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Fitch Affirms Walmart at 'AA/F1+'; Outlook Stable
October 26, 2017 / 7:15 PM / 24 days ago

Fitch Affirms Walmart at 'AA/F1+'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 26 (Fitch) Fitch Ratings has affirmed the ratings of Wal-mart Stores, Inc. (Walmart). The ratings reflect its massive scale, with over $485 billion of annualized revenue, dominant market share position, positive comparable store sales (comp) trend, strong cash flow, and consistent financial strategy which have resulted in stable leverage over time. The company's operational strategy is to lead on price, operate efficiently, and provide customers a convenient omni-channel shopping experience. Fitch projects revenue growth of 2%-3%, EBITDA margin in the mid-6% range, FCF (cash flow from operations less capex and dividends) of $7 billion-$8 billion (excluding working capital benefits), and total adjusted debt/EBITDA around 2.0x in both 2017 and 2018. See the full list of ratings at the end of this release. KEY RATING DRIVERS Massive Scale, Defensible Position: Walmart's ratings reflect the operational strength, financial flexibility, and strong cash flow profile that result from its substantial scale and dominant market position as the world's largest retailer and grocer in North America. Walmart generated $485 billion of sales in 2016 (year ended Jan. 31, 2017) and is maintaining market share despite increased competition from alternative discount and online-only players due to its price leadership and investments in its business. Sales trends at Walmart U.S., which represented 64% of revenue, have grown at a 3.1% five-year CAGR to $308 billion in 2016 while U.S. retail sales excluding autos and gasoline grew at a 3.7% CAGR to $3.3 trillion according to the U.S. Census Bureau. U.S. retail sales excluding autos, gasoline, and online sales grew at a 2.7% CAGR to $2.9 trillion (inclusive of data from comScore). Less than 5% of Walmart U.S.'s sales are currently online. Integrating Physical, Digital Assets: Walmart has been integrating its physical and digital assets for an omni-channel sales approach that addresses consumers' changing shopping patterns and deepens its relationship with customers. The company is improving the in-store experience with cleaner and more organized stores, better customer service, and a focus on fresh-food offerings. Moreover, Walmart's substantial cash flow generation enables it to make outsized investments in e-commerce relative to peers to further improve its competitiveness. The company has increased on-line offerings, improved distribution, implemented two-day free shipping, and made acquisitions including Jet.com, Inc. for $3.3 billion in 2016 to complement Walmart.com's already established position in e-commerce. Walmart expects e-commerce sales for its U.S. operations to total $11.5 billion in 2017 and to grow about 40% in 2018. Fitch expects e-commerce's contribution to sales, which has increased to an average of 0.8% in the first half of 2017 (1H17) from an average of 0.3% during the same period last year, to continue to accelerate to north of 1% in 2018. However, the shift toward on-line sales for grocery which currently has low penetration is expected to be more gradual than that of other categories given logistical complexity and the desire by many consumers to select their own fresh merchandise. Positive Comps, Traffic: Walmart U.S. has reported 12 consecutive quarters of positive comps) and 11 straight quarters of increased traffic with growth fairly broad-based across categories. The positive trend is due to improvements in traffic following price investments, better in-store execution, and an increased contribution from e-commerce sales. Walmart's U.S. comp growth has averaged about 1% since 2008. However, Fitch expects Walmart's U.S. comps to accelerate toward 2% in both 2017 and 2018 as increased traffic and a growing contribution from e-commerce offset the impact of price investments. Fitch is concerned that continued expansion by German hard discount chains Aldi and Lidl, and Amazon.com, Inc.'s $13.7 billion acquisition of Whole Foods Market could place additional downward pressure on food prices in the U.S. due to consumers' desire for value and the disruption Amazon.com has caused in other retail categories. Walmart International represented 24% of the company's revenue in 2016 with all key markets reporting positive comps in the quarter ended July 31, 2017. Walmex, which includes Mexico and Central America, has been the segment's best-performing market, with comps growing consistently in the mid- to high-single-digit range. The United Kingdom had experienced persistent comp and traffic declines due to expansion by hard discounters and intense price competition but growth has improved to the low single-digit rate in 2017 due to investments in price. Lastly, comps and traffic are growing at a low single-digit rate in Canada while trends in China have been mixed over the past few years. Walmart's partnership with JD.com could help produce steadier performance in China. Comps at Sam's Club, which represented 12% of revenue in 2016, have lagged the mid-single-digit growth rate of Costco Wholesale Corporation - its primary competitor - rising 1.4% in 2016 and 0.2% in 2015 excluding fuel. Fitch attributes the disparity to Costco's loyal higher-income membership base and fresh food options. Nonetheless, Sam's Club positive 2016 sales trajectory has continued in 2017, with comps rising 1.0% excluding fuel in 1H17 due to mainly to increased traffic. The better comp trends at Sam's Club have been due to a focus on fresh food, simplifying the checkout and new-member sign-up process, and growth at samsclub.com. E-commerce sales rose 27% in 1H17 while membership income is growing at a low single-digit rate. Margins Reset, Stabilization Anticipated: The 2015 and 2016 step-down in Walmart's EBITDA and margins as it invested in labor, e-commerce, and other initiatives was a rebasing of profitability but the company continued to generate substantial FCF; due to working capital improvements and lower, more targeted capex. Walmart's operating margin fell from 5.6% in 2014 to 4.6% in 2016, excluding the gain from the sale of Yihaodian, as the result of these investments. EBITDA is down from a peak of $36 billion in 2014 but Fitch expects it to grow roughly 2% to nearly $33 billion in 2017 and $34 billion in 2018. Gross margin will see the negative impact of price investments but product mix and the leveraging of SG&A expense should provide an offset such that EBITDA grows. Operating margin and EBITDA margin are expected to stabilize around mid-4% and mid-6%, respectively. Fitch expects the leveraging of SG&A expenses could provide Walmart with meaningful additional flexibility to continue to lower prices if necessary. SG&A margin has increased from roughly 19% in 2012 to 21% in 2016, which suggests savings could be several billion dollars if the margin declines back to 19%, given over $485 billion in revenue. Substantial Cash Flow, Stable Leverage: Fitch believes Walmart is taking the appropriate actions to drive long-term sales growth while using its significant bargaining power with suppliers and other counterparties to support near-term cash flow with working capital improvements. Walmart's considerable cash from operations (CFO), which has averaged approximately $27 billion annually since 2013, provides the financial flexibility that many peers do not have to invest in its business and return cash to shareholders while maintaining relatively stable leverage. Working capital improvements have added $2.1 billion-$5.7 billion to operating cash flow over each of the past three years due to better inventory management and accounts payable terms with suppliers. Fitch projects approximately $7 billion-$8 billion of FCF in both 2017 and 2018 (excluding potential working capital benefits which could add another $1.5 billion to $2.0 billion to FCF annually) due to low single-digit EBITDA growth, relatively stable capex at around $11 billion, and continued but declining reductions in working capital. Total adjusted debt/EBITDAR is expected to remain stable at around 2x as share repurchases and tuck-in acquisitions are funded with internally generated cash. Walmart announced a new $20 billion share repurchase plan in October 2017 to replace its existing $20 billion authorization and expects to utilize the new authorization over an approximate two-year period. DERIVATION SUMMARY Wal-Mart's 'AA'/Stable rating is the highest among retail and consumer peers due to its massive scale, leading market share position, substantial cash flow, and moderate financial leverage. The company's EDLP (everyday low price) strategy and established portfolio of store brands, including Great Value, Sam's Choice, Parent's Choice and Equate, are expected to support its price leadership as competition from hard discounters Aldi and Lidl increases. Additionally, Walmart's e-commerce capabilities, Walmart.com and Jet.com, and product diversity enable it to compete effectively with on-line leader Amazon.com. Fitch's other publicly rated investment-grade U.S. grocery and big box retailers include Costco Wholesale Corporation (A+/Stable), Target Corporation (A-/Negative), and The Kroger Company (BBB/Negative). Walmart U.S. generated 56% of sales from grocery, 33% from general merchandise, and 11% from health and wellness in 2016 and has a sizeable lead over these competitors in e-commerce capabilities. Costco, Target, and Kroger have strong store brands, but their omni-channel strategies are less developed than Walmart's. The two-notch rating difference between Walmart and Costco balances Costco's lower leverage against Walmart's significantly larger revenue, store base, and FCF generation. Target's rating relative to Walmart considers its higher margins, similar leverage, smaller scale, and history of inconsistent comp performance, while Kroger's rating reflects higher leverage and meaningful but less robust FCF. The Negative Outlook on Target and Kroger is due to recent comp weakness and market share trends and the significant investments required to reposition the business. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: ---Revenue grows 2% in 2017 and 3% in 2018 to over $500 billion, reflecting 1%-2% comps growth and about 1% square-footage growth; --Operating income rises slightly to $22.3 billion in 2017 and grows 3% to $23 billion in 2018; --Operating margin is sustained in the mid-4% area in 2017 and 2018 as SG&A savings offset price investments; --EBITDA margin sustained the mid-6% area in both 2017 and 2018; --FCF after dividends of approximately $7 billion-$8 billion annually in both 2017 and 2018 (excluding potential working capital benefits which could add another $1.5 billion-$2 billion during these years) assuming yearly capex of about $11 billion and dividends payments of around $6 billion annually; --Adjusted leverage of approximately 2x through the forecast period. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --An upgrade is unlikely, given the rating is currently at the high end of the rating spectrum and fully captures the company's financial and qualitative strengths. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --A weakening comp trajectory, due to negative store traffic and the absence of an acceleration in e-commerce contribution. --Adjusted leverage sustained above 2x as a result of meaningful margin contraction, led by investments in business that do not result in top-line growth or due to debt-financed share buybacks would also be rating concerns. LIQUIDITY Significant Liquidity, Laddered Maturities: Walmart had about $15 billion of liquidity inclusive of revolver availability and $6.5 billion of cash at July 31, 2017. Roughly $1 billion of overseas cash and equivalents may not be freely transferable to the U.S. due to local laws and other restrictions. Liquidity is supported by meaningful FCF generation and good market access. Walmart's undrawn $7.5 billion 364-day revolver expires in June 2018 and its undrawn $5 billion revolver expires in June 2021, and back up its $20 billion CP program. Walmart had $47 billion of debt at July 31, 2017 and upcoming maturities total $4 billion, $3.8 billion, and $1 billion, respectively, in 2018, 2019, and 2020. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Wal-mart Stores, Inc. --Long-Term Issuer Default Rating (IDR) at 'AA'; --Senior unsecured debt at 'AA'; --Bank credit facility at 'AA'; --Short-Term IDR at 'F1+'; --CP at 'F1+'. The Rating Outlook is Stable. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Secondary Analyst Fitch Ratings, Inc. 70 W Madison St. Chicago, IL 60602 David Silverman, CFA Senior Director +1-212-908-0282 Committee Chairperson Monica Aggarwal, CFA Managing Director +1-212-908-0282 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA are adjusted for material one-time items as reported in financials. --Fitch views operating leases as debt-like obligations, so capitalizes gross rent expense using a multiple of 8x. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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