ACC4320- Final Project,

Final Project College of Professional Studies, Northeastern University ACC4320: Financial Statement Analysis December 17, 2022 1

This paper thoroughly evaluates the company Target and Walmart, covering their basic overview, industry analysis, financial ratios, dividend discount models, stock price analysis, and sensitivity analysis. Company Information Target Target ranks as the seventh-largest retail business in the United States, with more than 400,000 workers domestically and abroad. It has locations in each of the 50 states as well as the District of Columbia, and 75% of Americans live within 10 miles of a Target store. However, the headquarters of Target is in Minneapolis, Minnesota, where it has been based ever since the launch of the first Target shop in 1962. The retailer provides high-quality, in-style products at discounted rates through its web channels and stores. It reported a substantial increase in sales of 19.3% in 2020 as a result of Americans rushing to discount retailers like Target to load up on necessities like toilet rolls and sanitizers (Fortune, 2022). The increase still continued in 2021 when people's purchasing switched from emergency storage towards a typical consumer choice (Target, 2022). Walmart Walmart ranks as the first-largest retail business in the United States, with over 2,300,000 workers worldwide and over 1,600,000 million in the United States. It operates around 10,500 locations, clubs, and eCommerce websites worldwide. The business provides a range of goods and services at relatively low pricing. Walmart U.S., Walmart International, and Sam's Club comprise its three business segments (Walmart, 2022). First, the Walmart U.S. sector offers consumer goods under the Walmart (supercenter), Wal-Mart (discount store), and Walmart Neighborhood Market trademarks in addition to Walmart web channels: 1)    2

entry barriers are considerable. In addition, it is considerably harder for any new entry to find outlet space at great locations as the established stores have already taken over all desirable areas in the market. Lastly, new entrants would need to offer many incentives to the customers to convince them to stop shopping at the established stores and switch because many consumers have brand recognition and loyalty for their current merchants (MBA Skool, 2022). The Threat of Substitute: The threat of substitutes to Target is quite severe because there are many available alternatives to Target's goods. It tries to differentiate its products, but competition is still fierce. Also, the threat of alternatives has increased as a result of the development of internet shopping because it is now much simpler to have groceries delivered to the door and at substantially reduced costs (MBA Skool, 2022). Bargaining Power of Customers: Customers can easily change merchants if they are dissatisfied with one because there are many alternatives in this market and switching fees are inexpensive. In addition, the services are what any customer looks forward to because all the offered products are similar at similar prices. However, since there are so many consumers and their purchases aren't always significant, the customer's bargaining power is slightly diminished. Also, Target has an excellent reputation globally, and many customers are devoted to the store because of its strong brand recognition, affordable prices, and attentive customer care (MBA Skool, 2022). Bargaining Power of Suppliers: Manufacturers or large distributors who are established in the market supply Target. They offer goods to a wide range of merchants, so they can switch their supplies to another retailer if the deal fails. On the other hand, Target is a well-known company, and all suppliers want to 4

work with them to earn a similar reputation and notoriety. Furthermore, there is a high likelihood of standardization because suppliers can start their own outlets and offer the goods for less because they will save on distribution costs. Nonetheless, due to the huge number of suppliers and no product differentiation, it will be simple for the target to change suppliers in the event of a conflict (MBA Skool, 2022). As a result, suppliers' bargaining position becomes moderate. Competitive Rivalry: As a constantly growing sector, the retail business has drawn significant investment from domestic and foreign sources. Many retail competitors of Target have entered the industry due to the availability of capital, and currently, the competition is intense. There are numerous domestic competitors in each region, as well as numerous worldwide rivals like Alibaba, Walmart, Amazon, and others. So, it is necessary for Target to stay informed about new trends and to generate sufficient profits to provide decent discounts in comparison to other participants. It is simple to compete because the products are widely available and have many alternatives (MBA Skool, 2022). Walmart’s Industry Analysis Porter's Five Forces Analysis can analyze the competitiveness and industry-specific factors that influence Walmart. The analysis includes the threat of new entrants, the threat of substitutes, the bargaining power of customers, the bargaining power of suppliers, and competitive rivalry. The Threat of New Entrants: While entry barriers to the retail industry are moderate to high, Walmart faces a moderate to low threat from new competitors. Walmart doesn't need to worry too much about new entrants because it is the market leader in the United States and the largest retailer globally. The funding 5

be demanding. Additionally, Vendor Managed Inventory (VMI), a unique supply chain effort used by Walmart, places the responsibility of inventory management on the suppliers (MBA Skool, 2022). This strategy is for meeting the needs of both vendors and customers because it puts them at the center of many supply chains. This lessens the supplier's power in negotiations. Competitive Rivalry: Competitive rivalry is moderate in this industry because there are few major firms and several lesser competitors on a domestic level. It has been able to capture most of the market due to its presence in both online and offline channels. It encounters considerable competition, but as the industry leader, it can set its own terms. It also faces low threats from small-scale local opponents because the trademark gives them a significant advantage, and the local companies cannot compete with the price edge of Walmart (MBA Skool, 2022). Target’s Financial Ratios Liquidity Ratios The current ratio for Target Corp. increased in 2020 but then slightly declined from 2020 to 2021 (see appendix A). The exact store growth and e-commerce sales growth were the primary drivers of the increase in current assets in 2020. In addition, Target had to increase its current assets because of a spike in demand for its products during the COVID-19 crisis. This also resulted in a rise in current liabilities to accommodate this demand. So, the demand probably explains the small change between the two years. Still, the ratio seems ideal since it is around 1 for both years. Target has 0.35 in quick assets for each $1 in the current liabilities for 2021. Its quick ratio increased in 2020 but slightly declined from 2020 to 2021 and didn't reach the ratio of 2020 7

(see appendix A). This ratio can indicate that the corporation may struggle to satisfy its short- term obligations. Leverage Ratios The interest coverage ratio for Target Corp. dropped in 2020 but then highly increased from 2020 to 2021, surpassing the 2020 level (see appendix A). So, it wasn't terrible in 2020 as well, but it was solid in 2021, which indicates Target's high capacity to cover its interest expenses from its operational profits. The debt-to-equity ratio of Target Corporation (including operational lease liabilities) grew from 2020 to 2021. It had $3.19 in debt for each $1 in equity (see appendix A). This is not too ideal because it should not be higher than $1 or $2 for every $1 of equity. The debt-to-assets ratio for Target Corporation grew from 2020 to 2021. It was $0.76, which seems ideal as it is below $1. Thus, this indicates that the company is relatively safe in terms of leverage. Efficiency Ratios: Target's ratio indicates that it sold 6.1 times as much inventory as it had on hand throughout the period. So, it seems effective at managing its inventory. Additionally, the inventory turnover ratio at Target Corporation increased between 2020 and 2021 (see appendix A). It is probably because Target's COGS increased significantly while its inventory increased slightly between the two years. The growth is driven by its online sales as well as its store sales. Profitability Ratios: 8

The debt-to-equity ratio for Walmart Inc. was almost the same between 2020 and 2021. It was $1.88 in debt for each $1 in equity (see appendix B). This is a decent ratio that has been remarkably stable over the years. It shows that the company is financing asset purchases with more debt than equity, but its debt management procedures have remained constant for a while, and the company avoided using excessive debt even during economic uncertainty (Depresio, 2022). The debt-to-assets ratio for Walmart Inc. was almost the same between 2020 and 2021 as well. The ratio was $0.65, which seems ideal as it is below $1 (see appendix B). So, this indicates that the company is relatively safe in terms of leverage. Generally, due to the pandemic, many businesses increased their debt levels to stay in business. However, looking at Walmart's ratio, it maintained constant debt and has avoided an increase because of the pandemic. Efficiency Ratios: The inventory turnover ratio for the business was 9.4 (see appendix B). This indicates that Walmart sold 9.4 times as much inventory as it had on hand throughout the period. So, it is effective at managing its inventory. Also, the inventory turnover ratio for Walmart increased from 2020 to 2021. It's probably high because people were storing up supplies during the pandemic. Profitability Ratios: The return on assets (ROA) for Walmart in 2021 was 5%. The ratio seems ideal, but a bit higher would have been better. Additionally, the ratio increases slightly from 2020 to 2021 (see appendix B). The change is because companies had to reduce expenses to survive the pandemic, but this wasn't the case in 2021. 10

Walmart's gross margin percentage was 24 percent. The Gross profit margin ratio for Walmart Inc. increased from 2020 to 2021 (see appendix B). It is probably higher than in 2020 because it had to reduce its prices further in order to compete during the pandemic. Finally, Walmart's basic financial measures provide assurance that paying debts will not be a problem for the corporation, even though slightly better liquidity and leverage ratios would be nice to see. Target's Dividend Discount Model After studying the payment history of Target, its dividend consistently grows by around 8 cents annually, which equals an average growth of around 3%. The WACC calculated is 9% (see appendix C). Thus, the per-share value can be determined using the dividend discount model: Dividend Discount Model = Expected Dividend / WACC - Dividend Growth Dividend Discount Model (2020) = 2.62 / (9% - 3%) = 43.66 Dividend Discount Model (2021) = 2.69 / (9% - 3%) = 44.83 Dividend Discount Model (2022) = 2.77 / (9% - 3%) = 46.16 Dividend Discount Model (2024) = 2.85 / (9% - 3%) = 47.5 Dividend Discount Model (2025) = 2.93 / (9% - 3%) = 48.83 Data:     Cash Flow per Share 2.62 Growth (g) 3% WACC (r) 9% Stock Price Formula:   CF0(1+g)/(r-g)       Stock Price Calculation:     Year 0 Year 1 11

Furthermore, Target might be slightly undervalued when compared to Walmart, but it is understandable. This is because Walmart sells a lot of food products, whereas Target relies heavily on discretionary items for its sales (80% of revenues). Discretionary expenditures will be the first people will give up on during inevitable inflations. So, in the future, Target's comparable sales figures will be more delicate. The company is focused on product categories that sell food, but since the other major categories make up over 55% of the company's revenues, it is more likely to be impacted than Walmart (Blokhin, 2022). Thus, it makes sense that Target might be valued slightly lower than Walmart. Lastly, Target appears to be undervalued when compared to the straightforward valuation criteria, price-earnings ratio. It is currently trading for 14.5 times earnings, which is less than the 10-year average of 16.5 (Schonberger, 2022). As mentioned earlier, Target also appears to be trading below its implicit value when compared to its industry and competitors, such as Walmart, in addition to the P/E ratio's indication (being undervalued). Thus, Target’s dividends will probably increase more in the upcoming years since the undervalued stocks are the ones to purchase. Current Market Price: The calculated stock price of Target was about $44.97, with a 3% constant growth rate over the years. However, it is currently trading at 146.45. The current stock price appears to be overpriced when comparing both values. It does seem rather expensive, and investors might not find it the best buy anymore. However, the financial standing of Target is solid, and it is profitable. It is less risky due to its consistent profitability. Its average annual revenue growth over the past three years has increased, outpacing 83% of other companies in the retail sector (Yahoo Finance, 2021). Also, a highly decent dividend has been paid by the corporation for 50 13

straight years. Therefore, the current stock price does not seem like a strong buy due to its expensiveness, but it is worth holding on to in case it's already bought, considering its stability. Walmart's Dividend Discount Model: After studying the payment history of Walmart, it's clear that the company pays out annual dividends in chronological order. For example, it paid out $2.04, $2.08, 2.12, and 2.16 from 2018 to 2021. So, the Walmart dividend consistently grows by 4 cents annually, which equals an average growth of around 2%. The WACC calculated is 6% (see appendix D). Thus, the per-share value can be determined using the dividend discount model: Dividend Discount Model = Expected Dividend / WACC - Dividend Growth Dividend Discount Model (2020) = 2.12 / (6% - 2%) = 53 Dividend Discount Model (2021) = 2.16 / (6% - 2%) = 54 Dividend Discount Model (2022) = 2.20 / (6% - 2%) = 55 Dividend Discount Model (2023) = 2.24 / (6% - 2%) = 56 Dividend Discount Model (2024) = 2.28 / (6% - 2%) = 57 Data:     Cash Flow per Share 2.12 Growth (g) 2% WACC (r) 6% Stock Price Formula:   CF0(1+g)/(r-g)       Stock Price Calculation:     Year 0 Year 1 Div/Cash Flow 2.12 2.16 Stock Price   54.06 Walmart's Analysis 14

marginally grew to 57. Thus, buying the stock wouldn’t be recommended to investors expecting significant capital gains and strong growth. Overall, the value of the stock price has sustained to rise and is considered mature. For constant growth and little risk, it would be a great investment for an investor to keep on for a number of years. Thus, Walmart seems fairly valued based on the above analysis. Current Market Price: The calculated stock price of Walmart was about $54, with a 2% constant growth rate over the years. However, it is currently trading at 142.75. The current stock price appears to be overpriced when comparing both values. The price-to-earnings growth ratio for the company is 3, the stock is trading at 5 times book value, and the company is currently valued at 22 times projected earnings for the upcoming year. Despite having a healthy cash flow and balance sheet, Walmart has approximately $60 billion in debt, a payout ratio of 45%, and a current yield of only 1.48%. It has increased its market share over the past few years because of the epidemic and the subsequent severe inflation. Since customers gradually upgrade, Walmart may not be unable to hold onto most of its gains in market share for very long (Skeptical, 2022). Its growth rate is moderate and limited, and there is minimal scope for it to open additional retailers in the U.S. Thus, the current stock price isn't expected to be a large winner like the calculated one because the price is far beyond its buy point. The current stock is not a smart investment at this time. Sensitivity Analysis: The sensitivity analysis is conducted for the stock value of both Target and Walmart using the WACC and constant growth rate (see Appendix G and H). So, the value in each cell is recalculated based on the different entries. Some of the values in the cells are undefined because the denominator is zero in the estimation. 16

To conclude, Target and Walmart were both carefully assessed in this paper, which included their fundamental overviews, industry analyses, financial ratios, dividend discount models, stock price analysis, and sensitivity analysis. Appendixes Appendix A     Target's Financial Ratios 2021 2020 Liquidity Ratios     Current Ratio = Current Assets / Current Liabilities   Current Assets 21573 20756 Current Liabilities 21747 20125 Current Ratio 0.9919989 1.0313540 4       Quick Ratio = Current Assets - Inventory / current liabilities   Current Assets 21573 20756 Current liabilities 21747 20125 Inventory 13902 10653 Quick Ratio 0.3527383 1 0.5020124 2       Leverage Ratios     Interest coverage ratio = EBIT / Interest Expense   EBIT (Earnings before interest and taxes) -> income statement 8907 5546 Interest Expense 421 977 Interest coverage Ratio 21.156769 6 5.6765609 17

Current Ratio = Current Assets / Current Liabilities   Current Assets 90067 61806 Current liabilities 92645 77790 Current Ratio 0.9721733 5 0.7945237 2 Retail Industry Average           Quick Ratio = Current Assets - Inventory / Current Liabilities   Current Assets 90067 61806 Current liabilities 92645 77790 Inventory 44949 44435 Quick Ratio 0.4869987 6 0.2233063 4           Leverage Ratios     Interest coverage ratio = EBIT / Interest Expense   EBIT (Earnings before interest and taxes) -> income statement 20564 20116 Interest Expense 2194 2410 Interest Coverage Ratio 9.372835 8.3468879 7         Debt to Equity Ratio = Total Liabilities/ Total Equity   Total Liabilities 164965 154943 Total Equity 87531 81552 Debt to Equity ratio 1.8846465 8 1.8999288 8         Debt to Asset Ratio = Total Debt / Total Assets   Total Debt 164965 154943 Total Assets 252496 236495 Debt to Asset Ratio 0.6533370 8 0.6551639 6           Efficiency Ratios     Inventory Turnover Ratio = = COGS / Average value of inventory   19

COGS 420315 394605 Average value of inventory 44692 44352 Inventory Turnover Ratio 9.4047033 8.8971185 1           Profitability Ratios     Return on Asset = Net Income / Total Assets   Net Income 14549 13618 Total Assets 252496 236495 ROA 0.0576207 1 0.0575826 1     Gross Margin Ratio = (Total Revenue - COGS) / Total Revenue   Total Revenue 559151 523964 COGS 420315 394605 Gross Margin Ratio 0.2482978 7 0.2468852 8 Appendix C     Target's WACC     WACC (Weighted Average Cost of Capital) = cost of equity * % equity + cost of debt *% of debt Equity 12827   Debt 40984   Total Liabilities and Equity 53811   %. Equity 23.837133 7 23.80% % Debt 76.162866 3 76.10% Cost of Equity = Required return 34.76%   Cost of Debt = Total Interest / Total Debt 0.0102723   Tax Rate 22%   WACC 9.0684177 9       Side Work:   Required return = risk free rate + beta * (market rate - risk free rate) 34.76%   Risk-free rate 4.58%   20