 193 1,620 2,667 (40) 2,627 5,326 263 5,589 10,516 (249) 10,267 1,212 2,529 (68) 2,461 1,503 2,874 (69) 2,805 1,254 2,446 (72) 2,374 1,835 3,703 (114) 3,589 0 0 5,804 11,552 (323) 11,229 1,404 2,725 (68) 2,657 1,539 2,987 (75) 2,912 1,614 3,132 (78) 3,054 2,046 3,972 (99) 3,873 0 0 6,602 12,816 (320) 12,496 7,482 14,524 (363) 14,161 Net income Basic net income per common share: Income from continuing operations Income from discontinued operation Basic net income per common share Diluted net income per common share: Income from continuing operations Income from discontinued operation Diluted net income per common share Weighted-average number of common shares: Basic Diluted Dividends per common share $6,295 $6,671 $7,955 $9,054 $2,627 $10,267 $2,461 $2,805 $2,374 $3,589 $11,229 $2,657 $2,912 $3,054 $3,873 $12,496 $14,161 1.41 1.49 1.77 0.03 1.80 2.03 0.05 2.08 2.41 0.59 2.41 0.58 0.67 0.57 0.86 0.86 0.86 2.68 0.64 0.64 0.71 0.71 0.76 0.76 0.97 0.97 3.08 3.08 3.54 3.54 1.40 1.49 1.76 0.03 1.79 2.03 0.04 2.07 2.41 0.59 2.41 0.58 0.67 0.57 0.86 0.86 0.86 2.68 0.64 0.64 0.71 0.71 0.75 0.75 0.97 0.97 3.08 3.08 3.54 3.54 4,465 4,484 4,465 4,481 4,430 4,446 0.30 16.8% 4,363 4,373 0.36 17.4% 4,259 4,266 4,259 4,266 0.52 21.6% 4,228 4,234 4,175 4,180 4,165 4,169 4,166 4,170 4,166 4,170 0.60 22.4% 4,124 4,128 4,083 4,087 4,042 4,046 4,002 4,006 4,042 4,046 4,002 4,006 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Exhibit II: Pro Forma Income Statement Assumptions Assumptions 2001 As a % of Net Sales Wal-Mart Stores Sam's Club International YOY (QOQ) Growth Wal-Mart Stores Sam's Club International Net Sales Other income, net Total Revenue Weighted Ave. Shares: Basic Diluted Margins Gross Margin (% of Net Sales) Operating Margin Wal-Mart Store Operating Margin Sam's Club Margin International Margin Other Total Operating Margin Net Margin Interest as a % of Sales: Debt Capital leases Interest income Interest, net Taxes as % of EBTMI: Current Deferred Total Provision for Taxes Income From Minority Interest as % of Inc. from Cont Ops. Net Income Margin YOY (QOQ) Growth 63.7% 14.0% 16.8% 2002 63.9% 13.5% 16.3% 2002 14.1% 9.7% 10.5% 13.8% 4.8% 13.8% 0.0% -0.1% 2003 68.4% 13.8% 17.8% 2003 12.9% 7.8% 15.0% 5.4% 4.7% 5.4% -0.8% -0.8% Actual 2004 01/31/2005 68.0% 13.5% 18.6% 67.9% 12.9% 19.3% 2005 67.3% 13.0% 19.7% 2005 10.1% 7.5% 18.3% 11.3% 17.6% 11.3% -2.4% -2.4% 04/30/2005 07/31/2005 10/31/2005 01/31/2006 67.2% 12.9% 19.9% 67.4% 13.0% 19.6% 66.6% 13.3% 20.1% 67.5% 11.9% 20.6% 2006 4/30/2006E 67.2% 12.7% 20.1% 2006 9.4% 7.2% 11.4% 9.5% 13.9% 9.6% -2.2% -2.3% 67.1% 12.5% 20.4% 7/31/2006E 67.6% 12.5% 19.9% Projected 10/31/2006E 1/31/2007E 66.1% 13.0% 21.0% 63.0% 11.0% 26.0% 2007E 65.7% 12.2% 22.1% 2008E 64.4% 11.7% 23.9% 2004 01/31/2005 10.9% 11.3% 8.9% 7.8% 16.6% 48.0% 11.6% 16.4% 19.9% 171.1% 11.7% 16.9% -1.5% -1.6% -1.5% -1.6% 04/30/2005 07/31/2005 10/31/2005 01/31/2006 9.3% 10.4% 9.5% 42.9% 5.9% 5.9% 10.3% 33.6% 12.4% 12.3% 12.0% 53.9% 9.5% 10.2% 10.1% 43.8% 13.5% -3.8% 7.2% 82.1% 9.5% 10.0% 10.1% 44.1% -1.5% -1.6% -2.1% -2.2% -1.8% -1.9% -2.2% -2.3% 9.0% 6.0% 12.0% 9.2% 5.0% 9.2% -1.0% -1.0% 10.5% 6.0% 12.0% 10.2% 5.0% 10.2% -1.0% -1.0% 9.5% 8.0% 15.0% 10.4% 5.0% 10.3% -1.0% -1.0% 11.0% 10.0% 50.0% 18.9% 5.0% 18.8% -1.0% -1.0% 10.1% 7.6% 23.9% 12.5% 5.0% 12.4% -3.0% -3.0% 9.0% 7.0% 20.0% 11.2% 5.0% 10.2% -1.0% -1.0% 22.4% 7.9% 3.5% 3.0% -0.1% 5.9% 3.3% 0.6% 0.1% -0.1% 0.6% 22.1% 7.3% 3.5% 3.7% -0.3% 5.4% 3.0% 0.5% 0.1% -0.1% 0.5% 23.2% 7.5% 3.2% 4.9% -0.6% 5.7% 3.4% 0.3% 0.1% -0.1% 0.4% 23.4% 7.4% 3.3% 5.0% -0.5% 5.8% 3.5% 0.3% 0.1% -0.1% 0.3% 22.7% 8.4% 3.4% 6.5% -0.3% 7.1% 4.2% 0.1% 0.1% 0.0% 0.2% 23.9% 7.4% 3.4% 5.3% -0.5% 6.0% 3.6% 0.3% 0.1% -0.1% 0.3% 24.1% 6.9% 3.2% 4.7% -0.5% 5.6% 3.4% 0.3% 0.1% -0.1% 0.3% 24.4% 7.7% 3.7% 5.0% -0.6% 6.1% 3.6% 0.4% 0.1% -0.1% 0.4% 24.2% 6.6% 3.4% 5.3% -0.5% 5.4% 3.1% 0.5% 0.1% -0.1% 0.5% 23.6% 7.8% 3.5% 6.1% -0.4% 6.6% 4.0% 0.4% 0.1% -0.1% 0.4% 24.1% 7.3% 3.5% 5.3% -0.5% 5.9% 3.6% 0.4% 0.1% -0.1% 0.4% 23.5% 7.0% 3.4% 5.0% -0.5% 5.6% 23.5% 7.0% 3.4% 5.0% -0.5% 5.6% 23.0% 7.5% 3.4% 5.3% -0.5% 5.9% 23.5% 7.5% 3.4% 5.3% -0.5% 5.9% 24.3% 7.3% 3.4% 5.2% -0.5% 5.8% 24.3% 7.4% 3.4% 5.3% -0.5% 5.9% 0.3% 0.1% -0.1% 0.3% 0.3% 0.1% -0.1% 0.3% 0.3% 0.1% -0.1% 0.3% 0.3% 0.1% -0.1% 0.3% 0.3% 0.1% -0.1% 0.3% 0.3% 0.1% -0.1% 0.3% 33.1% 3.4% 36.5% -2.0% 3.3% 36.7% 1.7% 36.2% -2.7% 3.0% 38.4% 3.8% 35.2% -2.4% 3.4% 48.8% 1.2% 36.1% -2.4% 3.5% 0.0% 0.0% 37.8% -1.5% 4.2% 33.1% 1.6% 34.7% -2.4% 3.6% 0.0% 0.0% 32.4% -2.7% 3.4% 0.0% 0.0% 34.3% -2.4% 3.6% 0.0% 0.0% 33.9% -2.9% 3.1% 0.0% 0.0% 33.1% -3.1% 4.0% 0.0% 0.0% 33.4% -2.8% 3.6% 32.0% 2.0% 34.0% -2.5% 3.4% 32.0% 2.0% 34.0% -2.5% 3.4% 32.0% 2.0% 34.0% -2.5% 3.6% 32.0% 2.0% 34.0% -2.5% 3.6% 0.0% 0.0% 34.0% -2.5% 3.5% 32.0% 2.0% 34.0% -2.5% 3.6% *Assumptions made to forecast income statement line items are highlighted in green. Exhibit III: Pro Forma Statement of FCF and FCF Valuation Year (in millions, except per share) 2006A 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E ================================================================================= =============== =============== =============== =============== =============== =============== =============== =============== =============== Net Revenue % Growth Operating Income Operating Margin Interest and Other- net Interest % of Sales Taxes Tax Rate Equity Income, net % of sales Net Income % Growth Add Depreciation/Amort % of Sales % of Capex Plus/(minus) Changes WC Initial Working Capital Subtract Cap Ex Capex % of sales Free Cash Flow YOY growth $315,580 9.6% 18,529 5.9% (1,173) 0.4% (5,804) 33.4% (323) -0.1% $354,850 12.4% 20,483 5.8% (1,065) 0.3% (6,602) -34.0% (320) -0.1% $391,035 10.2% 23,179 5.9% (1,173) 0.3% (7,482) -34.0% (363) -0.1% $430,138 10.0% 25,808 6.0% (1,290) -0.3% (7,846) 32.0% 0 0.0% $473,152 10.0% 28,389 6.0% (1,419) -0.3% (8,630) 32.0% 0 0.0% $518,101 9.5% 31,086 6.0% (1,554) -0.3% (9,450) 32.0% 52 0.0% $564,731 9.0% 33,884 6.0% (1,694) -0.3% (10,301) 32.0% 282 0.1% $615,556 9.0% 36,933 6.0% (1,847) -0.3% (11,228) 32.0% 616 0.1% $667,879 8.5% 40,073 6.0% (2,004) -0.3% (12,182) 32.0% 668 0.1% $721,309 8.0% 43,279 6.0% (2,164) -0.3% (13,157) 32.0% 721 0.1% Terminal Value =============== $11,229 $12,496 $14,161 $16,672 $18,339 $20,133 $22,171 $24,475 $26,555 $28,679 9.4% 11.3% 13.3% 17.7% 10.0% 9.8% 10.1% 10.4% 8.5% 8.0% =============== =============== =============== =============== =============== =============== =============== =============== =============== =============== 4,734 5,322.8 5,866 6,452 7,097 7,772 8,471 9,233 10,018 10,820 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 34.9% 34.9% 34.9% 37.5% 37.5% 40.5% 40.5% 42.9% 42.9% 45.5% 1,000 900 500 500 (500) (500) (400) (300) (200) (100) (13,570) 4.3% $3,392.76 (15,259) 4.3% $3,459.92 2.0% (16,814) 4.3% $3,711.77 7.3% (17,206) 4.0% $6,418.70 72.9% (18,926) 4.0% $6,010.57 -6.4% (19,170) 3.7% $8,235.19 37.0% (20,895) 3.7% (21,544) 3.5% (23,376) 3.5% $12,997.28 9.6% (23,803) 3.3% $15,595.68 20.0% $9,347.25 $11,863.39 13.5% 26.9% Valuation Discount Rate Terminal Growth Rate 10.0% 5.5% % Of Total 22.2% 77.8% '06-10 Cash/Op's Cash/Op's % of Sales $104,768 5.3% Terminal Value P/E FCF Yield $365,632 12.75 4.3% NPV of FCF NPV of Terminal Value Present Value of Firm (M) FCF Yield Shares Outstanding (M) Current Historical P/E Implied Value Per Share Current Price Current Discount (Premium) $44,296 $155,064 $199,359 1.7% 4266.0 18.9 $46.73 $45.45 2.8% 26 Exhibit IV: Balance Sheet (Amounts in millions except per share data) January 31, Assets Current assets: Cash and cash equivalents Receivables Inventories Prepaid expenses and other Total current assets Property and equipment, at cost: Land Buildings and improvements Fixtures and equipment Transportation equipment Property and equipment, at cost Less accumulated depreciation Property and equipment, net Property under capital lease Less accumulated amortization Property under capital lease, net Goodwill Other assets and deferred charges Total assets Liabilities and shareholders equity Current liabilities: Commercial paper Accounts payable Accrued liabilities Accrued income taxes Long-term debt due within one year Obligations under capital leases due within one year Total current liabilities Long-term debt Long-term obligations under capital leases Deferred income taxes and other Minority interest Commitments and contingencies Shareholders equity: Preferred stock (0.10 par value; 100 shares authorized, none issued) Common stock (0.10 par value; 11,000 shares authorized, 4,234 and 4,311 issued and outstanding in 2005 and 2004, respectively) Capital in excess of par value Other accumulated comprehensive income Retained earnings Total shareholders equity Total liabilities and shareholders equity 2001 2002 2003 2004 2005 2006 2,054 1,768 21,442 1,291 $26,555 9,433 24,537 12,964 879 47,813 10,196 37,617 4,620 1,303 3,317 9,059 1,582 $78,130 2,161 2,000 22,614 1,103 $27,878 10,241 28,527 14,135 1,089 53,992 11,436 42,556 4,626 1,432 3,194 8,566 1,333 $83,527 2,758 2,108 24,891 726 $30,483 11,228 33,750 15,946 1,313 62,237 13,537 48,700 4,814 1,610 3,204 9,521 2,777 $94,685 5,199 1,254 26,612 1,356 $34,421 12,699 40,192 17,934 1,269 72,094 15,684 56,410 4,286 1,673 2,613 9,882 2,079 $105,405 5,488 1,715 29,447 1,841 $38,491 14,472 46,582 21,461 1,530 84,045 18,637 65,408 4,997 1,838 3,159 10,803 2,362 $120,223 6,414 2,662 32,191 2,591 $43,858 97,302 21,427 75,875 3,415 12,188 2,833 $138,169 2,286 15,092 6,355 841 4,234 141 743 15,617 7,174 1,343 2,257 148 1,079 17,140 8,945 739 4,538 176 3,267 19,425 10,671 1,377 2,904 196 3,812 21,671 12,155 1,281 3,759 210 3,754 25,373 13,465 1,322 4,595 299 $28,949 12,501 3,154 1,043 1,140 $27,282 15,687 3,045 1,204 1,207 $32,617 16,607 3,001 1,761 1,362 $37,840 17,102 2,997 2,359 1,484 $42,888 20,087 3,582 2,947 1,323 $48,808 26,429 3,742 4,552 1,467 447 445 440 431 423 1,411 (684) 30,169 $31,343 $78,130 1,484 (1,268) 34,441 $35,102 $83,527 1,482 (509) 37,924 $39,337 $94,685 2,135 851 40,206 $43,623 $105,405 2,425 2,694 43,854 $49,396 $120,223 3,013 1,053 49,105 $53,171 $138,169 Exhibit V: Cash Flow Statement (Amounts in millions) Fiscal years ended January 31, Cash flows from operating activities Income from continuing operations Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes Other operating activities Changes in certain assets and liabilities, net of effects of acquisitions: Decrease (increase) in accounts receivable Increase in inventories Increase in accounts payable Increase in accrued liabilities Net cash provided by operating activities of continuing operations Net cash provided by operating activities of discontinued operation Net cash provided by operating activities 2001 2002 2003 2004 2005 2006 6,295 6,671 7,818 8,861 10,267 11,231 2,868 342 244 3,290 185 66 3,364 474 685 3,852 177 173 4,405 263 378 4,717 509 (422) (1,795) 2,061 11 9,604 (210) (1,235) 368 1,125 10,260 (159) (2,219) 1,748 1,212 12,923 82 373 (1,973) 2,587 1,896 15,946 50 (304) (2,635) 1,694 976 15,044 (456) (1,733) 2,390 975 17,633 $9,604 $0.66 $10,260 $0.65 (8,383) 0 331 (228) 1134 (7,146) $13,005 $0.60 (9,245) (749) 311 (73) $15,996 $0.55 (10,308) (38) 481 1,500 78 $15,044 $0.68 (12,893) (315) 953 (96) $17,633 $0.64 (14,563) (601) 1,049 (68) Cash flows from investing activities Payments for property and equipment (8,042) Investment in international operations (627) Proceeds from the disposal of fixed assets 284 Proceeds from the sale of McLane Other investing activities (329) Proceeds from termination or sale of net investment hedges Net cash used in investing activities of continuing operations Net cash used in investing activities of discontinued operation Net cash used in investing activities Cash flows from financing activities Increase in commercial paper Proceeds from issuance of long-term debt Purchase of Company stock Dividends paid Payment of long-term debt Payment of capital lease obligations Other financing activities Proceeds from issuance of Company stock Net cash used in financing activities Effect of exchange rate changes on cash Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year (1) Cash and cash equivalents at end of year Supplemental disclosure of cash flow information Income tax paid Interest paid Capital lease obligations incurred (8,714) (9,756) (83) (8,287) (25) (12,351) (14,183) ($8,714) ($7,146) ($9,839) ($8,312) ($12,351) ($14,183) (2,022) 3,778 (193) (1,070) (1,519) (173) 176 581 ($442) (250) 198 1,856 (1,533) 4,591 (1,214) (1,249) (3,519) (167) 113 1,836 2,044 (3,383) (1,328) (1,261) (216) (62) 688 4,099 (5,046) (1,569) (3,541) (305) 111 544 5,832 (4,549) (2,214) (2,131) (204) 113 (704) 7,691 (3,580) (2,511) (2,724) (594) ($2,978) (29) 107 2,054 ($2,370) (199) 597 2,161 ($5,563) 320 2,441 2,758 ($2,609) 205 289 5,199 ($2,422) (102) 926 5,488 $2,054 $2,161 $2,758 $5,199 $5,488 $6,414 3,509 1,319 576 3,196 1,312 225 4,539 1,085 381 4,358 1,024 252 5,593 1,163 377 28 Exhibit VI: Pro Forma Balance Sheet & Income Statement After Capitalizing Operating Leases Pro Forma Balance Sheet Pro Forma Income Statement (Amounts in millions except per share data) January 31, Assets Current assets: Cash and cash equivalents Receivables Inventories Prepaid expenses and other Total current assets Property and equipment, at cost: Land Buildings and improvements Fixtures and equipment Transportation equipment Property and equipment, at cost Less accumulated depreciation Property and equipment, net Property under capital lease Less accumulated amortization Property under capital lease, net Goodwill Other assets and deferred charges Total assets Liabilities and shareholders equity Current liabilities: Commercial paper Accounts payable Accrued liabilities Accrued income taxes Long-term debt due within one year Obligations under capital leases due within one year Total current liabilities Long-term debt Long-term obligations under capital leases Deferred income taxes and other Minority interest Commitments and contingencies Shareholders equity: Preferred stock (0.10 par value; 100 shares authorized, none issued) Common stock (0.10 par value; 11,000 shares authorized, 4,234 and 4,311 issued and outstanding in 2005 and 2004, respectively) Capital in excess of par value Other accumulated comprehensive income Retained earnings Total shareholders equity Total liabilities and shareholders equity 2006 Adjusted 2006 (Amounts in millions except per share data) 2006 Adjusted 2006 6,414 2,662 32,191 2,591 $43,858 6,414 2,662 32,191 2,591 43,858 Fiscal years ended January 31, Revenues: Wal-Mart Stores Sam's Club International Other Net sales Other income, net Total Revenue Costs and expenses: Cost of sales Operating, selling, general and administrative expenses Operating income 209,911 39,798 62,719 312,428 3,152 $315,580 209,911 39,798 62,719 312,428 3,152 $315,580 97,302 21,427 75,875 97,302 21,427 75,875 240,391 56,660 $18,529 240,391 56,500 $18,689 3,415 12,188 2,833 $138,169 10,822 12,188 2,833 $145,576 Interest: Debt Capital leases Interest income Interest, net Income from continuing operations before income taxes and minority interest Provision for income taxes: Current Deferred Total Provision for Taxes Income from continuing operations before minority interest Minority interest Income from continuing operations Income from discontinued operation, net of tax 1,172 249 (248) 1,173 17,356 1,172 551 (248) 1,475 17,214 3,754 25,373 13,465 1,322 4,595 299 3,754 25,373 13,465 1,322 4,595 660 0 0 5,804 11,552 (323) 11,229 0 0 5,853 11,361 (323) 11,038 $48,808 26,429 3,742 4,552 1,467 $49,169 26,429 10,788 4,552 1,467 Net income Basic net income per common share: Income from continuing operations Income from discontinued operation Basic net income per common share Diluted net income per common share: Income from continuing operations Income from discontinued operation Diluted net income per common share Weighted-average number of common shares: Basic Diluted Dividend Per Share $11,229 $11,038 0.86 2.68 2.65 2.65 0.86 2.68 2.65 2.65 3,013 1,053 49,105 $53,171 $138,169 3,013 1,053 49,105 53,171 $145,576 4,166 4,170 0.60 4,166 4,170 0.60 *Adjustments for capitalizing operating leases affected the line items highlighted in yellow. 29 VII: WACC and Cost of Equity Calculation WACC Calculation Cost of Equity Average Cost of Debt D/D+E E/D+E Tax Rate WACC Cost of Equity Calculation 9.65% 4.08% 41.17% 58.83% 34% 6.8% Re = 9.65% Rf + 4.55% Beta * 0.85 Market Risk Premium 6% VIII: Financial Ratios ROE Profitability ROE Net Margin Asset Turnover Leverage Ratio Check: ROA Net Income Growth (YOY) Efficiency Gross Margin Operating Margin Wal-Mart Store Operating Margin Sam's Club Margin International Margin Other Total Liquidity Interest Coverage Ratio Current Ratio Quick Ratio Liquidity Leverage Ratio Debt/Equity Debt/Total Capital 2001 20.1% 3.3% 2.4 2.5 20.1% 8.1% 2002 20.1% 3.1% 2.7 2.4 20.1% 8.3% 6.0% 2002 22.1% 7.3% 3.5% 3.7% -0.3% 5.4% 2002 15.7 1.02 0.15 2002 2.4 53.4% 30.9% 2003 21.4% 3.5% 2.6 2.4 21.4% 8.9% 19.2% 2003 23.2% 7.5% 3.2% 4.9% -0.6% 5.7% 2003 24.8 0.93 0.15 2003 2.4 49.8% 29.7% 2004 21.8% 3.5% 2.6 2.4 21.8% 9.0% 13.8% 2004 23.4% 7.4% 3.3% 5.0% -0.5% 5.8% 2004 31.7 0.91 0.17 2004 2.4 46.1% 28.2% 2005 22.1% 3.6% 2.5 2.4 22.1% 9.1% 13.4% 2005 23.9% 7.4% 3.4% 5.3% -0.5% 6.0% 2005 28.7 0.90 0.17 2005 2.4 47.9% 28.9% 2006 21.9% 3.6% 2.4 2.5 21.9% 8.7% 9.4% Adjusted 2006 21.5% 3.5% 2.3 2.7 21.5% 2001 22.4% 7.9% 3.5% 3.0% -0.1% 5.9% 2001 15.3 0.92 0.13 2001 2.5 49.9% 28.5% 8.1% 7.5% Adjusted 2006 2006 24.1% 24.1% 7.3% 3.5% 5.3% -0.5% 5.9% 2006 28.0 0.90 0.19 2006 2.5 56.7% 33.2% 6.0% Adjusted 2006 22.2 0.89 0.18 Adjusted 2006 2.7 70.0% 41.2% 30 0.5 0.5 1.5 2.5 1 2 3 0 1 2 1.5 2.5 0 2/23/1996 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 Relative P/E (1-Yr Forward) Relative P/CF 0.5 0 1.5 1 2.5 2 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 3 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 2/23/1996 2/23/1997 2/23/1998 2/23/1999 2/23/2000 2/23/2001 2/23/2002 2/23/2003 2/23/2004 2/23/2005 2/23/2006 Exhibit IX: WMT’s Relative Valuation Ratios (to S&P 500- SP5A) Relative P/S Relative P/BV 31