Wal-Mart Should Follow Home Depot’s Example To Improve Return On Capital

February 23, 2017

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Courtesy of Benzinga.

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A positive comp sales and traffic during the Holiday quarter and a surge in online orders isn’t enough for Argus to become more constructive on Wal-Mart Stores Inc (NYSE: WMT) shares. Argus still rates Wal-Mart Hold as it wants the company to improve its return on investment.

In the fourth quarter, Wal-Mart’s trailing 12-month ROI declined by 30 basis points to 15.2 percent. Adjusted operating income fell 1.7 percent, while average invested capital increased 0.7 percent.

“We believe that Wal-Mart must significantly improve its return on invested capital to become a multiyear outperformer,” analyst Christopher Graja wrote in a note.

In fact, Graja wants Wal-Mart to take a leaf out of Home Depot Inc (NYSE: HD)’s book to improve return on invested capital (ROIC).

According to Bloomberg data, Wal-Mart ended FY11 with an ROIC of 14.6 percent and FY2017 with an ROIC of 12.2 percent. By contrast, Home Depot ended FY2011 with an ROIC of 12.8 percent — about 180 basis points lower than Wal-Mart – but ended FY2017 with an ROIC of 30.3 percent, more than twice as high as the retail giant.

Graja noted Wal-Mart should grow income faster than sales and sales faster than its capital base.

“The implication is that it is not enough to simply boost earnings by opening more mildly profitable stores or to boost comp sales by stuffing stores with more inventory,” Graja highlighted.

Since the end of FY2011, Wal-Mart has increased square footage by 18 percent. But, Bloomberg data shows that sales have declined during this period to $420 per square foot from $436, and EBIT has dropped to $20 per square foot from $26.

On the other hand, Home Depot raised its square footage by less than 1 percent over the same period. But, the home improvement retailer’s sales have increased to almost $400 per square foot from $289, and EBIT has more than doubled from $25 per square foot to $57.

“Our intent isn’t to be judgmental. We simply want to show that megacap retailers have the potential to outperform if they follow the route taken by HD, and get operating and capital efficiency on track,” Graja added.

At last check, shares of Wal-Mart rose 1.9 percent to $72.67 and Home Depot were up 0.63 percent to $145.62.