October 11, 2017 / 1:47 PM / 2 months ago

Fitch Rates Wal-Mart's $6B Issuance 'AA'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 11 (Fitch) Fitch Ratings has assigned a 'AA' rating to Wal-Mart Stores, Inc.'s (Walmart) multi-tranche issuance of $6 billion two-year, three-year, five-year, seven-year and thirty-year senior unsecured notes. Proceeds will help fund the cash tender offer of up to $8.5 billion notes maturing 2019 through 2043. KEY RATING DRIVERS Significant Scale, Defensible Position Walmart's ratings reflect the operational and financial flexibility and strong free cash flow profile that result from its substantial scale and dominant market position in North America. Walmart generated $481 billion of sales in 2016 (year ended Jan. 31, 2017) and is maintaining market share in nearly all categories despite its large size and increased competition from alternative discount and online-only players, due to its price leadership and investments in its business. Ratings incorporate Fitch's view that margins will stabilize in the mid-6% range in 2017 following a step down in the company's EBITDA margin during 2016 due to significant investments in wages, e-commerce, and other initiatives. Fitch believes Walmart is making the appropriate actions to drive long-term sales growth while using its significant power vis-a-vis suppliers and other counterparties to support near-term cash flow with working capital improvements. Positive Comps, Traffic Walmart U.S., which represented 64% of the company's revenue in 2016, has reported 12 consecutive quarters of positive comparable sales (comps) and 11 straight quarters of increased traffic. Growth is being supported by investments in price and improved in-store execution and has been fairly broad-based across categories. Walmart's U.S. comp growth has averaged about 1% since 2008. However, Fitch expects Walmart's U.S. comps to grow 1% to 2% in 2017 and 2018 as increased traffic and a growing contribution from e-commerce offset the impact of price investments. Comp growth above 2% is not viewed as likely, given Walmart's size. Food deflation had a 50 - 100 basis point (bp) adverse impact on comps in 2016. While the negative trend reversed in the first half of 2017, Fitch is concerned that Amazon.com, Inc.'s $13.7 billion acquisition of Whole Foods Market could place additional downward pressure on food prices in the U.S. retail industry due to consumers' desire for value and the disruption Amazon 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 growth consistently in the mid-to-high single digit range. Walmex comps rose 7.2% and traffic increased 0.8% in the latest quarter. Comps and traffic rose 1.8% and 0.6% in the UK, after persistent declines due to expansion by hard discounters and intense price competition, and were up 2.5% and 1.4%, respectively in Canada. Lastly, comp growth in China slowed to 0.6% with traffic down 1.4% in the latest quarter. China's comp growth has been mixed over the past few years alternating between positive and negative territory. Fitch projects GDP growth in the UK will slow to 1.5% in 2017 from 1.8% in 2016 with weaker consumer spending. GDP growth in Mexico is projected to be similar to 2016 at 2.3% in 2017 with robust consumer spending. China GDP is also expected to be similar to last year at 6.7% while growth in Canada is expected to accelerate to 3.1% in 2017 from 1.5% in 2016 due mainly to a pickup in consumer spending. Sam's Club, which represented 12% of revenue in 2016, has shown consistently positive comps excluding fuel. Comps at the membership warehouse rose 1.2% in the latest quarter due to mainly to increased traffic. Membership income is growing at a low-single-digit rate. Integrating Physical and Digital Walmart is improving the in-store experience while deepening its digital relationship with customers due to the increasingly competitive landscape and shifting consumer buying habits. Cleaner and more organized stores, better customer service, and a focus on fresh food offerings are examples of ways Walmart is improving the in-store experience. Meanwhile, increased on-line offerings, new distribution centers, the acquisition of Jet.com, Inc. in 2016, and two-day free shipping are examples of how the company is strengthening its competiveness in e-commerce. Nonetheless, Fitch expects sales from physical stores will continue to represent the bulk of Walmart's revenue with the contribution from e-commerce increasing over time. Fitch believes consumer shift towards on-line grocery will be more gradual than that of other categories but recognizes an Amazon/Whole Foods could accelerate the shift. Margins Reset, Stabilization Anticipated The 2015 and 2016 step-down in Walmart's EBITDA and margins was a reset of the company's profitability but the company continues to generate substantial free cash flow (FCF; cash flow from operations less capex and dividends) due to working capital improvements and lower more targeted capex. Walmart's operating margin declined from 5.6% in 2014 to 4.6%, excluding the gain from the sale of Yihaodian, in 2016, due to price investments and increased wages, benefits, and training for U.S. employees. Fitch expects Walmart's operating margin to stabilize in the mid-4% range and EBITDA to approximate $33 billion in 2017, down from a peak of $36 billion in 2014. Gross margin is projected to continue to decline modestly as Walmart invests in price but the leveraging of SG&A expenses should provide an offset. Strong Cash Flow, Stable Leverage Walmart's considerable cash from operations (CFO), which has averaged approximately $27 billion annually since 2013, provides the company the financial flexibility to invest in its business and return cash to shareholders while maintaining relatively stable leverage. Fitch anticipates FCF of $7 billion to $8 billion in 2017, excluding improvement in working capital improvement which has added $2.1 billion to $5.7 billion to operating cash flow over each of the past three years. Fitch is forecasting adjusted leverage (debt plus capitalized leases/EBITDAR) to remain stable at around 2x. Share repurchases and tuck-in acquisitions are expected to be largely funded with internally generated cash. DERIVATION SUMMARY Wal-Mart's 'AA'/Stable rating is the highest among retail and consumer peers due to its significant scale, leading market share position, substantial cash flow, and moderate financial leverage. The company's established portfolio of store brands, inclusive of Great Value, Sam's Choice, Parent's Choice and Equate, provides additional opportunity to solidify its price leadership as competition from hard discounters Aldi and Lidl increases. Additionally, Walmart's e-commerce capabilities; inclusive of Walmart.com and Jet.com, and product diversity enable it to compete effectively with on-line leader Amazon.com. Fitch's other publicly rated U.S. grocery retailers include Costco Wholesale Corporation (A+/Stable), Target Corporation (A-/Negative), The Kroger Company (BBB/Negative), and SUPERVALU INC. (B/Stable). With the exception of Costco, these companies have less product diversification than Walmart U.S., which generated 56% of sales from grocery, 33% from general merchandise, and 11% from health and wellness in 2016. The two-notch difference between Walmart's and Costco's rating balances Costco's lower leverage against Walmart's significantly larger revenue, store base, and FCF generation. Target's ratings relative to Walmart considers its higher margins, similar leverage, smaller scale, and history of inconsistent comp performance while Kroger's rating relative to Walmart's reflects Kroger's higher leverage and less robust FCF. The Negative Outlook on Target and Kroger is due to recent comp weakness and market share trends. Costco, Target, and Kroger have strong store brands, but their omni-channel strategies are less developed than Walmart's. SUPERVALU's high yield rating reflects its inferior market share position in grocery retail and high relative financial leverage. Wholesale distribution is roughly 70% and 80% of SUPERVALU's sales and EBITDA, respectively, following its divestiture of Save-a-Lot and acquisition of Unified Grocers, Inc. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Walmart include: --Revenue grows approximately 2% in 2017 and 3% in 2018 to over $500 billion, reflecting 1% to 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% range in 2017 and 2018 as SG&A savings offset price investments; --EBITDA margin in sustained the mid-6% range in 2017 and 2018; --FCF after dividends of approximately $7 billion to $8 billion in 2017 and 2018, excluding potential working capital benefits, assuming yearly capex of about $11 billion and dividends payments in the $6 billion range annually; --Adjusted leverage of approximately 2x through the forecast period. RATING SENSITIVITIES 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. Negative Rating Action: Future developments that may, individually or collectively, lead to negative rating action include a weakening comp trajectory, due to negative store traffic and the absence of an acceleration of the contribution from e-commerce. 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 Walmart had approximately $15 billion of liquidity inclusive of revolver availability and $6.5 billion of cash, as of July 31, 2017. Approximately $900 million of the company's oversees cash and equivalents may not be freely transferable to the U.S. due to local laws and other restrictions. Liquidity is supported by the firm's meaningful FCF and good access to both bank and capital markets. Walmart has an undrawn $7.5 billion 364-day revolver expiring in June 2018 and an undrawn $5 billion revolver expiring in June 2021, which back up its $20 billion commercial paper (CP) program. FULL LIST OF RATING ACTIONS Fitch currently rates Wal-Mart Stores, Inc. as follows: --Long-Term Issuer Default Rating (IDR) 'AA'; --Senior unsecured debt 'AA'; --Bank credit facility 'AA'; --Short-Term IDR 'F1+'; --Commercial paper 'F1+'. The Rating Outlook is Stable. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison Ave. Chicago, IL 60602 Secondary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Committee Chairperson Monica Aggarwal, CFA Managing Director +1-212-908-0282 Date of Relevant Rating Committee: Sept. 15, 2016 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 include: --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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