Wal-Mart and Target.doc

Name_Xiaodan Dong_ Acct 7310 Final Exam: Spring 2008 (due Wednesday, May 14th at midnight)Wal-Mart and Target A. During the presentations, each group recommended Wal-Mart over Target as a preferred investment (based only on the groups specific topic). Describe, with examples from each groups presentation, evidence supporting Wal-Mart compared with Target. Group topics:Revenue Recognition Policy and Current AssetsGroup 1 summarized ways how Wal-Mart and Target recognized revenues and provided some ratios, such as current ratio and quick ratio for assets comparison. Targets current ratio (1.605) was higher than Wal-Marts (0.9002) in 2007. Targets quick ratio (0.8915) was higher than Wal-Mart (0.1973) in 2007. Both ratios indicate Target is more liquid than Wal-Mart. Wal-Marts working capital deficit was due to efficient use of cash in distributing earnings to shareholders and funding operations. Also Group 1 compared two companies in “number of days in the collection period”. It turned out Wal-Mart collected accounts receivable faster than Target. Thus, Wal-Mart is recommended for potential shareholders and Target is recommended for potential debt holders.Inventory and Cost of Goods SoldGroup 2 introduced the general COGS and inventory information. Both companies use perpetual inventory system and LIFO. Inventory turnover, number of days in selling period, gross margin percentage, and COGS/net sales were compared. Wal-Mart (inventory turnover=8.05) was more efficient to turnover inventory than Target (inventory turnover=6.93), and had lower gross margin (23.4%) than Target (31.8%) in 2007. However, Wal-Mart had a higher (76.6%) COGS/net sales ratio than Target (68.2%) in 2007. It means that Target cost less to bring in revenue. Group 1 concluded that Wal-Mart turned inventory over faster with a lower mark-up and managed inventory more efficiently.Stockholders EquityGroup 3 provided shareholders equity key statistics in market capitalization, outstanding shares, share prices, share ownership, and payouts, etc. Wal-Mart had a higher return on equity ratio (19.7%) than Target (18.4%), and a higher equity ratio (40.7%) than Target (34.4%) in 2007. It means Wal-Mart earned more on equity than Target. Wal-Mart outperformed Target in size and equity distribution, share prices and payouts, ownership, revenue, gross profit growth, retained earnings, and stockholders equity ratio, while Target had a higher gross profit percentage and operating margin. DebtGroup 4 introduced types of debt of Wal-Mart and Target and how much long term debt and interest the two companies will pay and paid in 2007. Wal-Marts total debt/equity ratio (1.45) was lower than Target (1.91), and its long-term debt/equity ratio (0.50) was also lower than Target (0.99). Wal-Mart had a higher (8.38) times interest earned than Target (8.15). According to Moodys ratings, Target had a long-term rating of A2, Wal-Mart had a rating of Aa2 which is better than Targets rating. Group 4 concluded that Wal-Mart had better financial flexibility and long-term healthier debt.Long-Lived AssetsGroup 5 summarized some significant events that may have influence on long-lived assets and accounting policies used for long-lived assets, such as straight ling depreciation method. Wal-Marts property, plant, & equipment average age (4.89 years) was greater than Target (4.38 years) in 2007. Wal-Mart had a higher efficiency ratio (4.23) than Target (2.76) in property, plant & equipment use. Wal-Mart had a higher return on total assets (2.24) ration than Target (1.56). Group 5 concluded that Wal-Mart is more efficient in operating and more effective in generating earnings.BWhat issues made this comparison challenging for your particular group (or other groups)? Describe at least three issues, and how these issues contributed to the challenge of comparing Wal-Mart with Target and the industry.1. When we found Target had an increase in return on equity ratio and a significant decrease in equity, we figured out the decrease from the retained earnings, while Wal-Mart had an increase in retained earnings. We tried to find out why Targets retained earnings decreased so much. One of the reasons is that some of the earnings went to community benefits. However, we believe there were some other reasons which might be capital restructure or some investors were leaving.2. We had difficulty in finding industry average data, such as equity ratios and return on equity ratios, for the comparison between the two companies and the industry. We used , but its information is limited, so our comparison between Wal-Mart, Target, and the industry still had some limitation.3. When group 2 was comparing the two companies and the industry, they encountered the similar challenge as above. The information about inventory and COGS of the industry was too general and vague. Competitors have different specializations, such as food or apparel, so different specialization will have very diverse inventory and COGS. Thus it is difficult to compare the two companies with the industry which has too much diverse information.C.What features of the financial statements helped to make the comparison easier for your particular group (or other groups)? Describe at least three features, and how these features contributed to making the comparison easier.1. The financial statements also include the historical records of the past a couple of years. When we are doing evolution self-comparison research on those statements, we dont have to look for other copies of the past two years. It also helps us check the companys development trend in a chronicle manner.2. The balance sheets have totaled sections, assets, liabilities, and shareholders equity. This feature helped us calculate some ratios comparable between companies, such as current ratio and debt ratio. 3. Income statements record where the expenses went, such as cost of sales, selling expenses, depreciation, etc. This feature can help us judge which company is more efficient in operating.D.In judging the soundness of Wal-Mart alone, determine whether any of the following occur. Then answer these questions. (I have provided some comparative numbers for all three financial statements, and the financial statements themselves, at the end of this exam, but you may also refer to the presentation handouts or Wal-Marts 2008 annual report.)1.For each one that occurs, go to Wal-Marts annual report, and find out how Wal-Mart explains the occurrence (look in the Letter to the Shareholders, Managements Discussion and Analysis, and the Notes to the Financial Statements). 2.For each one that does not occur, explain why it might raise a “red flag,” that would need to be further investigated. (Give examples of explanations that could cause you to think less of Wal-Marts soundness.) Revenue and earnings growing at different rates, or moving in opposite directionsWal-Marts revenue grew at the rate of 8.6%, while the net income grew at the rate of 12.8%. The net income growth is faster than revenue growth. It means that Wal-Mart increased its operation efficiency by reducing the cost of sales, operating, selling general and administrative expenses, etc.If revenue increase, but earnings decrease, it means the company has operating efficiency problem with a high operating cost which is eating off the revenue. If revenue decrease, but earnings increase, it means the company is not running very well, and probably is selling some property. Net income and cash flows from operating activities moving at materially different rates or in opposite directionsWal-Marts net income grew at the rate of 12.8%, but cash flow from operating activities grew at the rate of 2%. It is a red flag for Wal-Mart indicating that Wal-Mart is not collecting cash fast enough. Official management explanation would be needed on this cash flow issue. Accounts receivable and/or inventories growing much faster than sales, or in opposite directionsWal-Marts accounts receivable grew much faster than sales. It means Wal-Mart had difficulty in collecting its money back. However inventories grew slower than sales, which means Wal-Mart was more efficient to manage its inventory than before. Excessive use of “other” for material, unexplained itemsIt means the company wants to hide something, but Wal-Marts financial statements have a reasonable use of “other”. Borrowings growing faster than assets being financed; debt rising when assets are decreasing.Wal-Marts liabilities grew a little bit faster (9.9%) than assets (7.9%) in 2007. It means Wal-Mart was using borrowing money to fund some operation. This rate is acceptable, especially if the operation is funded for a long run. If debt rises, but assets decrease, it means a company is making money and use borrowing money to fund its operation. This is a red flag for a company. Financial statement notes obscure, rather than enlightenThis sign would be a red flag. It means the company probably wants to hide something that cannot be explained to the public, or the statement notes are disorganized due to the personnels irresponsibility. Wal-Mart has very clear notes in the financial statement notes. Large fluctuations or steady decline in cash flows from operating activities over timeWal-Mart did not have a large fluctuation or steady decline in overall cash flows from operating activities in 2007. However, there are some items changed a little unsteadily, for example, increase in accounts payable was much lower than 2006, and other operating activities expense was much lower than 2006. They may indicate previous investment in operating expense has a long run effect and reduces later expense. If a company would have large fluctuations or steady decline in cash flows from operating activities over time, we need to look into whether the company bought property/equipment for a long-term development or sold property/equipment before bankruptcy. Change in top company managementWal-Marts top management group is very stable and had great experience in retailing industry. We would expect Wal-Mart to develop steadily and healthily. If there is a change in top management group in a company, we would look into how much successful experience the executives have in the industry to predict a companys future. Key financial ratios indicating deteriorating trends According to the presentations in the class, Wal-Mart had healthy or acceptable ratios in all aspects, such as debt ratio, current ratio, and return on equity ratio, except that current ratio and quick ratio were lower than Target and turned to be less liquid than Target, but they were still acceptable, especially Wal-Mart generates enough cash from operating activities every year to cover debts as needed. Declining operating income when debt is risingWal-Mart did not have this sign. This phenomenon indicates a company is using the debt to fund operation, and it does not make money. Large increase in treasury stockWal-Mart does not have treasury stock issued in 2007.Large increase in treasury stock indicates a company wants to have shares available to issue for employee-purchase plans, or to issue in conversion of convertible preferred stock, or to use for the acquisition of other companies, or to reduce the number of shares outstanding, increasing earnings per share and helping to maintain the market price of the stock, or to defend against hostile takeovers.E.Read the Letter to the Shareholders (included below). What is the most positive information that you learned about Wal-Mart and what is Wal-Marts biggest challenge?The most positive information is that Wal-Mart had a good increase in earnings per share which was $3.16, and that the company is achieving its mission of saving people money so they can live better. The challenge is that the company still has to improve operations and merchandising management. Thats why Wal-Mart is still working on its management group improvement by internal promotion and external recruitment.A departure from Wal-Mart and Target. Wal-Mart states in its Notes to the Financial Statements that its inventory valued at LIFO approximates the value of the inventory if it were valued at FIFO. Therefore, I am asking you to leave Wal-Mart and think about ExxonMobile. The following is public information about ExxonMobiles profits during 2006 and 2007 from a website that reports on corporations and from the notes to ExxonMobiles 2007 financial statements. Explain the effect of the LIFO method on ExxonMobiles profit. Be sure to explain the effect of “inventory accumulations and drawdowns” (what do you think is happening?), as well as the LIFO contrast with FIFO.The website, AccountingWEB.com, said the following about oil prices and profits on August 14, 2006 :“Last weeks drop in oil prices resulting from the terrorist plot against airliners bound for the U.S. is likely to prove temporary, as economists predict continued escalation in global demand for fuel. And U.S. oil giants are expected to enjoy healthy profits, some of which are protected from taxation because the companies record their inventories based on the Last In First Out (LIFO) method, a tax benefit designed to protect cash flow in industries where prices increase rapidly.“Efforts in Congress to repeal the provision failed twice last year, but discussion of repeal continues in Senate Finance Committee hearings on broad tax reform, and news that Exxon recorded the highest LIFO reserve in history, $15.4 billion, has prompted charges that the company seriously understated income for the second quarter, according to the Wall Street Journal.”ExxonMobiles 10-K filing with the SEC for the year 2007 reported the following in its Notes to the Financial Statements:3. Miscellaneous Financial InformationIn 2007, 2006 and 2005, net income included gains of $327 million, $401 million and $215 million, respectively, attributable to the combined effects of LIFO inventory accumulations and draw-downs. The aggregate replacement cost of inventories was estimated to exceed their LIFO carrying values by $25.4 billion and $15.9 billion at December31, 2007, and 2006, respectively.ExxonMobile used LIFO to record the last units purchased as the first units sold. When prices ri