How Low Revenue Per Square Foot Is Impacting Walmart’s ROI?

Return on Investment is a meaningful metric to gauge Wal-Mart‘s (NYSE:WMT) performance. It  helps investors assess how effectively Walmart is deploying its assets or how much return is generated on each dollar invested in Walmart.  A decline in Walmart’s revenue growth has brought this metric down from 19.6% in 2008 to 16.2% for the twelve months ended July 31, 2015. ^[1] This implies that every new investment in Walmart is now generating a lower return compared to 2008.

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Margins Are Intact, Capital Turns Are Declining

Return on Investment can be calculated as a product of adjusted operating margins and capital turnover (revenue per unit of invested capital).  Walmart calculates its operating income for calculation of ROI by adjusting for interest income, depreciation and amortization and rent. The adjusted average invested capital is a calculated similarly. ^[1] The below table shows trend of Walmart’s adjusted operating margin and capital turnover since 2008.

Adjusted operating income is calculated by adding interest income, depreciation and amortization and rent to the operating income.  Average invested capital is calculated by adding average accumulated depreciation and amortization to average assets of continuing operations and subtracting average accrued liabilities+ rent*8 and average accounts payable from this number. ROI = Adjusted Operating Income/Average Invested Capital.  These calculations are as per details provided by the company in its annual report.

While adjusted operating margin of Walmart has remained in the range of 8%, capital turnover has shown a steady decline from 2.45 in 2009 to 2.07 in 2015.  This indicates that for each additional unit of capital invested by Walmart, it is not able to generate a similar amount of revenue anymore. New assets added over the past few years are not able to generate enough sales to keep the ROI intact. This can also be partly attributed to increase in working capital requirements since 2010.  The cash conversion cycle of the company was 7 days in 2010 and this figure increased to 13 days in 2014.  This indicates that the capital efficiency of Walmart is decreasing, leading to a lower ROI.

10% Downside In Price Estimate If Revenue Per Square Foot In International Markets Shows A Declining Trend

The low capital turnover trend is visible in low revenues per square foot of international stores.

We estimate that revenue per square foot for international stores would gradually increase over the forecast period.  The company is trying to make these stores more efficient by reducing the store sizes in emerging markets.  However, emerging markets typically have lower revenues per square foot and this will make Walmart less capital efficient over the years, as it grows in these markets.  A declining trend  in revenue per square foot in the international markets will lead to a 10% downside in our price estimate for Walmart.  Though we expect this metric to show a gradual increase over the forecast period, if the historical trend continues, this scenario is plausible.

E-commerce  growth remains strong  and the company registered  a 16% increase in global online sales in Q2 2015.  U.S. comparable sales were up by 1.5% in the same period.  This increase can compensate for loss in per square foot revenue in the international segment to some extent and improve the ROI.

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1. Walmart SEC Filings [↩] [↩]