4.17 Corporate Debt
Market: Wal-Mart and
Target Different Approaches
From the
10-K it is evident that Wal-Mart has more of a mix of short term
debt and interest rate swaps as part of its financing strategy.
This is reflected in the comparison of the long term debt
to total debt ratios for Wal-Mart and Target.
Observe that Wal-Mart is increasing its reliance on short
term debt to take advantage of the very low interest rate
environment in the US whereas Target is pursuing a more
traditional approach of increasing its long term debt.
However, the subtle difference between Wal-Mart’s and
Targets financing strategy is revealed in the following part of
the 10-K report from Wal-Mart:
We enter into interest rate swaps to minimize the risks and
costs associated with financing activities, as well as to
maintain an appropriate mix of fixed and floating-rate debt. Our
preference is to maintain between 40% and 60% of our debt
portfolio, including interest rate swaps, in floating-rate debt.
The swap agreements are contracts to exchange fixed- or
variable-rates for variable- or fixed-interest rate payments
periodically over the life of the instruments. The aggregate
fair value of these swaps represented a gain of $240 million and
$304 million at
January 31, 2010 and 2009, respectively. A hypothetical increase
or decrease of 10% in interest rates from the level in effect at
January 31, 2010, would have resulted in a loss or gain in value
of the swaps of $25 million and $24 million, respectively. A
hypothetical increase or decrease of 10% in interest rates from
the level in effect at January 31, 2009, would have resulted in
a loss or gain in value of the swaps of $17 million.
You can
see that Wal-Mart uses swaps to manage the cost of financing as
well as to manage interest rate risk, and they are aware of the
risks of the contracts, and that this was profitable.
On the
other hand, a close reading of the 2010 10-K reveals that
Target’s use of swaps is for hedging interest rate risk as
opposed to reducing borrowing costs.
A relevant excerpt from Target’s 10-K is:
Derivative financial instruments are reported at fair value on
the Consolidated Statements of Financial Position. Our
derivative instruments have been primarily interest rate swaps.
We use these derivatives to mitigate our interest rate risk. We
have counterparty credit risk resulting from our derivate
instruments. This risk lies primarily with two global financial
institutions. We monitor this concentration of counterparty
credit risk on an ongoing basis.
This
implication is reinforced by comparing the borrowings and
interest expense from the two firms.
For Target the debt that is not collateralized by credit
card receivables is:
2009: 707+10643,
2010: 728+12000
Targets
interest expense is:
2009: 707, 6.18%
2010: 728, 5.49%
This is
higher than Wal-Marts debt:
2009: 37,804
2008: 38,703
and the
interest expense is:
2009: 1787, 4.72%
2008: 1896, 4.90%.
From the
above it appears that Target is paying more for its non-credit
card collateralized debt than is Wal-Mart.
Qualification
While we
see differences in the financing strategies, this does not
necessarily mean that one firm has a better strategy.
For example, in the low interest rate environment of 2009
and 2010, a company with a good credit rating can lock in low
rates for a long period rather than using other methods.
It also depends on the company’s debt portfolio; if it
had issued high interest rate debt in the past, it can take
advantage of interest rate swaps.
If it has very little debt, it may be better to issue new
debt at fixed rates.
We next
turn to the main theme underlying leverage analysis.
This is to relate the various activities performed by a
firm to growth.