Analysis of Bond Issued

By Wal-Mart Stores

Table of Contents

  1. Introduction
  2. Company Background
  3. Balance Sheet
  4. Trends in YTM & Price
  5. Purpose of Offering & Financial Leverage
  6. Credit Rating
  7. Rate of Return
  8. Comparisons
  9. Comments
  10. References

Introduction

The purpose of the report is to select a company which would have issued bond in last three years. The Wal-Mart Stores had issued $1.75 billion worth bonds in April 2013; therefore the company was selected to complete the report.

The basic information about the company has been provided which includes nature of business, types of products, size of business and other general information.

The change in bond price during the period of April 13 to Jan 14 was found and then its inverse relationship with yield to maturity was presented. The rating of the bond and its impact on the financial position of the company has also been discussed.

The weighted average cost of capital of the company has been calculated which is based on the capital structure of debt and equity financing. The cost of equity has been calculated using the capital assets pricing model.

Finally, the importance of the project and its value has been discussed.

Company Background

Wal-Mart Stores, Inc. was founded in 1945. The company is located at Bentonville, Arkansas. It was listed on New York Stock Exchange in 1972. Its symbol is WMT and it is traded at around $75 per share at present. It belongs to service and discount variety stores. It has around 2.2 million full time employees. The board of directors of the company comprises of 17 members. It is the largest retailer among all retailers. The company has three segments and they are US, International and Sam Club. Total sales for the year ended January 31, 2013 are around $469.5 billion and 60% of total revenues come from US segment. The company is customer oriented; therefore it works on very low profit margin, thus set a low price of each product. Though, its main business is retails stores and discount stores but it also has other businesses such as restaurants, supermarkets, super centers, hypermarkets, warehouse clubs, apparel stores, neighborhood markets and other small formats including walmart.com and samclub.com. The products range of the company includes meat,, bakery, dairy, frozen foods, alcoholic and nonalcoholic beverages, and floral and dry grocery; health and beauty aids, baby products, household chemicals, paper goods, and pet supplies; and electronics, toys, cameras and supplies, photo processing services, cellular phones, cellular service plan contracts and prepaid service, movies, music, video games, stationery, automotive accessories, hardware and paint, sporting goods, fabrics and crafts, and seasonal merchandise; pharmacy and optical services, and over-the-counter drugs; shoes, jewelry, accessories, and apparel for women, girls, men, boys, and infants; and home furnishings, house wares and small appliances, bedding, home décor, outdoor living,horticulture products, tobacco, tools and power equipment, office supplies, office and home furniture, grills, gardening products and mattresses, etc. The company has around 11000 stores in 27 countries and e-commerce Websites in 10 countries. The company had raised its borrowing by around $1.5 billion in 2013, against the investment in fixed assets amounted to $12 billion, it shows that the company has relied on cash flow from operating activities of around $26 billion.

Balance Sheet

In April 2013 the company had issued bon worth $1.75 billion with a maturity period of 10 years, therefore the quarter used are for the period ended April 13, July 13 and October 13. The April 13 is the period in which bonds were issued therefore it is considered before the issue of bond and the other two quarters are after issue of bond. The following table will help in knowing the impact of issuance of bond as the data was used by

Oct. 13 / July 13 / ; April 13
EBITA / Interest Expense / 21.50 / 18.67 / 15.26
EBITA Margin / 11.15% / 9.58% / 7.62%
Debt / EBITDA / 10.19 / 11.10 / 14.53
Debt / Book Capitalization / 1.68 / 1.62 / 1.67
Operating Margin / 5.50% / 5.83% / 5.70%
Revenue in Billions in $ / 115.7 / 116.9 / 114.2

The ratios are very important for the rating of the company, in April 2013, the rating which would have been provided on the basis of April 2013 data, definitely the rating would have been improved afterwards, as most of the ratios have improved or no significant change except for debt to earnings before interest taxes depreciation and amortization. The EBITA to interest expenses improved from 15 times to around 22%, it shows that company has more earnings to meet the interest expense by end of October 2013 as compared to April 2013. The EBITA margin has also improved drastically from around 8% to 11% in six months by the end of October 2013. The Debt to EBITDA has gone down from around 15 times to 10 times due to more debts by the company, which shows increased financial leverage but the company has also utilized it effectively to generate more EBITA margin. The debt to book capitalization, the operating margin and the revenues are stable during the six months period and the changes in these ratios are not very significant.

Trend in YTM and Price

The Wal-Mart had issued bonds in April 2013 with maturity period of 10 years and amounted to $1.75 billion, the coupon rate is 2.55%; interest is paid on semiannual basis, with a face value of $1000 each, the bond was sold for around $914, with a yield to maturity of 3.60%. As the bonds were issued in April 2013, therefore the price and yield was not available last six quarter, therefore four months data starting from October 13 to January 14 was available, and it has been used for analysis purpose.

Month / Prices / YTM
Oct 13 / $ 925 / 3.45%
Nov 13 / $ 931 / 3.40%
Dec 13 / $ 922 / 3.50%
Jan 14 / $ 930 / 3.40%
/
931 / 925

The above analysis shows that the price and the YTM has inverse relationship, as the prices are increasing the YTM is going down. It is quite apparent that when price increased between Jan and Nov, the YTM declined and then the YTM increased between Nov and Dec, when price declined.

Purpose of Offering & Financial Leverage

In billions in $ / April 13 / July 13
Operating Income / 6.5 / 6.8
Interest / 0.57 / 0.6
EBT / 5.93 / 6.2
Financial Leverage / 1.096 / 1.097

The financial leverage of the company shows the effectiveness of the debt financing, as the interest cost is fixed, when the debt increased in the quarter ended April 2013, the financial leverage also increased, but not very significantly. It was around 1.096 at the end of quarter ended April 13, while it increased to around 1.097, it means that if the operating income increased by 5 percent, the increase in earnings before taxes will be around 1.1 times or 10% higher than the operating income increase, and it will be around 5.5% increase in earnings before taxes.

If the cash flows statement for the quarter ended April 13, is analyzed it is very clear that company had issued bonds or raised long term debt mainly to finance the purchase of fixed assets which is shown by cash used for investing activities amounted to around $3 billion. The total borrowing of the company was around $5 billion while the payment old debt was around $1 billion and the investment in fixed assets was around $3 billion, therefore remaining $1 billion would have been sued by the company either to pay the dividends or purchase of treasury stock.

Credit Rating

The major credit rating agencies in USA are Moody, S&P and Fitch. The rating by moody comprises of Aaa, Aa, A, BAA, BA, B, Caa, Ca and C. The Aaa to Baa falls into the investment grades, while other grades are for speculative purposes. The other two agencies use AAA, AA. A and BB ratings to evaluate long term credit risk and BB, CCC, CC, C and D ratings for speculative purpose. To further categories the rating the Moody uses numbers like A1, Aa2, etc, while other two company adds plus or minus sign against the original rating such as AA+, BB-, etc. The sequence of rating is according to risk involved in a security to be issued by the company. The higher the rating the lower the risk, but definitely, if the risk is on lower side the return will also be on lower side. Therefore the risk is compensated by return; the security with lower rating will be providing higher return.

Most of the rating company looks into the earnings power and ability to meet the debt obligation of the company. In addition the stability in the financial position is also one of the major criteria which determine the rating of the company. The major financial metrics are ability of the company to use assets and debt to generate earnings, which are enough to make payment of interest and dividends to shareholders. The company also looks at the relationship of debt to equity financial to judge the financial leverage of the company. If the stability in revenuesis earnings are met, then it is good for the health of company.

The Moody is expected to rate the company as Aa2. The financial statements of Wal-Mart suggests that the rating is justified as the company has problems in debt to earnings before interest taxes depreciation and amortization ratio and also the company financial leverage has increased, but due to stability in revenues and heavy generation of operating cash flow would have provided the rating to Wal-Mart.

Rate of Return

In April 2013, the bonds were issued at a discount price of $914 and today’s current price is around $930, the company would also have paid interest of $12.75 in October 2013. The total numbers of months are around 10 months since April 2013; the rate of return earned is calculated as follows:

Current Price / $ 930.00
Purchase Price / $ 914.00
Capital Gain / $ 16.00
add Interest / $ 12.75
Total Return / $ 28.75
Return for 10 Months / 3.15%
Annualized Rate / 3.77%

The above rate of return is better than YTM of 3.45% at present. Moreover the rate of return has been calculated assuming no tax, but if the tax rate is around 10% on all types of income, the rate of return would be 3.77*1-.1 = 3.39% per annum.

If the tax rate on capital gain and interest would be different than the net rate of return would be as follows if tax rate on capital gain is 25% and 10% interest.

Total Return / $ 28.75
Tax on Capital Gain / $ 4.00
Tax on Interest / $ 1.28
Net Return / $ 23.48
Return for 10 Months / 2.57%
Annualized Rate / 3.08%

It is quite apparent that the annualized rate of return is affected by the period of holding the investment and the tax rate, higher the tax rate the return will be on lower side.

Comparisons

Oct 13 / April 13 / Difference / % Change
Earnings Per Share / $1.14 / $1.15 / -0.01 / -0.87%
Total Equity in billions / $78.5 / $75.8 / 2.7 / 3.56%
Cost of Debt
YTM / 3.45%
Average Tax Rate / 31%
After tax cost of debt / 2.38%
Cost of Equity (CAPM)
Risk Free Rate / 0.0275
Market Risk Premium / 0.0975
Beta / 0.29
Required Rate / 5.58%
WACC / Market Value / Weight / Cost / WACC
Bonds / 53.20 / 0.180004 / 2.38% / 0.43%
Equity / 242.33 / 0.819996 / 5.58% / 4.57%
295.53 / 1 / 5.00%

The above analysis shows that there is no significant change in EPS, while the total equity has increased by around 3.56%. It can be concluded that the issuance of bond in April was not big in ratio as compared to total long terms borrowing of the company therefore it has not affected the earnings to much.

It can also be concluded that as the beta of the company is quite low therefore the cost of equity is also around 5.58%, showing a difference of around 3.2% between cost of debt and cost of equity, if the beta would be greater the cost of equity would be on higher side.

Due to heavy weight of cost of equity the WACC is on higher side, if the debt financing would have higher market value, the WACC would be on lower side.

The WACC of 5% can be used as rate of discount to determine the net present value of investment in projects.

Comments

The project helped me in knowing about the largest retail stores chain’s financial position. It provided me the information about various types of business in which the Wal-Mart is involved. It shows the diversification strategy of the business to spread the risk by investing in various kinds of business.

The project also helped me in knowing the various aspects of bonds issue. It provided me the understanding of difference between interest rate and yield to maturity. It helped me in knowing the relationship of changes in market price of bonds and YTM, which is always an inverse relationship.

It provided me the understanding of rating criteria and meaning of various kinds of rating by various rating agencies such as Moody, Fitch and S&P. Various financial information and financial metrics being used by the rating agency was also understood.

It helped in learning the calculation of weighted average cost of capital. The cost of debt is admissible for tax purpose, therefore the tax shield is available on it and the cost of equity has no tax advantage.

It helped in knowing the impact on financial position of the company before and after the issue of bonds. If the issuance of bon is not significant in proportion to existing long term debt, the then the changes in financial position is not significant.

The main two characteristics of the project are information and research. The project was very informative and research was done to derive data for various calculation, analysis and conclusions.

References