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Walmart Inc's Overview

The successful control of the Covid 19 epidemic resulted in greater consumer confidence and an immediate surge in consumer spending all across the world. Food services, transportation, and amusement services were among the primary industries that benefited from this expansion. The global unemployment rate has also decreased dramatically, while consumers have reaped the advantages of increased incomes growth. All of this adds up to a favorable indicator for retailers in the future. In the year 2022, the US economy is predicted to rebound, with GDP rising by roughly 3.5 percent (Deloitte 2022). Consumers' real personal income is predicted to rise during the current year as a result of fewer health concerns and more employment opportunities. The services sector is predicted to rise, whilst demand for durable goods is expected to drop, despite the category's robust growth in 2020-2021. While the effects of the covid-19 epidemic continue to cause problems for customers throughout the world, better global conditions have provided merchants with some clarity, allowing them to simplify their expectations. With an increase in expenditure, merchants anticipate a shift in consumer spending behavior in their favor. Revenue and profit growth are likely to continue to improve. Retailers have implemented a variety of techniques that are appropriate for the current scenario, such as eliminating underperforming stores and giving promotional incentives that have boosted and will continue to enhance retailer profitability (Fuller 2022).

Walmart Inc is a multinational supermarket chains which also operates discount stores, departmental stores and hypermarkets under the name of the brand. Groceries, consumables, health and wellness items, technology, office, and other leisure products are among the many products offered by the firm. Consumers may also purchase hardlines, clothes, and other home categories at exceptionally low costs from the firm. Equate, Mainstays, Bonobos Fielder, George, Onn, Parent's Choice, No Boundaries, and Wonder Nation are among the company's own labels and licensed brands. Money orders, prepaid cards, wire transfers, money transfers, cashing, and bill payments are among the company's other services. Canada, Africa, Central America, China, Mexico, and India are all places where the firm has a presence (Britannica.com 2022). The corporation is headquartered in Bentonville, Arkansas, in the United States. The company owned as many as 10,500 shops and clubs which have a presence in across 24 countries as of January 31 2022. As per the Fortune Global 500, the company was regarded as the world’s largest company in terms of revenue with a revenue of $548.74 billion. In 1972, the firm was listed on the New York Stock Exchange, and by 1988, it had risen to become the largest retailer in the United States. The company had a mixed bag of results in terms of profitability in regions outside the United States, as the company had witnessed success in Central America, South America and China whereas it had suffered losses in countries like Germany, Japan and South Korea (money.cnn.com 2022).

The goal of valuing an equity is to estimate the fair market value of a company's shares, which will aid an investor in evaluating an investment opportunity. To arrive at a choice, users of valuation methods compare the price indicated by equity valuation techniques to the observed market value of the stock (Pinto 2020). Dividend Discount Model, Free Cash Flow Model, Comparable Company Approach, and Residual Earnings Method are some of the most popular stock valuation procedures, each with its own set of assumptions and valuation processes (Pinto, Robinson and Stowe 2019). The free cash flow model and the Residual Earnings Model were the two methods utilized to value Walmart Inc shares in this study. The models are explained below with the set of assumptions and process explained:

Walmart Inc's Presence Globally

The DCF model is one the most frequently used and famous equity valuation technique in the financial world. The model is based upon discounting the expected future free cash flow values of a company using an appropriate discount rate which represents the cost of capital of the company including debt and equity. Unlevered cash flow before debt capital payments, as well as free cash flows available to the company's equity owners and debt holders, will be shown as discounted free cash flows (Fernandez 2019). The DCF model uses the information published in the annual reports published by the company which includes net profit amount, depreciation amount, interest expense, capital expenditure, change in net working capital and others (Weber 2018).

The following section demonstrates the different aspects and parts of the DCF model in a comprehensive manner:

  • Free Cash Flows – The cash available to the firm after adjusting for the cost of liabilities both externally and internally is known as the Free Cash Flow of the company. In other words, the amount which is available to the company’s management to pay off its interest on the debt capital and dividend amount on the equity capital. There are multiple ways in which the Free Cash Flow of a company can be estimated (Buus 2015). The Cash flow from operations of the Walmart Inc for the year 2019 and 2020 were accumulated from the statement of cash flows of the company. The capital expenditure amount made by the company in 2019 and 2020 were subtracted from the Cash Flow from Operations to arrive at the Free Cash Flow of the firm  
  • Terminal Value – Terminal value can be defined as the value of the company on the basis of a constant growth at the end of the valuation period. In the DCF method of valuation, the terminal value represents a major chunk of the value hence it becomes important to forecast the terminal value appropriately based on sound assumptions. The long-term growth rate is the key element to look out for estimating an appropriate terminal value. In this case, we have used the EV/EBIT exit multiple method to forecast the terminal value of the firm. The average EV/EBIT multiple of four peer companies which included Amazon, Costco, Kroger and Home Depot, were multiplied with the current EBIT of the Walmart Inc to arrive at the terminal value. The company's terminal value was assessed to be $480,693 million, which was added to the free cash flow for 2020.
  • Discount rate – The most primary requirement from a discount rate is to accurately reflect the cost of capital that the company experiences for the debt and equity capital in its capital structure. The Weighted Average Cost of Capital serves the purpose appropriately as it considers the cost of capital for both equity and debt. For this case, the interest expense of the company for the year was assumed to be the cost of debt of the company in percentage terms (Budhathoki and Rai 2020). The after-tax cost of debt of the company after taking into considerations the interest cost was equal to 7.42% based on the tax rate calculated using the financial statement of the company for the year 2018. To value the cost of equity, the Capital Asset Pricing Model was used with the assumptions discussed as follows: 

Risk free rate – The risk-free rate was equal to 2.90 percent and it represented the bond yield on US government bond with a maturity of 10 years. 

Market premium (9.20%) – S&P 500 index returns for the last 10 years represented the market premium of the company 

Beta – The beta of the stock was adopted from freely available data on website like yahoo finance and it was equal to 0.55.

Taking into considerations the above factors, the WACC was calculated to be equal to 6.65%. The DCF model estimated the firm's value to be $451,807.41 million, translating to an intrinsic value per share of $153.12 after accounting for the number of outstanding shares, which was 2950.70 million in 2018.

The residual earnings approach is a model which is not much prevalent amongst investors and users of financial statements as the method of valuing a company’s equity. The model states calculating the residual income of a company after adjusting the cost of capital of the company with the net profits of the company (Huang 2015). The adjustment made in the net profits is called the equity charge which is based on the cost of equity. The model is based on the assumption that the net profit of the company does not fully reflect the profit to the shareholders as it does not adjust for the charge of equity capital. Since dividends paid are not deducted from a company's net profit, the idea is that net income is generated after incorporating the cost of debt in the form of interest expense, but not the cost of equity. As a result, a company's positive net income is immaterial because it may not be delivering value to its stockholders once it has been adjusted with the amount of dividend that is going to be paid. The approach estimates residual income, which is then discounted with the cost of equity, using all of the essential information from the company's financial records. Following that, the method is similar to the DCF valuation technique, which involves determining the terminal value and discounting it using the cost of equity. The key benefit of the residual earnings technique is that it may be used to value enterprises if the DCF model cannot be utilized owing to the possibility of future negative cash flow (Budagaga 2017).

Revenue and Profit of Walmart Inc

The CAPM model was used to ascertain the cost of equity of the company, which has an assumption that the stock return of a company is only exposed to the systematic risk factors as unsystematic risk factors can be easily diversified across sectors and industries. The similar method and assumptions of DCF valuation technique were used to calculate the cost of equity in residual earnings method of valuation. The following table represents the calculations and components of Residual Earnings for the year 2019 and 2020.

The company's cost of equity was used to discount the residual income for 2019 and 2020, as well as the terminal value, which was determined using the exit multiple approach. The firm's worth was assessed to be $435,699 million, which translates to $147.66 per share when converted into intrinsic value per share. The company's book value per share, which was $27.39, and adding to the intrinsic value per share, resulting in a total value per share of $175.05.

The following table compares the IV of the stock obtained from two methods with the market observed values of the stock at the end of 2018:

To arrive at an appropriate stock price combining the suggestion of both the methods, we had assigned an equal weight to the methods. The final stock price estimated using an equal combination of each method was equal to $169.19. The intrinsic value of the stock is significantly higher than the observed market price of the stock at the end of the year 2018. This implies that the stock of the company was significantly undervalued. Recently in the beginning of April 2022, the stock price of the company converged with the intrinsic value of the company as estimated at the end of 2018. The current value of the company’s stock is equal to $156.86 which still is undervalued and an investment in the stock can be made.

The company's credit quality was reasonably strong, as indicated by a credit rating of AA from Fitch Ratings. The corporation did well in the year thanks to its dominant retail position and a whopping $500 billion in revenue. Due to a consistent financial strategy, the firm saw a positive retail sale with a significant quantity of cash flow and an incredibly low level of leverage. In 2018, the firm continued to priorities growing areas such as China and India, which allowed it to maintain a steady stream of cash flows and remain profitable through a variety of monetization tactics. The company's credit situation was further strengthened by Fitch maintaining an AA grade and a stable outlook. In the year 2019, the firm concentrated on strengthening the technology component of client handling and the company's supply chain. The company's EBITDA has been steadily improving over the last several years, and this trend was expected to continue in 2019. The company's working capital management has improved, resulting in increased cash flows. The company's debt level increased in 2019 as a result of funding the Flipkart purchase, which was offset by utilizing FCF to reduce debt. As a store in the year 2020, the firm saw higher sales and was able to weather the effects of the corona virus pandemic since customers needed to acquire vital general merchandise products. The corporation did not suffer any liquidity concerns due to a large cash position of over $15 billion and a commercial paper programme that sustained the company's activities.

Equity Valuation Methods

This section is focused towards assessing the credit risk of the company for the years starting from 2018 till 2020 with the help of liquidity, long-term solvency and operating profitability ratio:

The current ratio measures the ability of a firm to meet its immediate liquidity requirement which can include paying of the short-term debt obligations and production related expenses. A current ratio more than 1.5 is considered to be extremely healthy. As presented in the table below, it can be seen that the current ratio of the company has been extremely low in the year 2018. Although the liquidity went on to improve slightly in the year 2019 reaching at 0.80, it is still significantly below the optimal level of current ratio. The company would struggle with issues related with liquidity and it may not be able to meet its debt obligations which are short term in nature.

Particulars

2018

2019

2020

Current ratio

0.76

0.80

0.79

The time series plot of the company’s current ratio is shared below, which graphically represents the current ratio of the company:

As it can be seen the current ratio of the company has risen slightly in the year 2019 from a level of 0.76 to a level of 0.80. The current ratio of the company was maintained going forward in the year 2020 with a value of 0.79. The slight jump in the liquidity of the company from 2018 to 2019 can be attributed to an increase of cash and cash equivalent of the company and the accounts receivables. The long-term debt that were due within one year also witnessed a significant fall in the year 2019 resulting in a rise of the company’s liquidity as suggested by the current ratio.

The solvency ratio is a valuable tool for determining a company's capacity to retain solvency and pay off long-term debts using the assets it owns. Creditors frequently use the ratio to analyses the company's financial situation in terms of repaying the loan in the future. Interest coverage ratio and debt to equity ratio are the two solvency measures that will be used to assess the company's solvency.

The interest coverage ratio is a ratio which is useful in measuring the ability of a firm to pay the interest of its long-term interest-bearing debt. To ascertain the coverage ratio, we need to divide the EBIT of the company with the amount of interest expense for that particular year. The table below represents the interest coverage ratio of the firm for the year 2018-2020:

Particulars

2018

2019

2020

Interest coverage ratio

9.38

10.31

8.53

The interest coverage ratio indicates a very healthy operating profit margin which is sufficient for meeting the interest cost of the company for a particular year. The ratio was around 9.38 which means the company had 9.38 times more funds to meet the interest expense of that year. The ratio went on to improve in the year 2109 to a value of 10.31. The coverage ratio fell by a big margin in the year 2020 reaching to a level of 8.53 due to the impacts of covid-19 pandemic on the company’s financial performance.  

Discounted Cash Flow Model

For the years 2018 to 2020, the debt to equity ratio was computed using the company's long-term borrowings and equity capital. The debt to equity ratio compares the amount of debt a firm has to the amount of equity capital it has. The ratio calculates how much each unit of stock funds the company's assets. With a rise in the debt to equity ratio of a company, the risk element in the company rises. The table below represents the debt to equity of the company for the three years.

Particulars

2018

2019

2020

Debt to Equity ratio

0.37

0.55

0.54

The company had minimal level of debt as the company only has 0.37 units of debt with 1 unit of equity in the company. The debt level in the company witnessed a rise in value in the year 2019 reaching of which was maintained in the year 2020. The following is the time series graph of the debt to equity ratio of the company:

Operating profit margin assesses the company’s profit without adjusting for charges like interest and tax. The profit of the company after adjusting the variable cost from the revenues earned is called the operating profit. The following table represents the operating profit margin of the company for the year starting from 2018 till 2020:

Particulars

2018

2019

2020

Operating margin

4.08%

4.27%

3.93%

The margin for the company has been at the lower level at 4.08% in the year which went on to rise slightly in the year 2019. The operating profit of the company witnessed a fall in the year 2020 with a value of 3.93 percent. The following graph presents the time series plot of the data for the three years:

After 2018, the company's revenue has increased each year, which is the key reason for the company's better operating profit margin in 2019. The modest drop in value was mostly due to an increase in the company's cost of sales in 2020.

Conclusion

The report’s primary goal was to find out the ex-post value of the Walmart Inc shares from 2018 to 2020 using financial data from the company's books. The study compares the stock's current market price to its theoretical fundamental intrinsic value at the end of 2018. The ex-post value of the company's shares was calculated using the DCF model and the residual earnings method. The intrinsic values provided by the DCF and Residual earnings methods were $153.12 and $175.05, respectively, which were greater than the stock's observed market price at the end of 2018. The study went on to talk about the firm's credit quality for the years 2018 to 2020. Due to the firm's robust balance sheet and minimal level of debt, it was discovered that the company did not have any substantial liquidity issues. The report's last section detailed the company's liquidity, solvency, and profitability as evaluated by several financial parameters. The corporation was discovered to have liquidity concerns, as evidenced by a low current ratio. The firm was sufficiently solvent since its coverage ratio was above average and it had little debt. The company maintained a stable level of profit margin and was able to withstand the impacts of the Covid 19 pandemic. 

References

(2022). Retrieved 24 April 2022, from https://www2.deloitte.com/content/dam/Deloitte/au/Documents/consumer-business/deloitte-au-cb-2022-retail-industry-outlook.pdf

Budagaga, A., 2017. Dividend payment and its impact on the value of firms listed on Istanbul stock exchange: A residual income approach. International Journal of Economics and Financial Issues, 7(2), pp.370-376.

Budhathoki, P.B. and Rai, C.K., 2020. The Impact of the Debt Ratio, Total Assets, and Earning Growth Rate on WACC: Evidence from Nepalese Commercial Banks. Asian Journal of Economics, Business and Accounting, 15(2), pp.16-23.

Buus, T., 2015. A general free cash flow theory of capital structure. Journal of Business Economics and Management, 16(3), pp.675-695.

Fernandez, P., 2019. Three residual income valuation methods and discounted cash flow valuation.

Fuller, A. et al. (2022) Retail Industry Trends for 2022 and Beyond | Silicon Valley Bank, Svb.com. Available at: https://www.svb.com/industry-insights/consumer-internet/retail-industry-trends-for-2022-and-beyond (Accessed: 24 April 2022).

Huang, J., 2015. A review of brand valuation method. Journal of service science and management, 8(01), p.71.

Pinto, J.E., 2020. Equity asset valuation. John Wiley & Sons.

Pinto, J.E., Robinson, T.R. and Stowe, J.D., 2019. Equity valuation: A survey of professional practice. Review of financial economics, 37(2), pp.219-233.

Walmart | History & Facts (2022). Available at: https://www.britannica.com/topic/Walmart (Accessed: 24 April 2022).

Weber, M., 2018. Cash flow duration and the term structure of equity returns. Journal of Financial Economics, 128(3), pp.486-503.

WMT - Walmart Inc Company Profile - CNNMoney.com (2022). Available at: https://money.cnn.com/quote/profile/profile.html?symb=WMT (Accessed: 24 April 2022).

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