Walmart: Where is the moat?

“The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.” —Warren Buffett

In this post I will take a look at Walmart’s operating segments to see if there are any different characteristics between them. Do they all enjoy a moat, i.e., a sustainable competitive advantage, or not?

Let’s start with a brief business description taken taken from the 2014 annual report 10-K form. Underlinings and boldings made by me.

Business description

WMT2Wal-Mart Stores, Inc. (“Walmart,” the “Company” or “we”) helps people around the world save money and live better – anytime and anywhere – in retail stores, online, and through their mobile devices. We earn the trust of our customers every day by providing a broad assortment of quality merchandise and services at everyday low prices (“EDLP”), while fostering a culture that rewards and embraces mutual respect, integrity and diversity. EDLP is our pricing philosophy under which we price items at a low price every day so our customers trust that our prices will not change under frequent promotional activity.

Our operations comprise three reportable business segments: Walmart U.S., Walmart International and Sam’s Club. Our fiscal year ends on January 31 for our United States (“U.S.”) and Canadian operations. We consolidate all other operations generally using a one-month lag and on a calendar basis. Our discussion is as of and for the fiscal years ended January 31, 2014 (“fiscal 2014”), January 31, 2013 (“fiscal 2013”) and January 31, 2012 (“fiscal 2012”).

During fiscal 2014, we generated total revenues of $ 476 billion, which was primarily comprised of net sales of $473 billion.

Walmart U.S. is our largest segment and operates retail stores in various formats in all 50 states in the U.S., Washington D.C. and Puerto Rico, as well as its online retail operations, walmart.com. Walmart U.S. generated approximately 59% of our net sales in fiscal 2014 and, of our three segments, historically has had the highest gross profit as a percentage of net sales (“gross profit rate”), and contributed the greatest amount to the Company’s net sales and operating income.

Walmart International consists of the Company’s operations in 26 countries outside of the U.S. and its operations include numerous formats of retail stores, wholesale clubs, including Sam’s Clubs, restaurants, banks and various retail websites. Walmart International generated approximately 29% of our fiscal 2014 net sales. The overall gross profit rate for Walmart International is lower than that of Walmart U.S. because of the margin impact from its merchandise mix. Walmart International has generally been our most rapidly growing segment, growing primarily through new stores and acquisitions and, in recent years, has been growing its net sales and operating income at a faster rate than our other segments. However, for fiscal 2014, Walmart International sales growth slowed due to fluctuations in currency exchange rates, as well as no significant acquisitions, and operating income declined as a result of certain operating expenses.

Sam’s Club consists of warehouse membership clubs and operates in 48 states in the U.S. and in Puerto Rico, as well as its online operations, samsclub.com. Sam’s Club accounted for approximately 12% of our fiscal 2014 net sales. Sam’s Club operates as a warehouse membership club with a lower gross profit rate and lower operating expenses as a percentage of net sales than our other segments.

We maintain our principal offices at 702 S.W. 8th Street, Bentonville, Arkansas 72716, USA.

Operating segment moat watch

The operating segments disclosure in the annual report provides some figures that could be used in trying to figure out the moatiness of each individual operating segment.

A great business generates high and sustainable returns on invested capital. The same holds true for any operating segment. For an operating segment to be considered great, it also has to be able to generate high and sustainable returns on invested capital.

Some of the metrics provided in the operating segments disclosure are net sales, operating income (or, Earnings Before Interest and Taxes — EBIT) and total assets. In the notes to the financial statements – Goodwill and Other Acquired Intangible Assets – goodwill per operating segment is disclosed. Having the goodwill figures at hand allow us to calculate tangible assets per operating segment (Total Assets minus Goodwill).

From this we can calculate return on invested capital (ROIC) per operating segment by taking EBIT divided by tangible assets, below called EBIT Return on Total Tangible Assets (EBIT ROIC).

Walmart as a whole generated an EBIT ROIC in fiscal year 2014 of 14.5%. Per operating segment Walmart U.S. generated the highest EBIT ROIC of 22.7%, compared to 8.2% for Walmart International and 14.4% for Sam’s Club.

What stands out is two things, 1) the superb returns generated by Walmart U.S. and 2) the not so good returns generated by Walmart International.

Clearly, Walmart U.S. seems to enjoy a moat which is consistent with earlier posts discussing the issue of likely competitive advantages enjoyed by Walmart. In the U.S. market Walmart seems to enjoy a moat through the benefits of captive customers via its Every Day Low Prices (EDLP) and economies of scale mostly in distribution, even if it seems reasonable to assume there also are some scale advantages from marketing and purchasing. Walmart International does not seem to have any of these advantages at the moment, at least not to the extent that it shows up in great returns as measured by the EBIT ROIC calculation. Upon reflection, this may not look as surprising as one might expect. Just as Walmart enjoys advantages in U.S., other retailers most likely enjoy, at least to some degree, the same advantages in their own domestic markets.

ROC1Below is a breakdown of EBIT ROIC and its two main drivers, EBIT margin (Operating income / Net sales) and Tangible assets turnover (Net sales / (Total Assets – Goodwill)).

  • EBIT ROIC = EBIT margin × Tangible assets turnover

In recent years, Walmart U.S. has shown a high and increasing EBIT margin. During the same period Walmart International’s EBIT margin has declined from 5.8% in 2006 to 4.0% in 2014. Sam’s Club’s EBIT margin has been pretty consistent during these years, close to 3.5%. At a consolidated level, Walmart’s EBIT margin has declined from 6.0% in 2006 to 5.6% in 2014, mainly due to the deterioration in Walmart International’s EBIT margin.

ROC3

The second driver of EBIT ROIC, the tangible assets turnover shows that Sam’s Club enjoys the highest asset turnover. Asset turnover for Walmart U.S has been pretty consistent in recent years, hovering around 2.9 times. Walmart International has improved its asset turnover from 1.6 to 2.0, but due to the decline in EBIT margin the EBIT ROIC has not improved.

ROC2

So, the Walmart operating segment moat king, at least as of today (and also in recent years) is Walmart U.S.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

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