We’re now in a position to apply the frameworks and techniques introduced in Chapters 1 through 13 through a comprehensive case study of the world’s largest retailer (as measured by revenues), Wal-Mart Stores, Inc. (Walmart). Based in Arkansas and founded by the legendary Sam Walton, Walmart has over 10,000 retail units worldwide, including stores in all 50 states and Puerto Rico, as well as in 26 other countries. The firm has more than 2 million employees and 200 million customers. Walmart is best known for its discount stores (Walmart Stores), but it also runs combined discount and grocery stores (Walmart Supercenters), membership-only warehouse stores (Sam’s Club), and smaller grocery stores (Neighborhood Markets). Walmart’s motto is “Helping customers save money and live better.” The firm is organized into three business segments:
Walmart U.S. includes the firm’s U.S. discount and grocery operations, as well as its online retail operation, walmart.com. As of the fiscal year ending January 31, 2012, Walmart U.S. accounted for 60 percent of the firm’s net sales.
Walmart International consists of retail operations in numerous formats, including retail stores, restaurants, Sam’s Clubs, and online retail operations outside the United States. As of January 2012, it made up 28 percent of the firm’s overall sales.
Finally, Sam’s Club consists of membership warehouse operations in 47 states and Puerto Rico, as well as the online operations of samsclub.com. As of January 2012, it accounted for 12 percent of Walmart’s net sales.
Fig 14.1 Financial Management Framework
In the spring of 2012, Walmart had just released its results for the fiscal year ending January 31, on which date its shares were selling for $61.36. Let’s see how we can use the frameworks and techniques described in previous chapters to do the following:
Assess current economic conditions.
Understand Walmart’s position in its industry and identify industry key success factors.
Assess Walmart’s strengths and weaknesses in terms of operations, marketing, and management, as well as the firm’s strategic focus.
Assess Walmart’s recent financial performance and overall financial health in terms of liquidity, resource management, capacity to issue debt, and profitability.
Determine Walmart’s profitability outlook and financing needs over the next year.
Assess the extent to which Walmart has been able to generate economic value added over the past year.
Assess the intrinsic value of Walmart’s shares relative to the current market value.
Identify possible ways by which Walmart can attempt to create value for its shareholders
Our first step, as discussed in Chapter 2 , is to gather information. Then, once we’ve compiled the appropriate information, our second step is to perform an analysis of the gathered data, as we’ll do in the following sections.
14.1 Sizing-Up Walmart
Objective 14.1
Describe economic conditions, the retail industry, and Walmart’s strengths and weaknesses in operations, marketing, management, and strategy, and assess Walmart’s financial health.
Let’s begin our analysis by assessing Walmart’s current business environment (as of the spring of 2012) through a size-up (or SWOT analysis) of external factors, including the larger industry and the economy as a whole. We’ll then continue our size-up by looking at Walmart’s internal strengths and weaknesses in the areas of operations, marketing, and management. Through this process, we’ll identify various opportunities and risks facing Walmart and the financial implications of each. Finally, we’ll assess the financial health of the firm through an analysis of financial ratios. Through these steps, we’ll put ourselves in a better position to meaningfully interpret Walmart’s financial information and performance.
14.1.1 Analyzing the Economy
As previously mentioned, one of the most important elements of our business size-up is an examination of external factors, including the overall economy in which Walmart operates. Of course, to better understand economic conditions in early 2012, we must first look back a few years. In doing so, we see that the United States suffered a major recession between December 2007 and June 2009. Then, from June 2009 until the spring of 2012, the nation’s economy entered a mild recovery stage, with 2010 real GDP growth of 3.0 percent and 2011 real GDP growth of 1.7 percent. This overall growth in GDP was fueled primarily by increases in personal consumption and exports. Still, decreased federal spending meant that the growth rate in 2011 was lower than that in 2010. According to the International Monetary Fund’s World Economic Outlook for the United States in the spring of 2012, there were signs of expansion in employment, but there was also continuing weakness in the housing market and potential negative spillover from economic problems in Europe. Inflation had been muted, but there was the possibility of an increase in inflation due to higher oil prices. Real GDP growth for the United States in 2012 and 2013 was forecast at 2.0 percent and 2.5 percent, respectively, indicating average expected growth relative to historical growth rates. Globally, real GDP growth in 2012 and 2013 was expected to be similar to that in 2010, around 4 percent.
Early 2012 was also a period of political uncertainty, due to both the upcoming presidential election in November and the perceived gridlock in Congress as Republicans and Democrats disagreed on major fiscal issues. In the area of fiscal policy, long-term government bond yields had dropped by around one-and-a-half percentage points since the beginning of 2011. Borrowers were benefitting from lower rates, and the yield curve was strongly upward sloping. Despite low long-term rates, short-term treasury bill rates were also near historic lows. Here, the Federal Reserve had aggressively pursued lower short-term rates in hopes of spurring economic growth, which in turn would lead to higher employment. Consumer confidence had improved substantially over the past several years. According to the Thomson Reuters/University of Michigan Index of Consumer Sentiment released in February 2012,1 although consumer confidence was still well below historical averages, a marked improvement had occurred in the prior twelve months.
1 See Richard Curtin, “Job Growth Maintains Consumer Confidence,” Survey of Consumers, Thomson Reuters University of Michigan, February 24, 2012, http://thomsonreuters.com/content/financial/pdf/i_and_a/438965/2012_2_24_job_growth_maintains_consumer_confidence.pdf is no longer online (accessed May 30, 2013).
Key Economic Take-Aways
The key take-away from our size-up of overall economic conditions in early 2012 is that the U.S. economy was expected to grow at a moderate rate, with moderate inflation. Continued low interest rates would help drive consumption and keep firms’ borrowing costs low. Given the importance of the consumer sector to overall GDP, the retail sector, and firms like Walmart in particular, any potential strengthening in consumer confidence would have a positive impact on the economic outlook and on retail businesses. In fact, world-wide economic outlook was cautiously optimistic—which was positive news for global firms such as Walmart.
14.1.2 Analyzing the Industry
Now that we have a basic understanding of general economic conditions in the spring of 2012, let’s consider the other major external factor affecting Walmart: industry conditions. Walmart is in the retail industry and considered a general merchandise store, but it also competes against grocery stores and has an increasing Internet retail presence. What sorts of trends did experts observe in these industries, and what was their forecast for the coming year?
To begin to answer these questions, let’s consider a 2012 report in which the consulting firm KPMG surveyed top retail industry executives about current business conditions, growth opportunities, and barriers to growth. The title of this report summarized the overall results: “Retail Industry Outlook Survey: Modest Gains Keep Cautious Optimism in Style.”2 According to the report, the executives were not expecting a substantial U.S. recovery until 2014, although two-thirds were expecting improved business conditions in 2013. Adding customers was anticipated to be the largest driver of revenue growth, followed by retaining customers and market expansion. One of the biggest concerns expressed by the executives was a possible decrease in consumer confidence. Increases in merchandise costs and discounting were seen as the biggest threats to profits, whereas decreases in selling, general, and administrative (SG&A) expenses were viewed as the best strategy to combat those threats. Retail firms included in the survey tended to have significant amounts of cash on their balance sheets, and most planned to increase spending on information technology (including data analytics), new products and services, and geographic expansion. Finally, online shopping trends were clearly on the executives’ radars.
2 See http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/retail-industry-outlook-survey.pdf (accessed May 30, 2013).
As part of our size-up, we can also consider the retail industry from a life-cycle perspective. If we consider revenue growth since 2002, we can make a strong case that the overall retail industry was in a phase of stabilization/maturity in early 2012, while the Internet retail industry was experiencing rapid growth. Based on this assessment, we can anticipate that any long-term growth in retail revenue will tend to occur at a similar rate as growth in the overall economy—with traditional retail revenue expected to grow slightly below the rate of the overall economy and the Internet retail revenue expected to grow at a higher rate than the overall economy.
The next step in our industry analysis is to consider Walmart’s competitive position. Although each country in which Walmart does business has unique economic, political, and social factors, the general competitive environment is similar. Recall Porter’s Five Forces model from Chapter 2, which identified five key contributors to the intensity of competition: the threat of new entrants, the threat of substitutes, the bargaining power of suppliers, the bargaining power of customers, and the intensity of rivalries among current competitors. These forces determine the overall profitability of an industry—but how do they affect the retail industry in general and thus relate to Walmart in particular? Let’s summarize in Fig 14.2.
Fig 14.2 Porter’s Five Forces for the Retail Industry
Fig 14.2 shows that there is little threat of new entrants to the retail industry, largely because of barriers such as large capital expenditures in plant and equipment as well as investments in distribution channels. There is also steady demand for both groceries and nonfood retail products, with no likely emergence of major substitute products. Suppliers appear to be numerous, so the bargaining power of suppliers does not appear to be a threat to profitability. Similarly, customers are individual consumers who do not wield major power, so the bargaining power of customers presents little threat. Rather, the largest potential impact on Walmart’s profit margins relates to the intensity of existing rivalries.
Walmart faces myriad competitors in a variety of segments in which it competes. In the general merchandise area, Walmart’s main competitors include Sears, Target, and Kmart, as well as specialty apparel retailers like Gap and Limited. Department store competitors include Macy’s and J. C. Penney. Grocery store competitors include Kroger and Safeway. The major membership-only warehouse competitor is Costco Wholesale; the major drug retailing competitor is Walgreens; and a prominent online competitor is Amazon. Although many of these competitors are formidable, Walmart dominates due to its ability to achieve many of the key industry success factors described in the “take-away” feature for this section, but it probably faces the largest threat in its online business segment.
Key Industry Take-Aways
Given the mature nature of most of the retail segments in which Walmart competes, long-term growth expectations for the industry as a whole should be similar to expectations for the overall economy (except the online retail segment, which is expected to grow at a greater rate). Thus, the overall industry outlook can be described as neutral. In other words, retail isn’t a growth industry, but it’s not expected to be in decline in the near future either. As a whole, the industry is anticipated to remain profitable. However, given the intense nature of existing traditional competition and the increasing threat of online competition, individual firms (including Walmart) may be challenged to grow their profits at the overall economic growth rate over the long term.
Based on our general knowledge of the retail industry and comments by research analysts, we can compile a list of key success factors. To succeed in the retail industry, firms such as Walmart need to strive to be the lowest cost producer, or they must somehow differentiate their products. In terms of groceries, given the commodity-based nature of the industry, product differentiation is difficult. In other retail areas, product differentiation may be possible, but price (and hence low costs) is a key success factor. Another key success factor is the ability of firms to deliver quality products. Both price and quality can be combined into value. Service is another important factor, including availability of products and post-purchase satisfaction. Developing a strong brand through marketing is also crucial. All of these key success factors have important financial implications. For example, a firm’s pricing strategy affects its profitability, and its management of cash flows is crucial to efficient operations. In addition, capital expenditures are required to maintain facilities and provide growth, and marketing expenditures must be maintained.
14.1.3 Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy
Next, an internal analysis of Walmart’s strengths and weaknesses in the areas of operations, marketing, management, and strategy will help us examine the firm’s ability to achieve industry key success factors. It will also help us better understand the financial analysis to follow.
14.1.3.1 Analyzing Walmart’s Operations
In terms of operations, Walmart has a clear strategy of being the lowest-cost, lowest-priced competitor in the industry. By reducing costs, Walmart can maintain its profit margin even with lower prices, thereby increasing market share and increasing overall profitability. In fact, Walmart is renowned for its efficiency of centralized distribution and inventory control. The firm strives to maximize sales volume and inventory turnover while minimizing expenses. Walmart relies on its suppliers to provide quality goods. However, between 2010 and 2012, it was involved in a number of product and food recalls.
14.1.3.2 Analyzing Walmart’s Marketing
Walmart dominates most of its markets and offers a strong assortment of brands and products. The company attempts to have a special relationship with its customers, from the time they walk through the doors until they make their purchases. However, early in 2012, Walmart eliminated its famous smiley-faced “Welcome to Walmart!” greeters from night shifts and moved them from its lobbies to nearer its cash registers—a hotly debated action that was interpreted by some as a cost-saving measure that deemphasized the importance of service and by others as a modernization of an outdated concept.
Walmart relies heavily on advertising to create a strong and recognizable brand. It spent $2.5 billion, or 0.5 percent of net sales, on advertising in the fiscal year ending January 31, 2012. During a similar period, Target, in comparison, spent 2.0 percent of its net sales on ads. Walmart’s marketing efforts emphasize the firm’s everyday low prices and attempt to capture a local connection with customers in particular communities while providing one-stop shopping. To meet competitive pressures, Walmart employs many programs, including “Everyday Low Prices” and “Price Rollbacks,” which pass along cost savings to customers.
14.1.3.3 Analyzing Walmart’s Management and Strategy
Although Walmart’s founder Sam Walton died in 1992, his family still has a strong presence in the firm. Together, members of the Walton family own or control just under 50 percent of Walmart’s outstanding shares. In addition, Walton’s son S. Robson Walton currently serves as chairman of the board. With the chairman of the board representing family interests in particular, there is a clear alignment between management oversight and shareholder control.
One of Walmart’s major strengths has long been its corporate culture, inspired by Sam Walton’s mission of saving people money so they could live better. Walmart’s management team works hard to achieve this mission and is often recognized for its efforts. For example, in Fortune magazine’s 2012 list of “most admired companies,” Walmart ranked twenty-fourth out of 1,400 firms, due in part to the perceived quality of its management.3
3 See list at http://money.cnn.com/magazines/fortune/most-admired/2012/full_list/ (accessed May 30, 2013).
According to the firm’s 2012 annual report, Walmart’s strategy for improving shareholder value emphasizes three priorities: growth, leverage, and return. Growth involves increasing sales through higher volumes at each “comparable” (i.e., same-size) store relative to the previous year, as well as increasing volume through greater square footage. Leverage refers to increasing operating income at a faster rate than growth in sales by increasing the firm’s operating, selling, and administrative expenses at a slower rate than the growth in net sales—in other words, by reducing operating expenses as a percentage of net sales. In fact, Walmart’s stated goal is to reduce operating expenses as a percentage of net sales (currently 19.2 percent) by at least a full point over the next five years. And last, Walmart defines return as efficient use of the firm’s assets. Walmart’s internal return on investment (ROI) measure is EBITDAR (the usual EBITDA measure, but with the additional R that represents rent) relative to invested capital. Management attempts to improve the firm’s ROI by both better managing free cash flow (thus increasing EBITDAR) and better managing working capital (thus decreasing the amount of invested capital).
Of course, a firm’s value isn’t solely driven by growth—it’s also driven by risk. But what sort of risks does Walmart face? Like other firms in the retail industry, Walmart could be negatively affected by any number of general economic factors, including inflation, consumer debt levels, currency exchange rates, trade restrictions, unemployment, and interest rates. The firm’s 10-K form lists several other common threats that could materially affect financial performance, including changes in the cost of goods; increased expenses (such as greater transportation, fuel, electricity, and labor costs); and competitive pressures that might force Walmart to sacrifice margin. In addition, management identifies a number of company-specific risks, including impediments to expansion (such as problems converting discount stores to supercenters); failure to retain qualified employees; competition from Internet-based retailers; supply risks and issues of product safety; regulatory, political, and economic risks that might affect the firm’s international operations; and failure to identify or effectively respond to consumer trends. Walmart is also involved in a variety of legal proceedings related to a compensation class action and a gender discrimination class action, as well as an internal investigation pertaining to potential violations of the Foreign Corrupt Practices Act.
Key Operating, Marketing, Management, and Strategy Take-Aways
Based on our reading of Walmart’s annual reports and 10-K filings, as well as comments by research analysts, we can reach several conclusions about the firm’s strengths. In terms of overall opportunities, Walmart’s size and dominant position give it tremendous clout relative to its competitors and allow it to pursue its successful low-cost, low-price strategy. In the United States, Walmart has the opportunity to increase its market share relative to its competitors in some of its key segments. Internationally, Walmart has made great inroads in many global locations, but it has room to grow.
Still, Walmart faces several significant threats. For one, the firm’s ongoing legal proceedings introduce the possibility of monetary fines or settlements, although the cost of these is relatively low. A far greater threat is the reputational damage these lawsuits may bring, with potential customer loss that could hamper future revenue growth. Yet another potential risk is that Walmart’s online retail efforts might cannibalize its regular store sales.
14.1.4 Analyzing Walmart’s Financial Health
Now, let’s begin our assessment of Walmart’s financial health by examining the firm’s 2011 and 2012 consolidated financial statements, presented in the figures on the next few pages. Walmart’s consolidated statements of income are presented in Fig 14.3, its consolidated balance sheets are presented in Fig 14.4, and its consolidated statements of cash flows are presented in Fig 14.5.
Upon examining the consolidated statements of income (Fig 14.3), we see that Walmart’s net sales in the fiscal year ending January 31, 2012, grew by almost 6 percent relative to the previous fiscal year, slightly better than nominal U.S. GDP growth. Income from continuous operations grew modestly by about 3 percent. However, due to losses associated with discontinuous operations, consolidated net income shrunk by over 4 percent. Earnings per share grew modestly at just over 1 percent due to Walmart’s share repurchase program, which reduced the number of outstanding shares. In fact, in fiscal year 2012, Walmart spent $6.3 billion buying back over 115 million shares.
Fig 14.3 Walmart Consolidated Statements of Income*
Source: Adapted from 2012 Walmart Annual Report.
Turning to Walmart’s consolidated balance sheets (Fig 14.4), we see that the firm’s assets grew by almost 7 percent. More specifically, its current assets increased by almost 6 percent, and its net property and equipment grew by about 4 percent. Also, the firm’s current liabilities and equity both grew by just over 6 percent, while its long-term debt grew by over 7 percent.
Next, as we examine Walmart’s consolidated statement of cash flows (Fig 14.5), we see that the firm’s cash provided by operating activities grew modestly by 2.6 percent. Walmart continued to invest heavily in capital expenditures (i.e., property, plant, and equipment) as well as in acquisitions. Consequently, Walmart’s net cash used in investing activities increased by 36 percent. Because Walmart’s cash provided by operating activities exceeded its cash requirements for investing, it could use this extra cash to pay dividends and also buy back some shares—spending a collective amount of over $11 billion on these two activities. Also, since Walmart’s net cash used for investing and financing exceeded its net cash from operating activities by just under $1 billion, the firm’s cash on hand decreased by that amount between 2011 and 2012.
Fig 14.4 Walmart Consolidated Balance Sheets*
Source: Adapted from 2012 Walmart Annual Report.
Now that we have an overview of Walmart’s three major financial statements, let’s examine its financial health through ratio analysis. A summary of important performance measures in the four categories of profitability, resource management, liquidity, and capacity is presented in Fig 14.6. After that, Walmart’s financial ratios for 2012 and 2011 are presented in Fig 14.7 (some numbers may appear to be off slightly due to rounding).
Fig 14.5 Walmart Consolidated Statements of Cash Flows*
Source: Adapted from 2012 Walmart Annual Report.
As shown in Fig 14,7, Walmart’s return on equity in 2012 was 22.0 percent, only slightly off 2011’s pace of 23.9 percent. Examining other profitability measures, we see that the firm’s gross margin was only slightly below that of the previous year, at 24.5 percent, and its EBIT margin was also only slightly lower at 6.0 percent. Its operating expense ratio was also slightly lower at 19.2 percent (compared to 19.4 percent the previous year), reflecting part of Walmart’s key “leverage” strategy described earlier. The firm’s net sales grew by 5.9 percent (from $418,952 million to $443,854 million), but its operating, selling, and administrative expenses increased by just 4.8 percent (from $81,361 million to $85,265 million). Looking at the figure, we also see that even though Walmart’s after-tax EBIT improved, its invested capital increased, resulting in a slightly lower return on invested capital measure.
Fig 14.6 Performance Measures Summary
Examining resource management ratios, we see a marginal improvement in Walmart’s fixed asset turnover, with revenue growth slightly greater than growth in net property and equipment. Inventory turnover was slower—reflected in an increase in the age of inventory. There was also a slight increase in the age of receivables. Although Walmart was able to marginally stretch its payments to suppliers, the overall gap—measured as the age of inventory plus the age of receivables less the age of payables—increased slightly. Consequently, Walmart was investing more in its working capital and needed to finance this investment.
We now turn our attention to Walmart’s liquidity ratios. Examining these figures, we see that both the current ratio and the quick ratio remained almost the same as the previous year, suggesting a steady position. The one concern is that these ratios are below 1, which means that in a forced liquidation situation, Walmart would have difficulty converting its current assets into cash in order to cover its current liabilities. However, given the extreme remoteness of liquidity issues at Walmart, we shouldn’t be too concerned. In fact, the ratios might suggest that Walmart is attempting to minimize any excess cash.
Finally, as we examine Walmart’s capacity or leverage ratios, we see little change over the past year. The firm’s debt-to-assets ratio remained the same, while its debt-to-equity ratio increased slightly. The long-term debt to capital ratio also increased slightly—from 42 percent to 43 percent—due in part to share repurchases but also due to an increase in both short-term and long-term borrowing as Walmart took advantage of favorable low interest rates. The management discussion presented in Walmart’s 2012 annual report notes that the debt-to-capital ratio is one particular ratio that management monitors because it can impact the company’s credit rating as well as its long-term financial decisions. Interest coverage decreased slightly but remained strong, whereas the firm’s debt service coverage—which also took principal repayments into account—improved substantially.
Fig 14.7 Walmart Financial Ratios*
A decomposition of Walmart’s ROE explains the slight decrease from 23.9 percent to 22.0 percent. As shown in Fig 14.8, Walmart’s profit margin slipped; its asset turnover or ability to “sweat its assets” remained stable; and its financial leverage increased slightly as the firm took on more debt while repurchasing shares. Because the profit margin decline was most prominent, the resulting ROE declined. Nonetheless, at 22 percent, the overall measure was still quite strong, indicating that Walmart created profits for its shareholders.
In-Depth Target Corporation: ROIC
Throughout this chapter, we provide an opportunity to compare Walmart with Target Corporation, one of its main competitors, albeit much smaller in size. Target describes itself as “an upscale discounter that provides high-quality, on-trend merchandise at attractive prices in clean, spacious and guest-friendly stores.” Target has over 350,000 employees and operates over 1,700 stores in the United States. The firm recently opened stores in Canada, and—like Walmart—it has an online business component. Target also offers branded proprietary credit and debit cards.
For the fiscal year ending January 31, 2012, Target’s EBIT was $5,322,* and its tax rate was 34.3 percent. Its short-term borrowings were $3,786, and its long-term debt was $13,697. In addition, the firm’s book value of equity was $15,821. Estimate Target’s return on invested capital or ROIC, then compare it with Walmart’s. Are you surprised at the difference?
* All amounts related to Target in this chapter are in millions of dollars, unless otherwise noted.
Fig 14.8 Walmart ROE Decomposition*
Key Financial Health Take-Aways
Overall, Walmart is in a strong financial position. Although its profitability ratios—gross margin, EBIT margin, and ROIC—were down slightly, the company was able to decrease its operating expenses and was still very profitable. Also, even though the firm’s financing gap increased slightly despite an increase in the age of payables, this gap was still very low, suggesting effective management of resources. Our review also shows that Walmart’s liquidity position (as captured in the current and quick ratios) is steady, its financial capacity is strong (with room for an increase in the long-term debt to capital ratio), and the firm is in a good position to service debt (with a very high interest coverage ratio).
In-Depth Target Corporation: ROE
For the fiscal year ending January 31, 2012 (2011), Target had total revenues of (in millions) $69,865 ($67,390) and net earnings of $2,929 ($2,920). Its total assets were $46,630 ($43,705) and its equity was $15,821 ($15,487). Estimate Target’s return on equity (ROE) for each of these two years, using the DuPont decomposition to indicate the profit margin, the asset turnover, and the firm’s financial leverage. Why has the ROE changed? How would you compare the ROE drivers for Walmart and Target?
14.2 Projecting Walmart’s Future Performance
Objective 14.2
Describe the process for projecting Walmart’s income statement and balance sheet.
Now that we better understand overall economic conditions, the industries in which Walmart competes, Walmart’s competitive position, and the firm’s strengths and weaknesses, we can examine Walmart’s future financing requirements through pro forma financial statements or projections. As we learned in Chapter 6, understanding a company’s current financial position is a springboard to projecting its future financial position.
According to Walmart’s 2012 annual report, the management team feels that it will be able to generate sufficient cash flows from operations and will be able to borrow short term in order to cover any seasonal increase in inventories as well as any other requirements for cash. In the unlikely event that such cash flows from operations aren’t also able to pay for dividends or planned capital expenditures, then management is confident it can rely on short-term borrowings and long-term debt. Let’s perform our own pro forma analysis to determine Walmart’s anticipated profits, as well as its anticipated borrowing needs.
14.2.1 Projecting Walmart’s Income Statement
We’ll start our projections with Walmart’s income statement. The firm’s pro forma income statement for the fiscal year ending January 31, 2013, is presented in Fig 14.9, along with the relevant assumptions. Given the previous year’s revenue growth of 6 percent, and considering what we learned through our industry and firm size-up analysis, Walmart’s revenues are anticipated to grow by a similar but slightly lower rate of 5 percent for net sales, as well as for membership and other income. Using this information, we can estimate costs and expenses in the coming year to arrive at Walmart’s projected operating income. Here, we assume a gross margin similar to the previous year at 24.5 percent of net sales, implying cost of sales at a 0.755 fraction of net sales. We also assume operating, selling, general, and administrative expenses similar to the previous year at a 0.192 fraction of net sales.
Now that we’ve estimated Walmart’s operating income, or EBIT, let’s consider interest and taxes. Based on information presented in the firm’s 2012 annual report, interest expenses are anticipated to be around 4.5 percent of beginning interest-bearing debt (i.e., short-term borrowings and long-term debt, including any long-term debt due within one year). Taxes are anticipated to remain at a similar percent as last year, at 32.6 percent of income before taxes. We assume there will not be any discontinued operations. We also assume net income attributed to noncontrolling interest is 4 percent of consolidated net income, a similar percentage to the previous year. Consequently, once we subtract the noncontrolling interest amount from the consolidated net income, we arrive at consolidated net income attributable to Walmart of $16,497 million.
Fig 14.9 Walmart Pro Forma Consolidated Statement of Income*
Finally, we want to estimate how Walmart’s retained earnings will change, since we need that information for our balance sheet projection. Dividends reflect management’s announced $1.59 per share for fiscal year 2013. If we multiply this amount by the 2012 weighted average common shares outstanding of 3,460 million, we get anticipated dividends of $5,501 million. Subtracting this amount from the consolidated net income attributable to Walmart results in an anticipated increase in retained earnings (after common share dividends) of $10,996 million. On the basis of shares currently outstanding, Walmart is anticipated to have earnings per share of $4.77. Given all of these assumptions, we are anticipating an increase in consolidated net income attributable to Walmart of 5.1 percent.
Key Pro Forma Income Statement Take-Aways
The major conclusion from our pro forma income statement analysis is that we anticipate Walmart to continue to be profitable, with a growth in profits in line with revenue growth, assuming the firm is able to maintain many of the same financial ratios as in the previous year.
14.2.2 Projecting Walmart’s Balance Sheet
Fig 14.10 Walmart Pro Forma Balance Sheet*
Now, let’s examine Walmart’s projected balance sheet. The firm’s pro forma balance sheet as of January 31, 2013, is presented in Fig 14.10. As shown in the figure, we anticipate that cash will be at a similar level as that of the previous year. We also anticipate that Walmart’s age of accounts receivable will be at a similar level as that of the previous year at 4.9 days of net sales, and its age of inventory will remain at 44.3 days of cost of sales. Additionally, we assume prepaid expenses will be at a similar level as the previous year and current assets of discontinued operations will be zero. Property and equipment reflect management’s anticipated increase in capital expenditures of around $13,500 million (as indicated in the 2012 annual report), to a total of $174,438 million. To estimate accumulated amortization, we start with the previous year’s accumulated amortization of $48,614 million, then add our estimate of next year’s amortization. We see that last year’s depreciation and amortization amount was $8,130 million (from the cash flow statement). Let’s assume that next year’s will be 5 percent higher, or $8,537 million. So the expected accumulated amortization is $57,151 million ($48,614 million plus $8,537 million). Consequently, we project Walmart’s net property and equipment to be $117,288 million and its total assets to be $200,613 million.
We can now proceed to the liabilities and equity portion of the balance sheet. Because we know that all balance sheets must balance, we note that the bottom-line total liabilities and equity amount must equal the total assets amount of $200,613 million. Recall that our goal is to identify what Walmart’s borrowing needs will be. As such, we will use the “short-term borrowings” item as the balancing item, after we’ve projected all the other balance sheet items. Let’s proceed “up” the balance sheet with the remaining items before looking more closely at Walmart’s short-term borrowing needs.
We begin our way up the balance sheet by assuming Walmart’s noncontrolling interest is the same as that of the previous year at $4,446 million. We then calculate shareholders’ equity as the beginning amount of $71,315 million plus our anticipated increase in retained earnings of $10,996 million, for a total of $82,311 million. Adding this amount to the noncontrolling interest (which is also considered equity, since it represents Walmart’s minority stake in other firms) gives us total equity of $86,757 million. Because we know the firm’s total liabilities and equity is $200,613 million and its equity is $86,757 million, the difference between these two amounts represents total liabilities of $113,856 million.
Our next objective is to continue proceeding “up” the balance sheet to arrive at total current liabilities. To do this, we first subtract from the total liabilities amount $404 million in redeemable noncontrolling interest (Walmart’s minority stake in other firms that it can redeem from the other firms at a fixed price), which we assume to be the same as that of the previous year. We then subtract $7,862 million of deferred income taxes, which we again assume to be the same as that of the previous year. Finally, we subtract $44,778 million of long-term debt (representing the previous year’s long-term debt of $47,079 million less the amount of $2,301 million that was previously due within one year). We are then left with projected current liabilities of $60,812 million.
Next, we estimate four of the five current liabilities items—saving short-term borrowings as our balancing item. We first assume Walmart’s current liabilities of discontinued operations is zero. We then assume that the firm’s long-term debt due within one year amount of $2,301 million is the same as that of last year. We also assume that the accrued liabilities and income tax amount of $19,318 million is the same as that of last year. Accounts payable days are anticipated to be the same as that shown for the previous year at 39.9 days, resulting in an accounts payable amount of $38,438 million. Subtracting these four amounts from the total current liabilities amount gives us our final balancing amount for short-term borrowings: $755 million. And we are done estimating next year’s balance sheet!
Key Pro Forma Balance Sheet Take-Aways
Our major conclusion from our pro forma balance sheet analysis is that we anticipate Walmart will require less in short-term borrowings than the current amount of $4,047 million, which is good news. We’ve projected that, if it chooses to do so, Walmart will have the ability to pay down both short-term borrowings and long-term debt. Of course, Walmart’s leadership could decide to increase dividends beyond the amount we’ve forecast; could continue to repurchase shares; or could decide to make acquisitions. The point is that Walmart is anticipated to be in a strong financial position next year—if our assumptions hold true. Accordingly, there isn’t any urgency to renegotiate larger loans or find additional sources of financing.
14.2.3 Examining Alternate Scenarios
We can now consider some alternate scenarios by performing sensitivity analysis on some of the key variables in Walmart’s financial statements. Let’s start by examining the impact of net sales on net income and short-term borrowings. Suppose, for example, that Walmart’s net sales increase by 10 percent over the previous year, instead of the 5 percent we’ve used in our analysis. Because of the higher forecasted sales, the consolidated net income attributable to Walmart increases by 5.2 percent over our base-case pro forma, going from $16,497 million to $17,357 million. Then, after we deduct anticipated dividends, the resulting increase in retained earnings leads to a decrease in required short-term borrowings, which drop from $755 million to just $397 million. Conversely, if Walmart’s net sales show no increase (rather than the 5 percent increase we used previously), then the consolidated net income attributable to Walmart decreases by 5.2 percent over our base-case pro forma, moving from $16,497 million to $15,638 million. In turn, the lower increase in retained earnings leads to an increase in required short-term borrowings, which rise from $755 million to $1,112 million. However, it appears that Walmart would have ample capacity to increase its borrowing.
Next, suppose Walmart is able to reduce its operating expenses by 0.2 percent, to 19.0 percent of net sales from the base-case 19.2 percent. Note that such a decrease in one year is consistent with Walmart’s five-year plan to reduce operating expenses as a percent of net sales by a full percentage point. The result of such a seemingly small change is substantial. Specifically, the consolidated net income attributable to Walmart increases by 3.8 percent over our base-case pro forma, from $16,497 million to $17,132 million. The increase in retained earnings also leads to a decrease in required short-term borrowings, which drop from $755 million to just $121 million.
Finally, suppose Walmart is able to improve its inventory management, thereby reducing its age of inventory slightly to 42.2 days—the same level as that shown in 2011—instead of 44.3 days. This change has no direct impact on the income statement. Rather, its only effect is on the short-term borrowings required, which are not only eliminated but result in an excess of available funds of $1,312 million, which could be used for purposes such as reducing long-term debt.
The results of each of these individual changes are summarized in Fig 14.11. Of course, there are many other possible scenarios we could consider in our sensitivity analysis. The likelihood of each of these outcomes and the particular variables on which to focus should relate back to our size-up analysis. For example, if we are not confident in our revenue projection—perhaps because of general economic uncertainty—then revenue is one key variable we might adjust. Similarly, since Walmart has a stated goal of reducing operating expenses, then operating expenses is another key variable on which we might focus.
Assumption
Net income attributable to Walmart
Short-term borrowings
Item
Base
Revised
Base
Revised
Difference
Base
Revised
Difference
Revenue growth
5%
10%
$16,497
$17,357
$860
$755
$397
–$358
Revenue growth
5%
0%
$16,497
$15,638
–$859
$755
$1,112
$357
Operating expenses
0.192
0.190
$16,497
$17,132
$635
$755
$121
–$634
Inventory days
44.3
42.2
$16,497
$16,497
$0
$755
–$1,312
–$2,067
Fig 14.11 Pro Forma Sensitivity Analysis*
*Dollar amounts are in $millions.
14.3 Assessing Walmart’s Long-Term Investing and Financing
Objective 14.3
Describe the process for estimating Walmart’s cost of capital.
We now examine issues related to Walmart’s need to raise long-term capital. As the company’s management notes in the discussion portion of the 2012 annual report, Walmart expected to be able to finance its international expansion through a combination of operating cash flows and borrowing. It is clear that Walmart will need to continually invest in the business through both capital expenditures and acquisitions. If our assumptions are reasonable (note that generating reasonable assumptions is one of the most critical aspects of pro forma analysis), we anticipate that Walmart will generate substantial earnings next fiscal year, two-thirds of which will be retained in the business, but it will also need to rely on external funding. As Walmart looks beyond the coming year, it will most certainly need to continue to invest and tap into capital markets on a regular basis. As such, we need to assess the magnitude of Walmart’s anticipated investments, as well as the firm’s ability to raise capital.
14.3.1 Assessing Walmart’s Investments
Currently, Walmart makes investments in a number of areas related to property and equipment, including new stores, expansions and relocations, remodels, information systems, and distribution. The firm also invests through acquisitions. In terms of numbers, Walmart made property and equipment investments of $12,200 million in fiscal year 2010, $12,700 million in fiscal year 2011, and $13,500 million in fiscal year 2012, with a similar level expected for fiscal year 2013. Acquisitions in fiscal year 2012 amounted to $3,500 million but were only $200 million in fiscal year 2011.
Investments in property and equipment are more predictable than investments in acquisitions, which tend to be more opportunistic. As such, it is important for Walmart to plan to continue to invest in plant and equipment in order to replace depreciating assets, but also to invest for growth. For example, the investments planned for fiscal year 2013 were expected to add over 45 million square feet of retail space. Such investments are reasonably predictable. On the other hand, given the opportunistic nature of acquisitions, it is important for Walmart to maintain financial flexibility to issue debt if and when such opportunities arise.
14.3.2 Assessing Walmart’s Capital Raising and the Cost of Capital
Given the vast amount of investments that Walmart must make each year, we need to examine the way in which the firm finances these investments and the cost of that financing—from both internal and external sources. Let’s examine these costs by estimating Walmart’s cost of capital. Recall from Chapter 10 that the cost of capital reflects the minimum return investors (and lenders) require, and it is a key driver of the overall value of a firm. Also recall that in order to estimate the overall cost of capital, we need to estimate Walmart’s cost of debt, its cost of equity, and the appropriate weights of each.
Based on information presented in Walmart’s 2012 annual report, the company’s borrowing costs are anticipated to be around 4.50 percent, reflective of the low interest rate environment. Taxes are anticipated to remain at a similar percent as last year: 32.56 percent of income before income taxes. Using this information, we can estimate Walmart’s after-tax cost of debt (kd) in the usual manner:
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Here, we should note that Walmart’s future borrowing costs depend on a number of factors. If economic conditions change—in particular, if the rate of inflation changes—then we can expect borrowing costs to change accordingly (for example, higher inflation will lead to higher interest rates). Federal Reserve monetary policy will also have a large effect on interest rates, with tighter monetary policy resulting in higher rates. Beyond these external factors, Walmart’s borrowing costs also depend on the credit rating it receives on its publicly traded debt, as discussed in Chapter 9 . In Walmart’s 2012 annual report, its chief financial officer stated that Walmart was pleased with its AA credit rating, which was the highest in the retail industry. The rating was interpreted as an indication of Walmart’s strong cash flows, its efficient working capital utilization and general sound financial practices. Later, the report noted that Walmart’s credit rating would impact on its ability to continue to issue commercial paper and borrow longer term at reasonable interest rates and terms. Our own assessment of the risks facing Walmart were discussed as part of our size-up process—but keep in mind that the credit-rating agencies use a similar process.
Although there are a variety of methods for estimating Walmart’s cost of equity [&(k_{e})&], including the capital asset pricing model (CAPM) approach, we’ll take a direct shortcut and utilize an estimate from one research firm that covers Walmart. According to this firm, Walmart’s cost of equity is 9.70 percent. Keep in mind how we should interpret this number. The cost of equity from an investor’s perspective reflects his or her expected return—both dividends and capital gains—from investing in Walmart’s stock. Recall from Chapter 9 that over the long term (since 1926), average stock returns have been around 10 percent. Of course, going forward, our expected stock returns will also depend on expected risk-free government bond returns at the time of our investment, plus whatever premium we would require for investing in riskier stocks.
Now that we’ve estimated Walmart’s cost of debt and cost of equity, we need to determine the appropriate weight of each component, which is meant to reflect how Walmart plans to raise capital in the future. Here, we’ll take the same approach as we did with Home Depot in Chapter 10 by estimating Walmart’s assumed target capital structure based on its spring 2012 market value weights. From Walmart’s balance sheet, we know the firm’s total interest-bearing debt (short-term borrowings plus long-term debt, including amounts due within one year) is $53,427 million. (Although this is actually a book value amount, we will assume it is similar to the market value of debt as well.) Given Walmart’s stock price in the spring of 2012 of $61.36 and the 3,460 million shares outstanding, the market value of its equity is $212,306 million. If we add the value of debt and equity, the estimated market value of the firm as a whole is $265,733 million. Given the relative amount of debt and equity, we arrive at our estimate of the weight of debt (wd) of 0.20 (or $53,427/$265,753) and the weight of equity [&(we) of 0.80 (or $212,306/$265,753). Finally, we estimate the overall weighted-average cost of capital [&(kc), or WACC, for Walmart as follows:
MathML removed
In-Depth Target Corporation: Cost of Capital
According to its annual report, as of January 31, 2012, Target’s borrowing costs averaged 4.6 percent, and its tax rate was 34.27 percent. A research report estimated Target’s cost of capital at 10.5 percent. The firm had interest-bearing debt of $17,483. Moreover, Target’s stock was trading at $50.81 per share, and there were 679.1 million shares outstanding.
Now, let’s assume Target’s amount of debt is also a market value estimate of the debt. Let’s also assume the current debt and equity values are at Target’s optimal capital structure. Based on market value estimates, what is Target’s cost of capital? How does it compare to Walmart’s, and what explains the difference?
14.4 Valuing Walmart
Objective 14.4
Describe the process for estimating Walmart’s economic value added and intrinsic value based on the discounted cash flow method and comparable analysis, and explain how Walmart can attempt to create value.
With the preceding information in mind, we can now estimate what we think Walmart is really worth, and we can also examine Walmart’s ability to add value for its shareholders. For our assessment of value added, we can measure Walmart’s most recent year EVA. For an overall assessment of value, including our expectation for the future, we rely on the discounted cash flow analysis approach presented in Chapter 13 , supplemented with relative value measures and comparable analysis.
14.4.1 Measuring Walmart’s Economic Value Added
Recall that EVA is a period measure that attempts to capture a firm’s ability to add value for shareholders, after accounting for the requirements of other stakeholders. We can use the EVA approach to examine Walmart’s true economic profit in 2012. Specifically, we can estimate Walmart’s net operating profit after-tax (NOPAT) as EBIT × (1 – tax rate). Note that we have implicitly assumed that the “accounting” costs from the financial statements are reflective of true “economic” costs. For 2012, Walmart’s EBIT was $26,558 million. Based on a 32.56 percent tax rate, Walmart’s NOPAT is $17,911 million.
Economic value added is calculated as the difference between NOPAT and the capital charge. Thus, we need to estimate invested capital (i.e., book value of debt plus equity) and multiply it by the cost of capital to get the capital charge. (For simplicity, we measure capital and cost of capital as of the end of the period, although an alternative measure could examine an average.) Walmart’s total interest-bearing debt (as calculated in Section 14.3.2) is $53,427 million. The book value of equity is $75,761 million, for a total invested capital of $129,188 million. The capital charge, estimated as the product of the invested capital and the cost of capital of 8.36 percent, is $10,800 million. Finally, EVA is calculated as the difference between NOPAT and the capital charge, or $7,111 million. Thus, for the fiscal year ending January 31, 2012, Walmart added considerable value for shareholders, far in excess of required or expected returns.
Our calculations are summarized in Fig 14.12, which also presents the alternative EVA estimation approach discussed in Chapter 13 . We additionally show the estimated market value added, or MVA, as the market value of the firm of $265,733 million less the invested capital of $129,188 million. The resulting estimated MVA of $136,545 million suggests that market participants feel Walmart is worth a substantial amount greater than the capital invested. One interpretation is that investors expect Walmart to continue to invest in positive net present value projects and continue to create value.
Fig 14.12 Walmart EVA and MVA*
In-Depth Target Corporation: EVA
Earlier, you were provided with the information necessary to estimate Target’s operating profit (EBIT) after-tax, also known as NOPAT; invested capital (the book value of equity plus interest-bearing debt); cost of capital; and market value of equity. Based on this information, estimate Target’s EVA for the year that ended on January 31, 2012. Was Target adding value? Did Target have a positive market value added or MVA? How did Target’s EVA and MVA compare with Walmart’s EVA and MVA?
14.4.2 Estimating Walmart’s Intrinsic Value: The DCF Approach
Given the firm’s positive MVA, which suggests market participants feel that Walmart is adding value by investing in value-enhancing projects, we can determine whether the current stock price reflects our estimated intrinsic value of Walmart’s stock. Specifically, we can apply the discounted cash flow analysis free-cash-flow-to-the-firm approach, described in Chapter 13 , to determine the per share value of Walmart stock based on our assumptions. Note that if our valuation assumptions are identical to the implicit prevailing market assumptions, then our estimate of the intrinsic value of Walmart shares should be identical to the prevailing market value. If the resulting intrinsic value estimate is greater than the market value, then we can conclude that the shares are undervalued. Our analysis is presented in Fig 14.13.
We start with the previously estimated cost of capital, which will be used as the discount rate for estimating the present value of anticipated cash flows. We next estimate annual cash flows for the next five years, using similar assumptions to our one-year pro forma financial statement analysis. We assume annual total revenue growth of 5 percent; an EBIT margin of 6 percent (similar to that of the previous year); 5 percent growth in depreciation (a reasonable assumption); working capital increases at a rate of 2 percent of the change in revenues (similar to changes over the past five years); a tax rate of 32.6 percent (same as that of the previous year); and $13,500 million in capital expenditures in fiscal year 2013 (as indicated by Walmart management); followed by a conservative 3 percent growth in capital expenditures. It is worth noting that we have intentionally assumed that in each year, capital expenditures are greater than depreciation, which is a critical assumption if a firm is growing.
For our final assumption, after five years, we assume a constant growth in free cash flows of 3 percent, used to calculate a terminal value (representing the value of all free cash flows beyond the fifth year). This terminal value growth estimate is meant to be conservative relative to the five-year growth estimate and relative to the long-term nominal GDP growth in the United States. We apply the growing perpetuity formula that incorporates the anticipated free cash flow in 2018 (labeled as FCF18 and estimated as the 2017 free cash flow multiplied by 1 plus the terminal growth rate of 3 percent), the cost of capital, and the terminal growth rate.
Next, we take the present value of each of the anticipated free cash flows—including the terminal value. Our resulting analysis estimates the present value of Walmart’s assets of $287.9 billion, which is our estimate of the intrinsic value of the firm as a whole. Given the current interest-bearing debt of $53.4 billion, the resulting estimate of the value of the equity is $234.5 billion. Given 3.46 billion shares outstanding, our estimated intrinsic value per share is $67.77, which is slightly greater than the spring 2012 price of $61.36, suggesting the shares are undervalued, based on our assumptions. Of course, as new information arrives in the marketplace causing a reassessment of our assumptions, we can expect the value of Walmart shares to fluctuate as well. The real value in this exercise of estimating intrinsic value is to enhance our understanding of what key factors might have a material impact on value.
14.4.3 Estimating Walmart’s Intrinsic Value: Comparable Analysis
As a check to our discounted cash flow (DCF) analysis, we can also estimate the intrinsic value of Walmart shares based on comparable analysis. In Chapter 13, we examined a number of alternative relative value approaches. Here, we focus our analysis on the enterprise value (EV)-to-EBITDA model, which involved two steps. First, we estimated the intrinsic value of the firm as a whole (EV0) as:
MathML removed
where the appropriate forward-looking EV/EBITDA multiple is based on an assessment of “comparable” firms in the same industry with similar growth prospects and risk, and EBITDA1 is the projected EBITDA next year. Second, we estimate the value of equity (VE) as:
MathML removed
where VD is the value of interest-bearing debt. We can then divide our estimated value of equity by the number of shares outstanding to arrive at our estimated intrinsic value. We present our analysis in Fig 14.14.
Fig 14.13 Walmart Discounted Cash Flow Analysis
We start with projected EBITDA from our DCF analysis projection in Fig 14.12: We add our 2013 projected EBIT of $28.1 billion and add projected depreciation and amortization of $8.5 billion. We then estimate an appropriate forward-looking EV/EBITDA multiple, which involves a bit of art and science. We obtained a number of investment research reports written on Walmart and examined reported forward-looking EV/EBITDA multiples for comparable firms, then averaged these across a number of reports, giving us 7.3. (If you don’t have access to such reports, then you can “do-it-yourself” by choosing a few key competitors to Walmart and projecting their EBITDA, then finding the EV/EBITDA1 ratio based on their current equity value and value of debt.) We then adjusted this average upward to 7.6, to reflect our size-up analysis that indicated Walmart would be deserving of an above-industry-average multiple given its strong market position, which translates into better growth prospects and less perceived riskiness relative to its competition. Note that the magnitude of this adjustment is more art than science. The value of debt and number of shares are the same as in our DCF analysis. The resulting intrinsic value share estimate of $64.99 confirms our DCF analysis that the shares may currently be modestly undervalued. We don’t expect our EV/EBITDA method intrinsic value estimate to be identical to our DCF estimate, but we do expect it to be in the same ballpark—otherwise, we need to question the consistency of our assumptions between the two models.
Fig 14.14 Walmart EV/EBITDA Valuation*
In-Depth Target Corporation: EV/EBITDA Analysis
Let’s suppose you forecast Target’s EBIT for the year ending January 31, 2013, to be $5,352, and you forecast Target’s depreciation and amortization to be $2,361. A research analyst determines that an appropriate forward-looking EV/EBITDA multiple for Target is 6.9 times. Based on this information, estimate Target’s enterprise value, or EV. Next, incorporating the value of Target’s debt, estimate the firm’s value of equity. Finally, based on 679.1 million shares outstanding, estimate the intrinsic value per share and compare it with Target’s stock price on January 31, 2012, of $50.81. Based on this analysis, is Target’s stock overvalued or undervalued?
14.4.4 Creating Value and an Overall Assessment of Walmart
Now that we have built our DCF and relative value models, we can complete our final task—identifying possible ways by which Walmart can attempt to create value for its shareholders. To do this, we can return to our DCF model. Let’s focus on the one particular target that Walmart highlighted in its 2012 annual report: reducing operating expenses as a percentage of net sales by 0.2 percent in each of the next four years. As a simplified estimate of the impact on our intrinsic value estimate, we reestimate our DCF valuation in Fig 14.13 by replacing our assumed EBIT margin of 6.0 percent in all five years with year-by-year EBIT margins as follows: 6.2 percent in 2013, 6.4 percent in 2014, 6.6 percent in 2015, and 6.8 percent in both 2016 and 2017. The resulting share price is $81.69—a substantial increase from our initial estimate of $67.77. We can see the dramatic impact of the change since Walmart competes in such a low-margin industry—meaning a small margin increase can have a huge effect. We can also appreciate why Walmart stresses the importance of cost efficiency and why it is such a key success factor.
Besides controlling costs, we know from our underlying theme throughout the book that there are two other ways by which Walmart and any other firm can create value. Recall our mantra that “Growth is good!” and “Risk is rotten!” Anything that will increase a firm’s projected free cash flows—both in the short term (in the next five years) and in the long term—will create value. This implies any combination of increasing revenues and decreasing costs. Thus, a reduction in the perceived riskiness of Walmart’s business should result in a lower cost of capital—investors will be satisfied with a lower return, which reduces the cost of equity, and lenders will also be satisfied with lower rates, resulting in a lower cost of debt.