Sears and Wal-Mart are both nationwide retailers, but their similarities are only skin deep. Sears started to lose its dominance in the early 1980s. In an attempt to boost the dwindling market share, Sears started to issue proprietary Sears Card, which gave customers payment flexibilities. A new slogan focusing on the “softer side of Sears”, and a revised product mix, were created to appeal to the middle-class female shoppers. On the other hand, Wal-Mart focused to achieve efficient operations, vertical integrations and high bargaining power, which allowed a low cost approach.
The slogan “Always low prices” was realized by Wal-Mart’s ability to deliver high “value for money” to customers across genders. Wal-Mart did not issue its own proprietary credit cards. While Wal-Mart had become a powerhouse, Sears had been struggling. Yet, Sears’ 22% ROE trumped Wal-Mart’s 19. 7%. The two companies were drastically different, and would require the ROE to be broken down into its components to reveal the true driving forces. Exhibit A shows that the two companies had almost identical net profit margin (ROS). Wal-Mart’s had high asset utilizations (ROA and Asset Turnover), while Sears’ high financial leverage of 6. contributed to the high ROE. In conclusion, Wal-Mart depended on its efficient operations to provide strong returns, while Sears used debt financing to drive its ROE. More ratio analysis can reveal the true strengths and weaknesses of the two companies. Below highlighted some ratios (see Exhibit B) that are important in assessing Sears and Wal-Mart current and future value creations abilities: · Sears relied heavily on debt financing. Compared to ROE, Return on Invested Capital (ROIC) is a superior indicator because ROIC includes long term debt in the denominator.
Securitization requires a repayment, Interest Coverage Ratio, Current ratio and Debt Cash Flow Coverage (OCF/Debt) can be used to determine its financial soundness in settling debt with its liquid asset and operating cash flow. · Over 55% of 1997 total sales utilized Sears Card. With 41 million active Sears Card accounts, Accounts Receivable Turnover (A/R turnover) is important. · Wal-Mart employed a low cost strategy, it’s important to assess Wal-Mart’s operational efficiency. Inventory turnover ratio is crucial in its profitability. Return on Asset (ROA) and Working Capital Turnover can measure management effectiveness in asset usages.
Cash Conversion Cycle (CCC) shows how long the company’s cash is being tied up by its current operations. Financial ratios are important in assessing the two companies’ performances. Referring to Exhibit A and B, we see that Sears relied heavily on debt financing. Although its 1997 ROE was high, it had a 300 days cash conversion cycle and a slow A/R turnover ratio. After evaluating various ratios, we concluded that the driving force behind Sears’ profitability was its proprietary card business. For a retailer, a strategy of using flexible payment options to boost sales is not a viable long term solution.
The slow A/R turnover and negative operating cash flow cause concerns. On the other hand, Wal-Mart had a quick cash conversion cycle of 91 days, and a working capital turnover of 24/yr (vs. 10/yr for Sears). These ratios represent a retail company with sound fundamental strategies, as well as the implementation and execution of those strategies. The financial ratios gave us insights into the companies’ operating and financing strategies, putting the two companies’ annual results into perspectives. Reading the footnotes of the companies, we concluded that the financial ratios were not a useful tool in analyzing their relative performances.
The differences in operating strategies yield highly contrasted numbers and ratios. The major differences in the two companies are as follows: · Proprietary credit cards – This increases Sears Receivables numbers 20 times from Wal-Mart and thus the turnover ratios become incomparable. · Lease- Wal-Mart has a high capital lease which increases its liability while Sears has six times less the number and thus the ratios become inappropriate to compare. · Non comparable Items: Reaffirmation cost of 320 million dollars affects the Net Income, and there is no assurance that this number cannot change.
The gains on credit card securitizations increase the Net Income of Sears by 136 million dollars. There were many such non comparable items that showed up in the net income number of Sears. · Sears adopted the SFAS No. 125 which stated that it need not account for the credit card uncollectible as a resource liability and this resulted in a gain of $136 million in 1997. · Inventory- 83% of the Inventory are revalued at a LIFO while the international operations inventory are valued at FIFO, this causes a difference in the Inventory turnover ratio as Wal-Mart has its complete inventory valued at FIFO.