Fitch: Wal-Mart Not Immune to Challenges Facing Discount Sector

Today's revised earnings guidance from Wal-Mart underscores the fact that the store is not immune to the economic challenges confronting the discount retail sector over the past year, according to Fitch Ratings.

These challenges include the increase in the payroll tax at the beginning of 2013 and the sluggish pace of job creation, both of which have disproportionately affected discounters' core low and middle-income customers. Wal-Mart also faces growing competition from dollar stores and hard discounters, as well as online retailers such as Amazon.

Negative comp store sales in the Wal-Mart U.S. business in 2013 follow four years in which comp sales ranged from -1.5% to 1.8%. Despite soft top-line results, Wal-Mart has been able to maintain a steady operating margin at or near 6% (5.9% in the LTM ended Oct. 31, 2013), as modest gross margin pressure has been offset by expense leverage. Going forward, Fitch expects operating margins will remain consistent with these levels.

The consistency of Wal-Mart's operating margins highlights the benefit of its dominant market position in North America and strong position in other markets internationally, as well as its low cyclicality and consistent free cash flow (FCF).

Steady operating results have enabled Wal-Mart to generate stable credit metrics over time, with adjusted debt/EBITDAR of 1.7x-2.1x and EBITDAR/interest plus rents of 7.8x-8.3x over the past five years.

Fitch expects FCF after dividends were around $4 billion in 2013, which is lower than recent experience due to a larger increase in working capital. FCF is expected to return to a more normalized range of $6 billion to $7 billion annually. The company is expected to direct this cash flow, and potentially some incremental borrowings, to share repurchases as it manages its adjusted debt/EBITDAR ratio at or under 2.0x, in the context of maintaining its 'AA' rating.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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