Derivatives & Risk Management Case Study: Walmart’s Use of Interest Rate Swaps
Walmart’s emergene as a glo!al !e"emot" !egan wit" t"e opening of t"e #rst Walmart store !y Sam Walton in $%' in Rogers( )rkansas*
Walmart’s suess was due to a disiplined ad"erene to t"e strategy of pur"asing "ig" volumes diretly from manufaturers om!ined wit" pioneering investments in information te"nology t"at allowed it to e+etively manage its supply "ain and distri!ution networks*
Walmart losed t"e twentiet" entury as t"e United State’s largest generator of sales and t"e world’s largest private,setor employer*
It targeted an inrease in its s"are of U*S* retail s"are sales from -. to $/.*
Introdution
0o
rea" t"is target( Walmart ompany o1ials !et on growt" of its Superenter stores( w"i" were larger versions of its 2ags"ip stores t"at added groeries to t"e normal produt o+erings*
Introdution
3aving #rmly esta!lis"ed itself as t"e prominent U*S* retailer( Walmart soug"t to !uild on it’s international e4pansion*
In '555( Walmart announed t"at international sales would aount for 65. of total sales !y '55/*
et Sales ;in
7rowt" and C"allenges: '555 ,'55/
'88
'/
'$9 $%$ $/
'555*5
'55$*5
'55'*5
'556*5 et Sales
'558*5
'55/*5
'55*5
Walmart Stores
$%-5
7rowt" and C"allenges: '555 ,'55/
$96
$9$6
$89
$/-
$89$6/6
$'/$5 %8'
%-'
'55'*5
'556*5
--$'
8-
'555*5
'55$*5
Dis ount Stores
Super enter s
$86$
$$9/
$'5%
'558*5
'55/*5
I nternatio nal Stores
7rowt" and C"allenges: '555 ,'55/
Walmart’s Reliane on De!t
'*6 !illion from !ond issuanes and only >/-$ million from e?uity issuanes*
Walmart’s long,term de!t grew from >$-*- !illion in '555 to >6/*$ !illion in '55( an inrease of -9.*
In onnetion wit" its !onds( Walmart also entered into interest rate swaps( w"i" impated its e4posure to "anges in market interest rates*
0"e
proportion of Walmart’s #4ed,rate de!t t"at was e4posed to 2oating rates as a result of Walmart’s interest rate swap ativity inreased steadily from /*-. in '55$ to a "ig" of /$*6. in '558*
Walmart typially swapped t"e #4ed rate payment o!ligations on its outstanding de!t for payments t"at would 2utuate wit" @ondon Inter!ank A+ered Rate ;@I
Walmart’s Reliane on De!t
Walmart’s Reliane on De!t
November 16, 2004 Q3 2005 Conference Call :
W"ile we are all pleased to see t"at t"e general improvement in t"e eonomy "as !een strong enoug" to trigger t"e Bed to raise interest rates( rising rates will o!viously "ave an adverse e+et on our !orrowing osts*
)nalysis
)t t"e end of Wal,Mart’s '55$ #sal year( during w"i" t"e yield urve was inverted on average ;spei#ally( t"e average $,year 0reasury yield was "ig"er t"an t"e average $5,year 0reasury yield !y %*/ !asis points making 2oating rates "ig"er t"en #4ed rates=( Wal,Mart "ad swapped only 6*%. of its de!t from a #4ed to a 2oating interest rate e4posure( resulting in an overall 2oating de!t e4posure of $-*9.*
During t"e '55' #sal year( t"e average 0reasury yield spread ;t"e $5,year 0reasury yield minus t"e $, year 0reasury yield= "ad risen to $*9/.( making 2oating rates signi#antly lower t"an #4ed rates* Wal, Mart ommensurately inreased its pay,2oating interest rate swaps to $9*6. of its de!t( !ringing '/*6. of its de!t to a 2oating e4posure*
0"e
0reasury yield spread rose even furt"er during t"e '556 #sal year( to an average of '*/%.* Wal, Mart again inreased its pay,2oating interest rate swaps to 6'*. of total de!t( resulting in 85*-. of its de!t wit" a 2oating e4posure*
In fat( its interest e4pense fell !y >'% million ;$-*/.= even t"oug" its total de!t inreased !y >6*/ !illion ;$*$.=* 0"eir resulting earnings e4eeded t"eir onsensus analyst earnings per s"are foreast !y t"ree ents in '556*
Consistent wit" t"e steep yield urve of '556( !y t"e end of Walmarts '55/ #sal year( s"ort,term interest rates "ad risen onsidera!ly* 0"is "ig"er interest rate environment led Walmart to issue an earnings warning stating t"at it e4pets interest e4penses to raise as mu" as >/55 million t"is year( due in part to "ig"er interest rates t"at ould "urt earnings !y eig"t ents a s"are
)nalysis
)nalysis
In e+et Wal,Mart "ose to drastially redue t"eir interest e4pense from '55' to '556 !y swapping to 2oating w"en t"ey ould "ave loked in low #4ed rates and avoided t"e antiipated inrease in 2oating rates t"at materialied in '55/*
0"is
strategy resulted in a near term gain in '55' at t"e e4pense of future earnings in '55/*
