American retail giant Wal-Mart (NYSE:WMT) has been investing heavily to expand and keep pace with the changing dynamics of the market. The big-box retailer's annual capital expenditure has consistently been north of $12 billion in the past decade, with the exception of 2009 when it was $11.5 billion.
For investors, it could mean an enormous figure eating into the company's cash flow, and naturally they might be curious to know where all that money is going. Let's take a deep dive to see whether Wal-Mart's huge capital investments are necessary to spur growth and enhance shareholder returns.
In the last 10 years, Wal-Mart has controlled its capex, scaling it down from over 4% of sales in the prerecession period to less than 3% in the last couple of years. Costco Wholesale (NASDAQ:COST) invests a lower proportion of its sales on capex than Wal-Mart. But this is to be expected because Costco is a warehouse club and needs to spend minimally on things like decor and attractive store layout. In comparison, other than Sam's Club, which has a business model similar to Costco's, Wal-Mart has to invest more on design and décor of its various other store formats.
Bringing into the picture Target's (NYSE:TGT) capital spending, we find that Wal-Mart has been more prudent than Target. Though the latter has also lowered spending in the post-2008 scenario, Target's capital budget is nearly 5% of its revenue because of ongoing expansion in Canada. So, Wal-Mart's spending appears reasonably balanced considering its scale of operations, but we need to see whether it's investing the money in profitable avenues.
Investing for future growth
Wal-Mart expects the capex for its current fiscal year, ending Jan. 31, 2015, to be in the range of $12.4 billion to $13.4 billion. This is $600 million more than what the company had forecast for the year back in October 2013.
It plans to invest more in U.S. operations than envisaged earlier. Wal-Mart will exhaust more than half of its capital budget on Wal-Mart U.S., around 33% on Wal-Mart International, and around 8% each on Sam's Club, and Corporate & Support. New investments will be centered around increasing small format stores in the U.S., international expansion, and e-commerce.
Neighborhood Markets and Express stores: The reason behind Wal-Mart's stepped up capital spending in the U.S. is the fast expanding dollar store chains that are eating into the retail giant's market share by drawing its low-end customers. It needs to win over consumers preferring to visit local groceries, dollar stores and neighborhood pharmacies. Presently, Wal-Mart has two small-store concepts: Express stores and Neighborhood Markets. It plans to open 90 to 100 Express stores and about 180 to 200 Neighborhood Markets in the U.S. this fiscal year.
Expanding global operations: With flat same-store sales in the U.S., strengthening international operations has become crucial. Wal-Mart entered the global market in 1991 and currently operates more than 6,100 stores in 26 countries.Its international efforts have reaped results as sales moved up 3.1% to $33.9 billion and operating income grew 8% to $1.4 billion in the second quarter, ended July.
To continue the growth momentum Wal-Mart's kept a $1 billion capital budget for its largest market, Mexico (2,300 stores), which will see 149 new stores this year. There will be more investments in China and India especially with focus on e-commerce. Notably, Yihaodian, Wal-mart's e-commerce grocer platform in China, is recording triple-digit growth. In Canada, Wal-Mart is stressing home and apparel as the grocery market is highly competitive and has become tougher with Target's entry.
Enhancing global e-commerce capability: Increasing its e-commerce reach is one of the Wal-Mart's biggest challenges. Wal-Mart has e-commerce websites in 11 countries and has acquired 14 companies in the last three years. Bloomberg reports that the pace of acquisition is going to increase. In fiscal year 2014, nearly 20% of Wal-Mart's total capex or around $2.5 billion went in e-commerce initiatives.
The company's built a recommendation engine for improving personalized searches, enhanced the experience of mobile shopping, widened the global technology platform, and broadened the assortment of merchandise on Wal-Mart websites. Thanks to these programs the retail giant's global e-commerce sales jumped 24% in the second quarter with phenomenal growth seen in China, Brazil, U.K., and the U.S. In future, the company plans for a better checkout procedure and is also developing a new e-commerce fulfillment center in Indiana.
What's in it for investors
So, Wal-Mart is putting billions in strategic growth avenues, but the final test lies in assessing whether these investments are creating value for investors. Return on invested capital (ROIC), which measures how well a company utilizes the capital invested in the business, is a relevant metric to assess these strategic plans.
Wal-Mart has consistently generated double digit returns in the last 10 years. In comparison, its weighted average cost of capital, using the last three years' data, is around 5.2%. The wide spread between the two indicates that Wal-Mart is utilizing its capex dollars profitably and maximizing shareholder returns.
Wal-Mart's spending is in line with the industry trends and commensurate with its size and operations. Investors can take heart from the fact that the company is spending its capex dollars profitably and fortifying its future growth prospects.
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.