Wal-Mart (NYSE:WMT) is by far the largest retailer in the world with more than $400 billion in store revenues as of 2009, far ahead of competitors like Costco (NASDAQ:COST), Target (NYSE:TGT) and Best Buy (NYSE:BBY). Retail and consumer goods manufacturers realize significant sales through Wal-Mart’s retail channel. This gives Wal-Mart leverage to influence and push suppliers to sell at cheaper prices. Wal-Mart, with its power over suppliers and strong credit quality, can thus efficiently manage its working capital.
Below we briefly discuss the components of Wal-Mart’s working capital, and how they together add value to the company.
Wal-Mart Rotates More Than $30 Billion of Inventory Every Month
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Wal-Mart had an inventory of close to $34.5 billion at the end of 2008 and around $33 billion at the end of 2009. With annual sales of more than $400 billion in 2009, the company is rotating about its entire inventory almost every month. The purpose of keeping inventory low is to reduce overhead costs related to inventory management as well as reduce the risk of inventory obsolescence (leading to markdowns).
High Payable Versus Low Receivables Free Up Cash For Investments
Wal-Mart currently maintains accounts payable of close to $30 billion, while its accounts receivables are close to $4 billion. Accounts payable is the amount that Wal-Mart is yet to pay to its suppliers for the inventory it has purchased, while accounts receivable is the sales revenue that Wal-Mart is yet to collect from its customers.
Wal-Mart has been able to maintain the wide difference between payables and receivables because of its influence over the suppliers and the brand image that it has built over the years. Higher payables balances allow Wal-Mart to hold significant cash that it can invest in its own business or that can earn interest. Wal-Mart can earn more than $2 million per day based on earning a modest 3% annualized return on $30 billion of cash yet to be paid to its suppliers.
With Payable Growing Faster Than Inventory, Additional Cash Available Creates More Value
Wal-Mart’s accounts payable grew from around $29 billion at the end of 2008 to around $30.5 billion at the end of 2009. During the same period, its inventory balance declined from about $34.5 billion to $33 billion. The company maintains this trend will continue going forward and expects its payables to grow faster than its inventory. Such a scenario will reduce net working capital for Wal-Mart and free up additional cash for investment.
We have conservatively estimated that Wal-Mart’s net working capital (as a percentage of Wal-Mart’s revenues) remain flat. However, you can modify our forecast below to see how Wal-Mart’s stock could be positively impacted if its net working capital (as % of revenues) were to decrease over time as a result of Wal-Mart’s ability to grow its payables faster than its inventory.