5.18 Example:  Wal-Mart versus Target

First, construct the ratios from the 10-K reports (Consolidated Balance Sheet for R1, R2, R4) and Consolidated Income Statement/Balance sheet for R3 & R5.

Wal-Mart:  In Valuation Tutor you can bring up the 30th March 2010 10-K and set up the Income Statement and Balance Sheet as described in section 5.2.  These statements contain the raw data for the following example:

 

Net Working Capital = (Current Assets - Current Liabilities) = 48331 – 55561

Total Assets = 170,706

Retained Earnings = 66,638

EBIT = 23950

Shareholders’ Equity = 72,929

Total Liabilities = 97,777

Sales = 408,214

Weighted-average number of shares Diluted = 3,877

 Ratios: 

In the above the Adjusted Z-Score more appropriately uses the current market value in lieu of Shareholders’ Equity.

Neither WMT or TGT are judged as being distressed using Altman’s Z-score.

Alternative Version of the Altman Z-score:  EM Model

An alternative form of the Altman model has been constructed (Altman, Hartzell and Peck (1995)) referred to as the EM-score (emerging markets) model.  This  is defined as:

EM Score = 3.25 + 6.56(X1) + 3.26(X2) + 6.72(X3) + 1.05(X4)

Where:

X1 = Working Capital/Total Assets = (Current Assets - Current Liabilities)/TA

X2 = Retained Earnings/Total Assets

X3 = EBIT/Total

X4 = Book Value or Market Value of of Equity divided by Total Liabilities

This model has been used to estimate bond ratings for a firm’s debt.  The following table provides the estimates:

 

 

 

 

Rating            

EM Score             

Rating                         

EM Score

AAA

8.15

BB+

5.25

AA+

7.60

BB

4.95

AA

7.30

BB-

4.75

AA-

7.00

B+

4.50

A+

6.85

B

4.15

A

6.65

B-

3.75

A-

6.40

CCC+

3.20

BBB+

6.25

CCC

2.50

BBB

5.85

CCC-

1.75

BBB-

5.65

D

0.00

The extended model uses R1-R4 above plus an intercept term.  For Wal-Mart and Target this is:

This places Target between A to A-  and Wal-Mart at Investment grade (BBB to BBB+).  For Wal-Mart on face value they have a negative current ratio.  This reflects their very aggressive working capital policy discussed earlier as opposed to any liquidity problems.  As a result, ratings’ agencies, when taking into account both qualitative and quantitative aspects of a firm, are unlikely to view this as a negative signal for Wal-Mart. 

Target’s implied bond rating from the EM model is slightly lower than current bond ratings (A to A+). Valuation Tutor by allowing you to work with averages for Industry, SIC or user defined benchmarks, provides a powerful tool for analyzing and predicting and understanding bond ratings.

Now that you understand how to work with this assessment you can use the Valuation Tutor calculator as the following P&G Reconciliation illustrates: