© The Author(s) 2020

Y. CoulonRational Investing with Ratioshttps://doi.org/10.1007/978-3-030-34265-4_6

6. Case Studies

Yannick Coulon¹  

(1)

Brest Business School, Brittany, France

 

 

Yannick Coulon

Abstract

Two large case studies allow the implementation of the full set of ratios:

• A small family business is fully analyzed

• Three giant retail companies, namely Amazon, Walmart and Alibaba, are also scrutinized.

Concise fundamental analyses, incorporating both qualitative and quantitative data, are performed.

Keywords

Enterprise valueRatio analysis of a non-listed family businessAlibabaAmazonWalmart

6.1 Brief Introduction to the Case Studies

In the following case studies, the full set of ratios will be implemented in two different company environments.

• A small unlisted company, PAB

• Three large corporations, namely Alibaba group, Amazon and Walmart

A simplified quantitative and qualitative analysis of the companies is performed.

6.2 A Private Company in Trouble: PAB Limited

PAB is a small, unlisted retailer. The manager is a young and energetic woman with true selling expertise. She bought the company in year X − 2.

The simplified financial statements for the year X and X − 1 are as follows (Tables 6.1 and 6.2):

Table 6.1

Company PAB’s balance sheet

Balance sheet PAB (in $)	Year X	Year X − 1		Year X	Year X − 1
Property, Plant and Equipment (PP&E) net	105,000	60,000	Equity	250,000	250,000
Inventories	715,000	580,000	Long-term bank loans	215,000	235,000
Accounts receivable	120,000	130,000	Loans from shareholders	15,000	0
Prepaid expenses	10,000	5000	Accounts payable	320,000	170,000
Marketable securities	5000	0	Wages and taxes payable	145,000	95,000
Cash	35,000	5000	Short-term bank loans	45,000	30,000
Total assets	990,000	780,000	Total liabilities and equity	990,000	780,000

Table 6.2

Company PAB’s income statement

Income statement PAB (in $)	Year X	Year X − 1
Sales	1,275,000	1,030,000
Purchases	860,000	670,000
Inventory change (beg–end)	−135,000	−55,000
Selling expenses	499,000	429,000
EBITDA	51,000	−14,000
Depreciation and amortization	14,000	12,000
Other charges	18,000	0
EBIT	19,000	−26,000
Interest expense	9000	10,000
Extraordinary items	−10,000	12,000
Tax	0	0
Net income	0	−24,000

Repayment of principal = $10,000/year ×

A negative inventory change, which is equivalent to an increase in inventory, should be deducted from the “purchases of goods” line. These purchased goods were not consumed or sold by the company during the current year and were added as an entry to ending inventory.

Here is EBITDA with COGS as an expense (Table 6.3):

Table 6.3

EBITDA with COGS

EBITDA with COGS (in $)	Year X	Year X − 1
Sales	1,275,000	1,030,000
Cost of goods sold or COGS (goods consumed)	725,000	615,000
Selling expenses	499,000	429,000
Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA)	51,000	−14,000

We will now analyze company PAB according to the different ratio families: namely efficiency, liquidity , solvency , debt and finally profitability ratios.

6.2.1 PAB’s Efficiency Ratios

We start with the working capital analysis.

Table 6.4 gives an overview of the working capital metrics.

Table 6.4

Company PAB’s working capital analysis

Working capital analysis (in $)	Year X	Year X − 1
Working capital (long-term capital − Fixed assets)	375,000	425,000
Non-cash working capital needs from operations	380,000	450,000
Net cash	−5000	−25,000

Working capital calculation

• Working capital = long-term capital − fixed assets (equivalent to current assets − current liabilities)

• =250,000 + 215,000 + 15,000 − 105,000 = $375,000

• =715,000 + 120,000 + 10,000 + 5000 + 35,000 − 320,000 − 145,000 − 45,000 = $375,000

Non-Cash Working Capital (NCWC) from operations calculation

• Non-cash working capital needs from operations = current assets excluding cash − current liabilities excluding short − term financing

• = 715,000 + 120,000 + 10,000 − 320,000 − 145,000 = $380,000

• Cash = 5000 + 35,000 = $40,000

Net cash calculation

• Net cash = 375,000 − 380,000 = 5000 + 35,000 − 45,000 = − $5000

Findings

The non-cash working capital needs from operations are financed by the excess of long-term capital over fixed assets (i.e., $375,000). Non-cash working capital needs are artificially low due to oversized accounts payable (i.e., $320,000). At a reasonable level, the accounts payable would be equivalent to approximately two months of annual consumption of traded goods (or cost of goods sold , for a retailer).

Two months of annual consumption (COGS ):

• = 2/12 × (Annual purchases + beginning stock − ending stock)

  = 2/12 × (860,000 + 580,000 − 715,000) = 1/6 × 725,000

  = approximately $120,000

  Normalized accounts payable = $120,000

If we replace $320,000 with $120,000 in the formula, the normalized non-cash working capital needs look much larger than the present figure: $580,000 versus $380,000.

Normalized non-cash working capital needs:

= 715,000 + 120,000 + 10,000 − 120,000 − 145,000 = $580,000

Conclusion on Working Capital

PAB would need to find an additional $200,000 to finance its operations. This is a considerable amount. It looks like the suppliers are either willingly or unwillingly subsidizing this business by granting exceptional (i.e., abnormal) payment terms.

We continue with the calculation of the working capital days, namely the inventory, accounts receivable and accounts payable days.

Inventory Days

Here is a list of possible inventory ratios employing different numerators (average or ending inventory) and denominators (i.e., purchases, sales or COGS ) (Tables 6.5 and 6.6):

Table 6.5

Company PAB’s inventory data

Inventory data (in $)	Year X	Year X − 1
Inventory, beginning	580,000	525,000
Inventory, ending	715,000	580,000
Inventory, average	647,500	552,500
Daily sales	3493	2822
Daily purchases	2356	1836
Annual consumption (COGS)	725,000	615,000
Daily consumption (daily COGS)	1986	1685

Table 6.6

Company PAB’s inventory days

Inventory days	Year X	Year X − 1
Inventory days = average Inv/daily purchases	275	301
Inventory days = ending Inv/daily purchases	303	316
Inventory days = average Inv/daily sales	185	196
Inventory days = ending Inv/daily sales	205	206
Inventory days = average Inv/daily COGS	326	328
Inventory days = ending Inv/daily COGS	360	344

The detailed calculation for inventory days (year X) using ending inventory and COGS is outlined below:

• Inventory days = ending inventory/daily COGS

• COGS = 580,000 − 715,000 + 860,000 = $725,000

• Inventory days = 715, 000/[725, 000/365] = 360 days

Not only do inventories appear excessive in relation to the goods sold, which are equivalent to one selling year, but the trend is also negative here. Why were the purchases so important (at $860,000) with such a high inventory (at $580,000) at the beginning of the year? Was the existing stock saleable? This could mean that there is a massive depreciation risk (inventory write-off)!

Accounts Receivable Days

Table 6.7 provides an overview of the calculated accounts receivable days.

Table 6.7

Company PAB’s accounts receivable days

Accounts receivable	Year X	Year X − 1
Ending accounts receivable (in $)	120,000	130,000
Accounts receivable days	34	46

Detailed calculation for accounts receivable days (year X)

• Accounts receivable days = Accounts receivable/daily sales

• Accounts receivable days = 120,000/(1, 275,000/365 days)

• Accounts receivable days = 120,000/3493 = 34 days

Accounts Payable Days

Table 6.8 provides an overview of the calculated accounts payable days.

Table 6.8

Company PAB’s accounts payable days

Accounts payable	Year X	Year X − 1
Ending accounts payable (in $)	320,000	170,000
Accounts payable days	136	93

The detailed calculations for accounts payable days (year X) are outlined below:

• Accounts payable days = Accounts payable/daily purchases

• Accounts payable days = 320,000/(860,000/365 days)

• Accounts payable days (purchases) = 320,000/2356 = 136 days

• Accounts payable days = Accounts payable/daily COGS

• Accounts payable days = 320,000/(725,000/365 days)

• Accounts payable days (COGS ) = 320,000/1986 = 161 days

Conclusion on Working Capital Days

On the positive side, customers have paid their bills more promptly, and this brings the accounts receivable ratio down from 46 to 34 days. On the negative side, the accounts payable ratio has deteriorated sharply, with the company paying its suppliers with an average delay of roughly four to five months. Thus, there is a significant risk that suppliers will stop their deliveries and start legal proceedings! Remember, they are suppliers, not bankers.

6.2.2 PAB’s Liquidity Ratios

We now undertake a liquidity analysis.

Table 6.9 provides an overview of the adjusted liquidity ratios excluding prepaid expenses.

Table 6.9

Company PAB’s liquidity ratios

Liquidity ratios	Year X	Year X − 1
Current ratio	172%	242%
Quick ratio	31%	46%
Cash ratio	8%	2%

The detailed calculations for the adjusted liquidity ratios (year X) are outlined below :

• Current ratio = (715,000 + 120,000 + 5000 + 35, 000)/(320,000 + 145,000 + 45,000) = 875,000/510,000 = 171.6%  >> 100 % (good)

• Quick ratio = (120,000 + 5000 + 35,000)/(510,000) = 160,000/510,000 = 31.4%  << 100% (too low)

• Cash ratio = (5000 + 35, 000)/(510,000) = 40,000/510,000 = 7.8%  << 50% (too low)

Prepaid expenses can be excluded from liquidity ratios. They do not represent future cash inflows, and they cannot be converted into cash to face short-term liabilities (e.g., a prepaid insurance policy or rent).

Conclusion on Liquidity

There is a huge imbalance between excessive stock and low cash on hand. Even if the cash ratio does slightly improve, the situation is still alarming with inventories reaching an astronomical level. They represent 80% of the current assets .

Figure 6.1 illustrates the unfavorable asset mix hurting PAB’s liquidity .

Fig. 6.1

Company PAB’s current assets

6.2.3 PAB’s Debt and Solvency Ratios

The ratios used for the debt analysis are presented below, namely the debt to equity and debt coverage ratios.

Debt to Equity Ratios (Static Approach)

Table 6.10 provides an overview of PAB’s financial leverage for the last two years.

Table 6.10

Company PAB’s debt ratios

Financial leverage	Year X	Year X − 1	Limits
Net financial debt to equity ratio	94%	104%	< 100%
Net banking debt to quasi equity ratio	83%	104%	< 100%

The calculations for the debt to equity ratios (year X) are outlined below :

• Net financial debt = 215,000 + 15,000 + 45,000 − 5000 − 35,000 = $235,000

• Net banking debt = 215,000 + 45,000 − 5000 − 35,000 = $220,000

• ^“Quasi^” equity = capital + loans from shareholders = 250,000 + 15,000 = $265,000

• Net banking debt to quasi equity ratio (year X) = 220,000/265,000 = 83 % (104 % in year X − 1)

Debt Coverage Ratios (Dynamic Approach)

Table 6.11 provides an overview of PAB’s coverage ratios.

Table 6.11

Company PAB’s debt coverage ratios

Debt coverage ratios	Year X	Year X − 1	Limits X
Debt servicing coverage ratio (EBITDA/debt service)	2.7	−0.7	>> 2 OK
Interest coverage ratio (EBITDA/int exp)	5.7	−1.4	>> 5 OK
Interest coverage ratio (EBIT/int exp)	2.1	−2.6	>> 3 not OK
Net debt to EBITDA ratio	4.6	−18.6	<< 5 OK

Detailed calculations for the Debt Service Coverage Ratio (DSCR) (year X)

• Debt service = 10,000 (principal) + 9000 (interest) = $19,000

• DSCR = EBITDA/debt service = 51,000/19,000 = 2.7 > 2

There is enough operating cash for debt servicing and possibly capital expenditure (capex ) but not enough cash for a negative extraordinary item (bad surprise).

Detailed calculations for the Interest Coverage Ratio (ICR) (year X)

• Interest expense = 9000

• ICR = EBIT/interest expense = 19,000/9000 = 2.1 << 3

The interest coverage ratio is too low.

Detailed calculations for the debt to EBITDA ratio (year X)

• Net financial debt/EBITDA = 235,000/51,000 = 4.6 < 5

• Net banking debt/EBITDA = 220,000/51,000 = 4.3 < 5

The amount of debt seems slightly out of proportion.

Cost of PAB’s Debt

The formula used for calculating PAB’s cost of debt is the following:

Detailed calculations for the cost of debt (year X)

• Financial debt = long + short-term loans + loans from shareholders

• Financial debt Year X − 1 = 235,000 + 30,000 + 0 = $265,000

• Financial debt Year X = 215,000 + 45,000 + 15,000 = $275,000

• Average financial debt = $270,000

• Apparent interest rate on debt = 9000/270,000 = 3.3%

Solvency Metrics

The formula used for calculating PAB’s solvency ratio is the following:

Detailed calculations

• Solvency ratio = equity/total assets

• Solvency ratio (year X) = 250,000/990,000 = 25.25% > 20%

• Solvency ratio (year X − 1) = 250,000/780,000 = 32%

• Net tangible worth (book value) = $250,000 >> 0

Equity finances 25% of the assets of the company, a satisfactory level. The trend is negative.

Conclusion on Debt and Solvency

PAB’s debt remains important even if the overall debt ratios have slightly improved.

The company is not in a position to raise additional funds or borrow from a bank, this is a serious concern.

It is worth mentioning that the apparent cost of debt is greater than either net return on capital employed (ROCE) or normalized Return on Equity (ROE). This is a very negative sign for a company!

6.2.4 PAB’s Profitability Ratios

The ratios used for the profitability analysis are listed and presented below, namely performance margins, ROCE and ROE .

EBITDA Margin

The formula used for calculating PAB’s EBITDA margin is the following:

Detailed calculations

The EBITDA margin stands at 4%.

Operating Margin

The formula used for calculating PAB’s operating margin is the following :

Detailed calculations

The Earnings before Interest and Taxes (EBIT ) margin stands at 1.5%.

Profit Margin

The formula used for calculating PAB’s profit margin is the following:

Detailed calculations

• Normalized net income = adjusted net income before tax × (1 − tax rate)

• Normalized net income = (0 + 10,000) × (1 − 0.25) = $7500

• Profit margin = 7500/1,275,000 = 0.6%

The extraordinary item, by definition non-recurring, of −$10,000 is eliminated, and a tax rate of 25% is then applied.

The profit margin stands at 0.6%.

Return on Capital Employed (ROCE, Net After Tax)

The formula used for calculating PAB’s ROCE after tax is the following :

Detailed calculations

• EBIT  − tax = EBIT  × (1 − tax rate) = 19,000 × 0.75 = $14,250

• Net operating assets  = fixed assets + operating non-cash working capital

• Net operating assets = 105,000 + 380,000 = $485,000

• Capital employed  = long-term capital  − cash

• Capital employed  = equity + interest-bearing debt − cash

• Capital employed  = 250,000 + 215,000 + 15,000 + 45,000 − 5000 − 35,000 = $485,000

• Net ROCE = 14,250/485,000 = 2.94%

The net ROCE stands at 2.94%.

EV Multiple

A standard enterprise value (EV) multiple for a retail company is around eight times.

If we take the assumption that the book value of capital employed (or net operating assets) is close to market value, that is to say $485,000, the EV to EBITDA multiple would be as follows:

Detailed calculations

The ratio is above the industry specific ratio, which indicates a lower operating efficiency than an average firm in the sector.

Return on Equity

The formula used for calculating PAB’s ROE is the following:

Detailed calculations

• Normalized net income = (0 + 10,000) × (1 − 0.75) = $7500

• The extraordinary item, by definition non-recurring, of –$10,000 is eliminated, and a tax rate of 25% is then applied.

• Normalized ROE = 7500/250,000 = 3%

The normalized ROE stands at 3%.

Conclusion on PAB’s Profitability

These returns are considered too weak for a retail company. A normalized ROE for a leveraged company such as PAB should be 10% at a minimum.

6.2.5 Summary and Final Thoughts on Company PAB

Here is a summary of meaningful PAB’s ratios (Table 6.12):

Table 6.12

Company PAB’s key ratios

PAB key ratios	Year X	Year X − 1	“OK if”
Working capital days
Inventory days	360	344	<< 60 days
Accounts receivable days	34	46	<< 60 days
Accounts payable days	136	93	30/60 days
Liquidity ratios
Current ratio	172%	242%	>> 100%
Quick ratio	31%	46%	→100%
Cash ratio	8%	2%	> 50%
Debt and solvency ratios
Net debt to equity	94%	104%	< 100%
Equity/assets	25%	32%	> 20%
Debt coverage ratios
DSCR (EBITDA/debt service)	2.7	−0.7	>> 2
ICR (EBIT/interest)	2.1	−2.6	>> 3
Profitability ratio
Operating margin	1.5%	−2.5%
Net ROCE (after tax)	3%	−5.1%
ROE	3%	−10%	> 10%

The PAB business model does not seem sustainable over the long run. Its financial profitability is not satisfactory for a leveraged company, and it urgently needs both an infusion of cash and massive destocking. With a trade debt of $320,000, the suppliers hold the fate of the company in their hands.

Note: A real-life company with the same metrics as the fictitious company PAB went bust one year after its balance sheet was initially published, due to its lack of cash and to the delivery limitations imposed by its suppliers!

6.3 Comparison Between Alibaba, Amazon and Walmart

Alibaba group, Amazon and Walmart are three giant retail companies with distinct core business models that fiercely compete against each other on the world stage. They have expanded their historic business models to become more diversified players on world markets. True omni-channel retailing may be the holy grail they are pursuing. Even the word “retail” may no longer suffice since Amazon Prime Video and the video streaming platform Youku are more services than “pure” retail units.

This comparison cannot however be oversimplified and limited to an “old versus new” economic paradigm. As we know, reality proves to be more complex than a simplistic vision.

Just a word of warning: The comparison between these three prestigious companies is for educational purposes only. It does not constitute a recommendation to buy or sell stock in these corporations, nor should it be considered investment advice. Moreover, it does not constitute in any way a value judgment on the businesses presented in this section.

Furthermore, readers should not place undue reliance on the calculated projections. They were made as of the date of publication and are not guaranteed to be error or bias free. Any investment remains risky and should respect the investor’s risk profile and objectives. Remember, past performance is no guarantee of future performance !

6.3.1 Alibaba Group

Alibaba has created one of the most profitable internet business models in the world. Its Business-to-Business (B2B) marketplace connects over two million merchants online. It is also present in the Business-to-Consumer (B2C) arena with Taobao and AliExpress. Most of its activity takes place in China but the situation is constantly evolving.

The following data were extracted from the Alibaba Group Holding Limited’s press releases, non-audited, errors and omissions excepted. The information is dated May 15, 2019 (Tables 6.13, 6.14, and 6.15).

Table 6.13

Alibaba Group’s balance sheet, RMB (Yuan), in millions, year ended March 31, 2019

Alibaba Group (RMB, in millions)	March 2019		March 2019
Cash and cash equivalents	189,976	Accrued exp., payables and other liabilities	117,711
Short-term investments and investment securities	13,189	Short-term debt	22,466
Prepayments, receivables and other assets	58,590	Other current liabilities	67,492
Inventory	0	Total current liabilities	207,669
Restricted cash and escrow receivables	8518	Long-term debt	111,834
Total current assets	270,273	Other liabilities	6187
Long-term investments	241,544	Deferred liability charge	23,984
Fixed assets	92,030	Total liabilities	349,674
Goodwill	264,935	Mezzanine equity	6819
Intangible assets	68,276	Non-controlling interest	116,326
Prepayments, receivables and other assets	28,018	Shareholders’ equity	492,257
Total non-current assets	694,803	Total equity	608,583
Total assets	965,076	Total liabilities and equity	965,076

Table 6.14

Alibaba Group’s adjusted balance sheet, $, in millions, year ended March 31, 2019

Alibaba Group ($, in millions)	March 2019	1 RMB = 0.15 USD	March 2019
Cash and cash equivalents	29,774	Accrued exp., payables and other liabilities	17,657
Short-term investments & inv. Securities	1978	Short-term financial debt/Current Portion of Long-Term Debt (CPLTD)	3370
Prepayments, receivables and other assets	8789	Other current liabilities	10,124
Inventory	0	Total current liabilities	31,150
Other current assets	0	Long-term debt	16,775
Total current assets	40,541	Other liabilities	928
Long-term investments	36,232	Deferred liability charge	3598
Fixed assets	13,805	Total liabilities	52,451
Goodwill	39,740	Mezzanine equity	1023
Intangible assets	10,241	Non-controlling interest	17,449
Prepayments, receivables and other assets	4203	Shareholders’ equity	73,839
Total non-current assets	104,220	Total equity	91,287
Total assets	144,761	Total liabilities and equity	144,761

Table 6.15

Alibaba Group’s original income statement , RMB, $ US, in millions, year ended March 31, 2019

Alibaba Group, March 2019 (RMB, $, in millions)	RMB	US$
Sales	376,844	56,527
Cost of revenue	206,929	31,039
Product development expenses	37,435	5615
Sales, marketing, general and admin expenses	64,669	9700
Amortization of intangible assets	10,727	1609
Impairment of goodwill	0	0
Income from operations	57,084	8563
Interest and investment income, net	44,106	6616
Interest expense	5190	779
Other income, net	221	33
Income before income tax	96,221	14,433
Income tax expenses	16,553	2483
Share of results of equity investees	566	85
Net income	80,234	12,035
Net loss attributable to non-controlling interests	7652	1148
Accretion of mezzanine equity (−)	286	43
Net income applicable to common shareholders	87,600 RMB	$13,140

Original RMB figures were converted into USD at an exchange rate of 1 RMB(CNY) = $ US 0.15

The income statement data was regrouped in the following order (Table 6.16):

Table 6.16

Alibaba’s adjusted income statement, $, in millions, year ended March 31, 2019

Alibaba Group ($, in millions)	March 2019
Sales	56,527
Cost of revenue	31,039
Gross profit	25,488
Research and development	5615
Sales, marketing, general and admin expenses	9700
Amortization of intangible assets	1609
Interest and investment income, net	6616
EBIT	15,180
Interest expense	779
Other income	33
Extraordinary items	42
Net income before tax	14,476
Income tax	2483
Net loss attributable to non-controlling interests	1148
Income available to common shareholders	13,140

The Alibaba’s minority interest is a net loss . This interest is therefore added to and not deducted from the net income, as the majority shareholders of Alibaba should not carry the loss of the minority shareholders. It is important to remember that in consolidated statements, all revenues and losses are fully integrated.

Additional useful data on Alibaba Group

• Maggie Wu, Chief Financial Officer of Alibaba Group, made the following comment: “Looking ahead to fiscal year 2020, we expect revenue to be over RMB500 billion.”

• Adjusted EBITDA 2019 = 121,943 million RMB or 18,291 million USD

• Total of 101,958 employees as of March 2019

• Softbank, Yahoo and Mr. Jack Ma are major shareholders of the company.

• Alibaba has acquired Koala for $2 billion in September 2019, the Chinese e-commerce platform is specialized in luxury goods.

6.3.2 Amazon

Amazon is one of the mightiest brand names in the world and is famous for its Business-to-Consumer (B2C) activities. Once an internet bookseller, it is now a leading e-commerce retailer with a capitalization that touched the $1 trillion mark in July 2019. Amazon is also very active in cloud computing (Amazon Web Services or AWS), and nearly 60% of its operating income comes from this segment.

Here are the yearly financial statements of Amazon, errors and omissions excepted (Tables 6.17 and 6.18).

Table 6.17

Amazon’s balance sheet, $, in millions, year ended December 31, 2018

Amazon ($, in millions)	Dec 2018		Dec 2018
Cash and cash equivalents	31,750	Accounts payable	38,192
Short-term investments and inv. securities	9500	Accrued expenses and other	23,663
Net receivables	16,677	Unearned revenue	6536
Inventory	17,174	Total current liabilities	68,391
Other current assets	0	Long-term debt	23,495
Total current assets	75,101	Other liabilities	27,213
Long-term investments	0	Deferred liability charge	0
Fixed assets	61,797	Total liabilities	119,099
Goodwill	14,548	Minority interest	0
Intangible assets	0	Equity	43,549
Other assets	11,202	Total equity	43,549
Total assets	162,648	Total liabilities and equity	162,648

Table 6.18

Amazon’s income statement, $, in millions, year ended December 31, 2018

Amazon ($, in millions)	Dec 2018
Sales	232,887
Cost of revenue	139,156
Gross profit	93,731
Fulfillment, technology and other exp	63,160
Sales, marketing, general and admin expenses	18,150
Interest income and other	257
EBIT	12,678
Interest expense, net	1417
Income tax	1197
Minority interest (Non-Controlling Interest or NCI)	0
Net income	10,073

EBITDA 2018 is estimated at $28,019 million.

Additional useful data on Amazon

• Total of 647,500 employees, as of December 2018

• Mr. Jeff Bezos owned 57.6 million Amazon shares, more than 11% of the company, in August 2019 (Securities and Exchange Commission filling, 08/02/2019).

6.3.3 Walmart

Walmart is a company of superlatives: It is the largest retailer, the largest employer and the largest holder of retail space in the USA. It faces formidable competitors but does not remain inactive on the world stage (the reader may refer here to Sainsbury/Asda’s merger proposal, Flipkart’s acquisition). Walmart is also pushing its digital shopping and omni-channel retailing called Sam’s Club.

Here are the yearly financial statements for Walmart, errors and omissions excepted (Tables 6.19 and 6.20).

Table 6.19

Walmart’s balance sheet, $, in millions, year ended January 31, 2019

Walmart (in millions)	Jan 2019		Jan 2019
Cash and cash equivalents	7722	Accounts payable	47,060
Net receivables	6283	Short-term debt/CPLTD	7830
Inventory	44,269	Accrued liabilities	22,587
Prepaid exp. and other	3623	Total current liabilities	77,477
Total current assets	61,897	Long-term debt	50,203
Long-term assets	126,217	Deferred income taxes and other	11,981
Goodwill	31,181	Total liabilities	139,661
Total assets	219,295	Minority interest	7138
		Equity	72,496
		Total equity	79,634
		Total liability and equity	219,295

Table 6.20

Walmart’s income statement, $, in millions, year ended January 31, 2019

Walmart (in millions)	Jan 2019
Sales	514,405
Cost of revenue	385,301
Gross profit	129,104
Sales, marketing, general and admin expenses	107,147
Interest income and other losses	−8151
EBIT	13,806
Interest exp	2129
Income tax	4281
Minority interest	−509
Income available to common shareholders	6670

EBITDA 2018 is estimated at $24,484 million .

Additional useful data on Walmart

• 11,300 stores

• Everyday low price (EDLP) and everyday low cost (EDLC)

• 2,200,000 employees or associates (including 700,000 internationally)

• The Walton’s family owns around 50% of the company.

• Exceptional items include $8.4 billion in losses: $4.8 billion pre-tax loss (sale of Walmart Brazil) + $3.5 billion pre-tax decrease in JD.​com. This should explain why the forecasted EBITDA increases on a large scale in the following years, in comparison with 2018.

• US sales represent 65% of the total sales

• Walmart has launched a major e-commerce offensive in Asia (e.g., JD.​com in China, Flipkart in India, Rakuten in Japan)

• Walmart’s acquisition of Flipkart in India costed $16 billion

6.3.4 Liquidity and Efficiency

Table 6.21 gives an overview of the main efficiency and liquidity ratios applied:

Table 6.21

Liquidity and non-cash working capital metrics, Dec. 2018 to Mar. 2019

Liquidity and working capital	Walmart	Amazon	Alibaba Group
Current ratio	0.80	1.10	1.30
Quick ratio	0.23	0.85	1.30
Cash ratio	0.10	0.60	1.02
One day of sales ($, in millions)	1409	638	155
Inventory days	31	27	0
Accounts receivable days	4	26
Accounts payable days	33	60
NCWC needs from operations (days)	2	−7
NCWC needs (days)	−17	−54	−144
Cash as a % of current assets	12%	55%	78%
Receivables as a % of current assets	10%	22%
Inventory as a % of current assets	72%	23%

“Dec. 2018 to Mar. 2019” means December 31, 2018 for Amazon, January 31, 2019 for Walmart and March 31, 2019 for Alibaba.

Formula Used in the Cash Ratio Calculation

The liquidity ratio calculations are outlined below

• Cash ratio for Walmart = 7722/77,477 = 10%

• Cash ratio for Amazon = (31,750 + 9500)/68,391 = 60%

• Cash ratio for Alibaba = (29,774 + 1978)/31,150 = 102 %

Formulas and Definitions Used in the Working Capital Calculations

• Non-cash working capital needs = NCWC needs = current assets − cash − cash equivalents − current liabilities

• 1 day of sales = sales/365 days

• Working capital days = NCWC needs/(sales/day)

• Working capital days from operations = inventories/(sales/day) + accounts receivable/(sales/day) − accounts payable/(sales/day)

The working capital calculations for Walmart are outlined below:

• NCWC needs = 61,897 − 7722 − 77,477 = − $23,302

• Sales/day = 514,405/365 days = $1409/day

• Working capital days = −23,302/1409 = − 17 days

• Working capital days from operations = 44,269/1409 + 6283/1409 − 47,060/1409 = 31 days + 4 days − 33 days = + 2 days

The working capital calculations for Amazon are outlined below:

• NCWC needs = 75,101 − 31,750 − 9500 − 68,391 = − 34,540

• Sales/day = 232,887/365 days = $638/day

• Working capital days = −34,540/638 = − 54 days

• Working capital days from operations = 17,174/638 + 16,677/638 − 38,192/638 = 27 days + 26 days − 60 days = − 7 days

The working capital calculations for Alibaba are outlined below:

• NCWC needs = 40,541 − 29,774 − 1978 − 31,150 = − $22,361

• Sales/day = 56,527/365 days = $155/day

• Working capital days = −22,361/155 = − 144 days

For Alibaba Group: The amounts of accounts payable and accounts receivable cannot be determined with the account headings provided.

Findings on Working Capital

These ratios are the perfect illustrations of the three different business models, namely a brick and mortar retail company with a complex supply chain (with 11,300 stores!), an internet Business-to-Consumer (B2C) company with large fulfillment centers, an internet B2B company with no necessary stock to invest (i.e., intermediary business).

The three companies generate large working capital deficits, which is the rule in the retail industry.

It is worth noting that Alibaba generates a non-cash working capital of –$22 billion, which is equivalent to 144 days’ worth of sales. It is a major source of financing for its operations.

By contrast, Walmart and Amazon have comparable non-cash working capital from operations days but different methods for financing. Walmart has practically no funding tied up in accounts receivable, while Amazon has 26 days’ worth of sales in receivables. Walmart also pay its suppliers more promptly than Amazon.

Amazon benefits from having a “treasure,” its unearned revenue, which represents the equivalent of ten days (6536/638) of sales (i.e., subscription services paid in advance and memberships).

Another Meaningful Comparison

It is interesting to compare Walmart with another brick and mortar retail group such as the French business Carrefour (Table 6.22).

Table 6.22

Walmart against Carrefour’ liquidity ratios, Dec. 2018 to Mar. 2019

Liquidity and working capital	Walmart	Carrefour
Current ratio	0.80	0.57
Quick ratio	0.23	0.30
Cash ratio	0.10	0.19
One day of sales ($, in millions)	1409	208
Inventory days	31	29
Accounts receivable days	4	12
Accounts payable days	33	68
NCWC needs from operations (days)	2	−26
NCWC needs (days)	−17	−43
Cash as a % of current assets	12%	24%
Receivables as a % of current assets	10%	14%
Inventory as a % of current assets	72%	33%

The two significant differences between these retailers lie in their cash and accounts payable holdings. Carrefour uses its accounts payable as a major source of financing. As a consequence, Carrefour’s relative level of cash is higher, and its debt is lower. If Walmart had the same accounts payable days as Carrefour or Amazon, it would generate massive amounts of cash:

These amounts are approximations as a more accurate calculation would imply using daily COGS instead of daily sales.

Today, Carrefour faces a number of major challenges. It is repositioning itself toward sustainable growth while pushing organic (or green) high margin products.

Workforce Productivity

Another way to track the global efficiency of a company is to look at the productivity of its “human and intellectual” capital in terms of sales and profit (Table 6.23).

Table 6.23

Workforce performance , $, Dec. 2018 to Mar. 2019

Workforce performance in $	Walmart	Amazon	Alibaba Group
Employees	2,200,000	647,500	101,958
Sales/employee	233,820	359,671	554,415
Profit/employee	3032	15,557	128,877

Alibaba’s employees are extremely productive, and its B2B business model and effective e-commerce platforms contribute to its financial success.

It is worth noting that full-time and part-time employees are agglomerated in the total number of employees, and thus the ratio is inaccurate but remains meaningful as the differences are significant.

6.3.5 The Debt and Solvency Situation

Here are the main debt ratios applied (Table 6.24):

Table 6.24

Debt and coverage ratios, $, in millions, Dec. 2018 to Mar. 2019

Company	Net debt/equity	Net debt	ICR (EBITDA/Int)	ICR (EBIT/Int)	ICR (EBITDA) & ICR (EBIT)
Walmart	63%	50,311	11.5	6.5	>> 5 OK; >>3 OK
Amazon	Net debt < 0	−17,755	20	9	>> 5 OK; >>3 OK
Alibaba group	Net debt < 0	−11,607	23.5	19.5	>> 5 OK; >>3 OK

Formula used: Net debt = total debt (short and long) − (cash + cash equivalents), $, in millions

Detailed calculations of the Walmart’s debt ratios

• Debt to equity ratio (Walmart) = [short + long-term debt (lease obligations incl.) − total cash]/(total equity, NCI included) = (7830 + 50,203 − 7722)/79,634 = 63% (as of January 2019)

• Carrefour’s debt to equity ratio stands at 34%, target’s debt to equity ratio at 86%.

• Debt service coverage ratio (Walmart) = EBITDA /(payment of long-term capital  + interest expense) = 24,484/(3784 + 2129) = 4.1 >> 2

• Net debt/EBITDA  = 50,311/24,484 = 2 << 5

$3784 million represent the amount of repayments of long-term debt for the current fiscal year.

Findings on the Debt and Solvency Situation

Walmart’s debt is significant but not excessive , as the company generates enough operating cash to service its debt.

It is worth noting that if long-term operating lease obligations were added to capital lease obligations and debt, the debt to equity ratio would reach 82% as of July 31, 2019. If only capital and finance lease obligations are included, the debt to equity ratio reaches 62% as of July 31, 2019.

Long-term debt was issued in 2018 to finance the Flipkart’s acquisition in India. This will have to be monitored as the legal environment becomes more restrictive in India. Debt to equity ratio stood at 49% one year before.

We use the following metrics for solvency (Table 6.25):

Table 6.25

Solvency metrics, $, in millions, Dec. 2018 to Mar. 2019

Solvency	Walmart	Amazon	Alibaba Group
Net tangible assets	79,634	43,549	82,069
Net tangible assets, excl. Goodwill	48,453	29,001	42,329

All three companies are significantly solvent, well beyond the prudential limits.

6.3.6 The Compared Profitability

The enterprise value of the three companies has to be first calculated:

We use the following formula :

Using market capitalization as of August 16, 2019, the EV calculations appear as follows (Table 6.26):

Table 6.26

EV calculations, $, in millions, August 16, 2019

EV calculation	Walmart	Amazon	Alibaba Group
Market cap	322,560	886,710	454,580
Minority interest	7138	0	17,449
Net debt	50,311	−17,755	−11,607
Enterprise Value (EV)	380,009	868,955	460,422

For the net debt, it would preferable to use the latest quarterly publications to update net debt as equity and debt valuation should be measured at approximately the same time. For educational purposes, we keep the same net debt as measured previously.

We concentrate first on EV /sales and EV/EBIT multiples (Table 6.27):

Table 6.27

EV multiples and operating margins

Current EV multiples	Walmart	Amazon	Alibaba Group
EV/sales	0.74	3.73	8.15
EBIT margin	2.68%	5.44%	26.85%
EV/EBIT	27.52	68.54	30.33

The EV /sales multiple cannot be properly analyzed without considering the associated operating margin. Alibaba appears expensive in view of its high EV to sales multiple, but its operating margin is ten times higher than Walmart’s.

Tables 6.28 and 6.29 give an overview of the projected EBITDA and earnings of the three groups for the next two years.

Table 6.28

Projected EBITDA , $, in millions

Forward EBITDA	Walmart	Amazon	Alibaba Group
EBITDA 2018	24,484	28,019	18,291
EBITDA 2019 (projected)	32,500	42,000	23,000
EBITDA 2020 (projected)	33,000	52,500	29,000
Growth in EBITDA	35%	87%	59%

Table 6.29

Projected earnings, $, in millions

Forward earnings	Walmart	Amazon	Alibaba Group
Earnings 2018	6670	10,073	13,140
Earnings 2019 (projected)	15,000	15,000	15,000
Earnings 2020 (projected)	15,500	19,000	17,500
Growth in earnings 2020/2018	132%	89%	33%

The forward EBITDA and earnings estimates are based on the following assumptions:

• Walmart’s growth in earnings = +8400 in 2019 and 2% in 2020 (exceptional items in 2018 = −$8.4 billion)

• Amazon’s growth in EBITDA  = +50%/year in 2019 and +25% in 2020 (real growth in operating income achieved for the six months ended June 30, 2019 = +52.8%)

• Amazon’s growth in earnings = +50%/year in 2019 and +25% in 2020 (real growth achieved for the six months ended June 30, 2019 = +48.6%)

• Alibaba’s growth in EBITDA  = +25%/year in 2019 and 2020 (real growth achieved in the quarter ended June 30, 2019, +25%)

• Alibaba’s growth in earnings = +15%/year in 2019 and 2020

Forward Earnings Methodology

The reader can either estimate the forward earnings independently by using earnings guidance provided by the firm, or can consult excellent internet sites providing low, consensus or high analyst earnings estimates. We can improve forecast quality by computing conservative (low) and aggressive (high) multiples. Here is a non-exhaustive list of prestigious institutions providing financial data and forward earnings estimates: Boursorama, the Financial Times, Handelsblatt, Morningstar, Nasdaq and the Wall Street Journal.

Here is a table depicting the main current and forward profitability ratios (Table 6.30).

Table 6.30

Main profitability ratios

	Walmart	Amazon	Alibaba Group
Current profitability
Capital employed ($, in millions)	129,945	53,007	80,703
ROCE 2018 (before tax)	10.6%	23.9%	18.8%
Adj ROE 2018	9.2%	23.1%	17.8%
EV/EBITDA 2018	15.52	31.01	25.17
P/E 2018	48.36	88.03	34.60
Forward profitability
EV/EBITDA 2020	12	17	16
P/E 2020	21	47	26

Formula used: Adjusted ROE  = net income attributable to the parent company (common shareholders of the parent company)/(total equity − minority interest or non-controlling interest).

Formulas Used in the Forward Profitability Calculations

• Forward EV /EBITDA  = current EV /forward EBITDA 2020

• Forward P/E = current share price/forward earnings 2020

Detailed calculations for Walmart

• Forward EV /EBITDA 2020 = 380,009/33,000 = 11.52

• Forward P/E 2020 = 322,560/15,500 = 20.81

Detailed calculations for Amazon

• Forward EV /EBITDA 2020 = 868,955/52,500 = 16.55

• Forward P/E 2020 = 886,710/19,000 = 46.67

Detailed calculations for Alibaba

• Forward EV /EBITDA 2020 = 460,422/29,000 = 15.88

• Forward P/E 2020 = 454,580/17,500 = 25.98

Profitability Findings

Amazon appears to be a very profitable company when book value ratios are applied (ROCE and ROE ) but less attractive when a market ratio like the P/E ratio is applied. Indeed, its equity valuation seems to be very high. However, Amazon’s growth in EBITDA and earnings may justify such a high equity valuation.

Alibaba is well-positioned both on a current and forward perspective.

Walmart has the lowest valuation but also the lowest growth in EBITDA and recurring earnings.

6.3.7 Summary and Final Thoughts

Here is a selection of ratios outlining significant differences between the three retail companies (Table 6.31):

Table 6.31

Selected ratios underlining key differences

	Walmart	Amazon	Alibaba Group
Liquidity & working capital
Cash ratio	0,1	0.60	1.02
NCWC needs (in days)	−17	−54	−144
Debt to equity
Net debt	63%	Net debt < 0	Net debt < 0
Workforce performance
Profit per employee in US$	3032	15,557	128,877
Current profitability
EV/EBIT	27.52	68.54	30.33
Forward profitability
EV/EBITDA 2020	12	17	16
P/E 2020	21	47	26

Quantitative and Qualitative Comments

These great companies have solid credentials and credibility:

• Amazon seems to be priced for perfection, even if it’s forward EV to EBITDA multiple looks reasonable. The company must continue to grow sales at an exponential rate in its diversified segments (i.e., AWS) and the company should continue to invest heavily in Artificial Intelligence (AI) and in “Phygital” marketing (e.g., amazon go stores).

• Alibaba seems to have potential and could turn out to be Amazon’s number one competitor. Its home market is China, and the “Middle Kingdom” has established a highly competitive e-commerce ecosystem; companies such as JD.​com or Pinduoduo may threaten and at the same time force Alibaba to be even more competitive. Questions remain as to where and how the company will be listed in the future (New York Stock Exchange and/or Hong Kong Stock Exchange, following the November 2019 IPO), on the consequences of the US trade war on China and the fate of the company without Jack Ma, its charismatic co-founder?

• Walmart looks inexpensive relative to Amazon, but the company carries some debt and is less diversified than the other two digital giants. Walmart may however succeed in the convergence of its offline and online retail services.

Final Thoughts

A value or defensive investor would most likely choose Walmart, while a growth investor would likely have some hesitation between Amazon and its challenger Alibaba. Geopolitics may provide proper guidance for the future, perhaps even more than business models.

Europe and key emerging countries such as India and Russia represent future battlefields for the three giants. Attacking the Chinese or US market head on is an immense task with high barriers to entry.

In the meantime, the US “delivery battle” has started: Amazon Prime’s one day shipping versus free NextDay delivery at Walmart. In the meantime, the US “video streaming battle” has also started: Amazon, Apple and Disney may prove to be formidable Netflix’s competitors. The huge investments required will affect Amazon’s profitability as in Q3, 2019.

Case Study Limitations: Alibaba, Amazon and Walmart

This purpose of this comparison is not so much the opinions of the author regarding these companies at the time of writing (market capitalization as of August 16, 2019), but the way ratios were implemented and the methodology used. Many positive or negative events such as changes in technology, a rising competitor, a new legal framework, even a recession may upend the present situation. Ratios are powerful tools at your disposal, and an up-to-date analysis in the current environment will be the foundation of your personal investment thesis.

In the next chapter, we will define an investment thesis and examine its implementation at the three companies.

References and Further Reading

1. Anthony, Robert N., and James S. Reece. 1989. Accounting: Text and Cases. Irwin.
2. Accounting: Text and Cases, Robert N. Anthony, David F. Hawkins, Kenneth A. Merchant, 2010, McGraw-Hill Higher Education.
3. Coulon, Yannick. January 2017. Guide pratique de la finance d’entreprise. Gualino.
4. ———. September 2018. L’essentiel des ratios financiers. Maxima Laurent du Mesnil.
5. Jones, Bill, Terry Jones, Theo Kocken, and Ben Timlett. March 2016. Boom Bust Boom. TV Documentary (USA).
6. Minsky, Hyman P. 2008. Stabilizing an Unstable Economy. McGraw-Hill.
7. Quiry, Pascal. Le Fur Yann, 2019, Finance d’entreprise 2020 de Pierre Vernimmen, Dalloz.
8. Stowe, John D., Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey. August 2002. Analysis of Equity Investments: Valuation. AIMR and CFA Institute.
9. Thauvron, Arnaud. 2013. Evaluation d’entreprise. 4th ed. Paris: Economica.
10. Thibierge, Christophe. November 2013. Comprendre toute la finance, 2ème édition. Vuibert.
11. Walsh, Ciaran. 2008. Key Management Ratios, 4th ed. Financial Times Series. FT Prentice Hall. Pearson Education Limited.

Webography

1. www.​alibabagroup.​com (Investor Relations).
2. www.​amazon.​com (Investor Relations).
3. www.​nasdaq.​com (AMZN, BABA, WMT).
4. www.​walmart.​com (Investor Relations).

Balance Sheets

1. Alibaba Group, Fiscal Year 2019 Results (Year Ended March 31, 2019), May 15, 2019.
2. Amazon 2018 Report (Year Ended December 31, 2018), January 31, 2019.
3. Carrefour, Consolidated Financial Statements as of December 31, 2018.
4. Walmart, Defining the Future of Retail, 2019 Annual Report (Year Ended January 31, 2019), April 23, 2019.