Analysis of Wal-Marts Capital Structure

2021-05-24 14:51:22
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Wal-Mart is a multinational retailing corporation with headquarters in the United States. The company operates hundreds of departmental stores and supermarket chains in several countries across the globe. Founded in the 1960s, Wal-Mart has grown steadily over the years to become the largest and most profitable retailer in the world (Lichtenstein 2009, p. 9). Wal-Marts capital structure is a mixture of debt and equity. By definition, equity capital is a financing option available to a company in which capital is obtained through the issuance of stock to the public. Equity is also obtained through accumulated earnings to which a companys shareholders have claims (Kieso, Weygandt and Warfield 2007, p. 1317). For several years, equity capital has been the largest and most important component of Wal-Mart's capital structure. At the beginning of 2016, Wal-Mart's shareholder equity stood at $83.7 billion (Wal-Mart Stores Inc. 2016).

The $84 billion can be broken down into capital accumulation in excess of par value at $1.8 billion, $318 million capital worthy of common stock, $90 billion worthies of retained earnings, and $3.1 billion worth of nonredeemable interest and accumulated a comprehensive loss of $11.6 billion. As shown in the companys financial statements, the $83.7 equity capital at the beginning of 2016 was a significant reduction from the previous years $85.9 billion mark. Although several factors played a major role in this reduction, the accumulated comprehensive loss accounted for the greatest reduction. In January 2014, the accumulated comprehensive loss stood at $3 billion, increasing to $7 billion at the beginning of 2015 and $11.6 billion at the beginning of 2016. The figure is projected to increase in the next five years, chiefly due to currency translations. On the positive side, the corporations retained earnings increased steadily from $76.6 billion at the beginning of 2014 to $90 billion at the beginning of 2016. Wal-Marts retained earnings are projected to continue growing in the next five years (2016-2020) (Wal-Mart Stores Inc. 2016).

Debt financing refers to the use of financial instruments that do not give shareholders any claims to a companys profits but entitles them to compensation through interest (Kieso, Weygandt and Warfield 2007, p. 1321). Common debt instruments include bank loans and bonds. Wal-Marts long-term debt stood at $38.2 billion as at January 2016. Also, the retail giant has short-term debts of short-term debts (consisting of current maturities and short-term borrowings) totaling to $5.4 billion. Therefore, Wal-Marts total debt financing in January 2016 was $43.6 billion. Notably, Wal-Marts long-term debts financing comprises of unsecured notes denominated in different currencies such as the US dollar, Japanese Yen, Euro and British pound. The maturities of these notes range from 2017 to 2040 and bear interest rates of up to 5.3% (Wal-Mart Stores Inc. 2016).

Analysis of Wal-Marts financial statements reveals that the corporation had a total debt of $53.6 billion and $47.3 billion at the beginning of 2014 and 2015 respectively. Compared with 2016s $43.6 billion, it is apparent that Wal-Marts use of debt has been decreasing over the three year period. This is an indication of positive financial performance during that time, although it is not clear whether the reduction in debt financing will be sustained in the long term owing to the volatile nature of the retail industry (Barstow 2012, p. 19). Wal-Marts proceeds from the issuance of long-term debts reduced significantly from $7.1 billion in the financial years ending in January 2014 to $39 million for the financial year ending in January 2016. This shows that Wal-Mart has not been raising funds through new debts as notes mature (Wal-Mart Stores Inc. 2016).

Closely related to the ideas of debt and equity financing is the concept of financial leverage. It describes the extent to which a company uses debts to finance its business operations (Ehardt and Brigham, 2008, p. 132). Financial leverage can be measured in terms of debt to total capital ratio. The ratio is obtained by dividing debt by the combined book value of debt and equity. As of January 2016, Wal-Mart had a debt to equity ratio of 34%, down from 36% and 40% in the respective years 2015 and 2014. The steady reduction in debt ratio is reflective of the companys stable financial performance over the years (Chandran 2009, p. 32).

In terms of credit ratings, Wal-Marts debt has been rated investment grade by various credit rating agencies. Standard & Poor has currently rated Wal-Marts long-term debt AA. Moodys has rated it Aa2, which is only two points below the highest possible rating awarded by the two agencies. Wal-Marts strong cash flow history, geographic diversification, market capitalization, portfolio diversification and positive debt history are some of the factors that influence the positive credit ratings. All these favorable ratings indicate a high probability that Wal-Mart is capable of meeting its debt servicing obligations in a timely manner (Brea-Solis, Casadesus-Masanell and Grifell-Tatje 2012).

Wal-Marts low debt ratio serves the company in terms of risk management. High debt financing comes with some restrictions, which may prevent a company from taking advantage of opportunities that lie outside the core business (Hicks, Keil and Spector 2012, p. 311). The low debt ratio is attractive to creditors and thus Wal-Mart does not stand any risk of losing its market value. The ratio indicates that the company is capable of repaying major debt obligations and even securing new ones as need arises. Since the debt to equity ratio has been decreasing over the past three years, it is evident that Wal-Mart is being financed from its financial sources rather than creditors. Thus, shareholders are assured of stable earnings with minimal risk of volatile revenue.

Wal-Marts view of risks and return is that only investments with good returns and manageable risks can be explored. It is for this motive that the business has been expanding steadily into riskier but profitable markets in Latin America and Europe (Wal-Mart Stores Inc. 2014). In Mexico for instance, there are high market risks because of the increasing competition in the retail industry. However, the Mexican market looks profitable, and thus Wal-Mart continues to open new stores in the country. The corporation is also expanding its business into Asian countries such as India where the market appears attractive (Matusitz and Reyers 2010, p. 252).

Analysis of Wal-Marts Financial Performance and Overall Approach to Managing Stakeholders Expectations

This part presents an analysis of Wal-Marts financial performance as at the fiscal year ending January 2015. During the three years period (January 2014 to January 2016), Wal-Marts sales revenue increased steadily from $476,294 million in 2014 to $ 485,651 in 2015 and then $482,130 million in 2016. Clearly, this shows that the company has been performing well in terms of sales. During the same period, operating income increased from $26,872 million in 2014 to $27, 147 million in 2015. It then declined to $24, 105 million in 2016. Accordingly, net income increased between 2014 and 2015 but decreased in 2016 (Wal-Mart Stores Inc. 2016). One of the most imperative aspects of financial performance is a price-earnings ratio. This ratio compares a companys share price to earnings per share and is a fundamental variable used in valuing stock performance in any industry (Wal-Mart Stores Inc. 2016). During the year ending January 2016, Wal-Marts price earnings ratio stood at 13.2. This ratio is significantly lower than that of rival retailers such as Costico whose price-earnings ratio was 28.1. At 13.2, Wal-Marts P/E suggests that the company is doing well financially and that it is still an attractive spot for investors. The companys shares do not appear to be overvalued based on this ratio. The 13.2 P/E ratio is indicative of good returns for Wal-Marts shareholders (Bergdahl 2004, p. 19).

Price to book ratio is another important indicator of financial performance. This ratio describes a companys market value during a particular period and dictates what the companys shareholders have committed to own the company. As such, price to book ratio is an indicator of the true value of a company. A price to book ratio of less than 3 is ideal, especially for large companies such as Wal-Mart. In January 2016, Wal-Marts price to book ratio stood at 2.4, which compares favorably to Costcos 6 and Targets 3.1. (Target and Costco are some of the biggest competitors of Wal-Mart in the retail industry). Wal-Marts book ratio is reflective of a reasonably good value for shareholders (Wal-Mart Stores Inc. 2016).

Another important ratio in financial analysis is a return on equity. This ratio compares a companys net income to shareholders equity. For-profit motivated organizations such as Wal-Mart, return on equity is a good indicator of how efficiently the management team and leadership are performing vis-a-vis the stated mission objectives. Potential investors are always interested in seeing that management can push equity into profitable earnings. Therefore, a higher return on equity can go a long way in attracting investors. Wal-Marts return on equity currently stands at 18.6%, which is far greater than the 10% threshold recommended by financial analysts. During the past three years, Wal-Mart has maintained a health return on equity of above 10% (Wal-Mart Stores Inc. 2016).

The current ratio is also an essential aspect in financial analysis. This ratio measures the ability of a company to service current debts (debts that mature in less than a year). The ratio is obtained by comparing current liabilities to current assets (only those assets that can be converted to cash within a year). A current ratio of 1 is preferred for the most company regardless of the industry or nature of business. Wal-Mart has a current ratio of 0.92 (January 2016). This ratio is slightly less than one meaning that the company should reduce its liabilities to give confidence that it does not have any problems paying debts (Wal-Mart Stores Inc. 2016).

The debt-equity ratio compares total debts to equity. As explained in the previous section, Wal-Mart has a debt to equity ratio of 34%, which has been decreasing in three straight years. This ratio is healthy for Wal-Mart and shows that the company is capable of meeting any debt commitments. Wal-Marts low debt ratio is a reflection of the companys strategic objective of maximizing returns on investment for shareholders and minimizing business risks. With a low debt ratio, the company is not under any major obligation to repay the profit acquired from equity financing. Essentiality, Wal-Marts shareholders, want the company to be successful and provide good returns on their investments (McWilliams 2009). This can only be achieved through a lower debt-equity ratio. As debt notes mature, Wal-Mart is relieved of the burden of interest charges or having to make regular payments. The companys preference for higher equity financing than debt means that there are little monthly payments to clear debts. Therefore, Wal-Mart has higher capital at its disposal to invest in business expansion and other corporate strategies.

Wal-Marts gross profit margin for years ending January 2015 and January 2016 was 24.4% and 24.36% respectively. At the same time, the net profit margin was 3.26% and 3.42% for 2015 and 2016 (Wal-Mart Stores Inc. 2016). These figures indicate that operating expenses for Wal-Mart have been modestly high, although slightly lower than the industry average. The high operating expens...

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