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Walmart not married to current ratings

| October 19, 2018

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

During an investor meeting Walmart’s CFO remarked that “we’re not married to our credit rating”, while discussing the potential for future acquisitions. The comment spooked Walmart’s bond investors, with medium to long-term debt widening 5 to 7 bp. The 30-year bonds could retest the June wides, particularly if speculation intensifies that Walmart may pursue a potentially transformative acquisition of Humana or Anthem.

Investment meeting recap

Walmart hosted an investment meeting earlier in the week that focused on its unique asset base coupled with its strong execution and innovation. Management used the time to reiterate fiscal year 2019 (FY19) total sales growth guidance of roughly 2% on a constant currency basis and updated full year earnings per share (EPS) guidance due to dilution from the Flipkart acquisition. Walmart management now expects FY19 adjusted EPS to be in the $4.65-$4.80 range, down from $4.90-$5.05, and provided FY20 guidance of total sales growth of 3% or greater, and SSS growth of 2.5%-3%. Management is forecasting that e-commerce growth will be roughly 35% for the year.  While 35% is a solid number, it is down from the 40% expected in FY19.

Interestingly enough, management used the meeting to discuss its financial prowess as they are the first company with $0.5 trillion in annual revenue and a rock solid balance sheet underscored by AA ratings.  However, when asked about asked about potential acquisitions and their willingness to “flex outside” of its current ratings, management noted that they were not “married” to the credit ratings and the ratings would not be a reason for them to not pursue an acquisition that was good for the business long term.  The comments alone injected some volatility into a credit that that is rarely characterized as volatile. The 5-year part of the curve widened roughly 7 bp after the headlines, while 10-year to 30-year paper widened out about 5 bp.

Potential Candidates

Walmart’s comments highlight the real threat from not only competitors but growth in general. While retail conditions have improved and Walmart’s annual same store sales growth is at levels last seen in fiscal 2009, the days of 5% annual growth seem to be a thing of the past. Retail has largely become a story of the have’s and have not’s as evidenced by the latest bankruptcy filing of Sears. Given WMT’s size and strong cash position on the balance sheet ($15.8 billion as of 7/31/18) any acquisition that would potentially move the needle with respect to its ratings would need to be quite large.  Earlier this year, WMT was speculated to be in talks to acquire or partner with Humana Inc. (HUM – Baa3/BBB+/BBB).  An HMO is a likely target and we believe Anthem Inc. (ANTM – Baa2/A/BBB) may be the better target.  In August, WMT and ANTM announced that they will be partnering to launch a program in January 2019 that would allow Anthem Medicare Advantage plan members to use over the counter (OTC) allowances for OTC medications and health-related items at both WMT stores and on walmart.com.  The partnership could be the first step in a potential acquisition down the road.

Relative Value

With the recent widening in the credit, Walmart bonds now trade roughly 7 bp wide to Home Depot (HD – A2/A/A) in the 10-year part of the curve (WMT 2028s 70/68 versus HD 2027s 63/60). This is consistent with credit default swaps, where Home Depot 5-year CDS is currently trading 5 bp inside of WMT.  However the reverse is true in the 30-year part of the curve, where WMT trades roughly 4-5 bp through HD (WMT 2048s 93/91 versus HD 2047s 98/95).  Walmart debt could come under further pressure in the 30-year part of the curve, and retest the wides witnessed in June, which were roughly around the 100 bp area.

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