In 2011, The Model Mill company created this post showing that there was no comparison between Target and Wal-Mart, with Wal-Mart dominating Target in every metric other than stock related metrics. This original post references the following Excel workbook, please download and open this workbook to follow along: TGT vs WMT Analysis.
Target Corp. (TGT) is a mid-quality department store, and Wal-Mart (WMT) is a lower-end department store. Both offer the same categories of merchandise, but Target is perceived as a higher grade of merchandise than Wal-Mart. Target’s slogan is “Expect More, Pay Less”, compared to Wal-Mart’s slogan “Low Prices. Every day. On everything.” Going beyond the slogan’s and perceptions, the financials will tell us the true story behind each of these company’s, at least from the perspective of the potential investor.
Let’s address these slogans upfront, and discover which of these two companies is truly the least expensive for their customer’s, and why, by looking at the two company’s income statement to discover the truth. Please refer to the worksheet called Common Size IS. This worksheet divides each of the company’s income statements by their revenue, thus creating a common size income statement for both companies. The revenue thus starts out at 100% for both companies (yellow), and we then subtract the cost of goods sold (COGS) from this to obtain the Gross Margin (orange). The initial view of these figures would suggest that Target is obtaining its goods at a lower cost than Wal-Mart, but we know this cannot be correct. Instead flip this notion around and say instead that Wal-Mart is charging its customers a lower sales price for its goods than Target, which means that its revenue on each good is lower, and its COGS would then appear to be higher. Factor in that Wal-Mart is probably paying a lower wholesale price than Target for its goods, and you can see that Wal-Mart must be offering its customers retail prices that are at least 8% lower than Target (i.e., assuming equal COGS, Wal-Mart’s revenue must be backed down 8% to balance out its gross margin).
Jumping down to the bottom of the income statement to the Net Income (green), we see that Wal-Mart is beating Target on its Profit Margin, but how can this be if they are charging their customers a lower price? The answer can be found in their SG&A expenses. Wal-Mart is approximately 19% lower in its SG&A expenses – this means that Wal-Mart has less overhead than Target, either in terms of less staff, lower salaries, or lower office expenses. Since the sales per employee are about the same between Wal-Mart and Target, this implies that it is salaries and/or office expenses that are higher at Target. Clearly Wal-Mart is a superior company in that it gives its customers lower prices, its investors higher net income, and runs its operations considerably leaner than Target. Note that Target’s credit card revenues were removed from its income statement for this analysis, as was Wal-Mart’s membership revenue, thus bringing both income statements to a purely retail level.
So why does Wal-Mart charge a membership fee, and why does Target ask you at the checkout “would you like to open up a Target credit card today?” Because Wal-Mart’s membership fee is essentially free cash to Wal-Mart and accounts for 19% of their earnings before tax (EBT), and for Target their credit card portfolio accounts for 41% of their EBT.
Applying the Three-Factor DuPont Equation to both companies (refer to the worksheet labeled DuPont – a future blog post will address the DuPont Equations in detail), we see that Wal-Mart’s Total Asset Turnover (TATO) is almost double that of Target’s, which means that Wal-Mart utilizes its physical assets much more effectively than Target. Target has more financial leverage (FL) than Wal-Mart, but their level of debt appears to be acceptable. Wal-Mart is generating higher returns for its shareholders than Target as can be seen by their 5-Yr average historical ROE of 21.4% versus Target’s of 17.7%, and this appears to be almost totally achieved this through better utilization of its assets, while Target achieved some of their ROE through financial leverage.
The under-utilization of physical assets becomes even more apparent if one compares the sales per square foot (SqFt) of floor space for both stores. Target has roughly $280 of sales per SqFt of floor per year, whereas Wal-Mart has 670 $/SqFt (refer to the worksheet called Floor Space).
For simplicity in this analysis, we assumed the average of the beginning and ending of the year for all balance sheet items.
A complete set of ratios were calculated for both Wal-Mart and Target, and compared – please refer to the worksheet called Ratios. Pictured below are the derived ratios with comments, for the majority of which, Wal-Mart is superior to Target:
From a profitability standpoint, Wal-Mart dominates Target across the board. And Target’s Return on Invested Capital ( ROIC) of 9% is barely above its Weighted Average Cost of Capital (WACC), meaning that it is barely providing its investor’s required returns.
In looking at liquidity, Wal-Mart’s strong Cash Conversion Cycle (CCC) of only 9 days allows it to enjoy minimal cash reserves on hand to cover its expenses. This is real cash that can be invested elsewhere and instead earning a return for its shareholders.
Debt levels are somewhat comparable between the two companies, but Wal-Mart is in a stronger position to pay its interest and lease payments due to its stronger operating cash flows.
Target compared to Wal-Mart is under-utilizing its assets, or phrased another way, has excess assets. Excess inventory, excess PP&E, large credit card receivables, and excess store space (as seen by its $ per SqFt sales being 34% less) all contribute to excess assets.
In terms of stock valuation and value created for the shareholder over time, both companies appear to be comparable. Despite this, based on the fundamental analysis above, Wal-Mart is a much stronger and financially secure company than Target, and should expect less volatility in its stock price because of this. This is definitely reflected in its beta which is currently 0.37 compared to Target’s which is at 0.95 (via Yahoo Finance). Assuming a market risk premium of 5.72% as per Damadoran on July 1st, 2011, and a current 30-Year US Treasury T-Bond yield of 4.198% on July 15th, 2011; these Betas equates to Cost of Equity values of 6.31% and 9.63% for Wal-Mart and Target, respectively.
A PDF of this post can be downloaded here.
©2018 Ben Etzkorn