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Case 6-1 You chair the Board of Directors at Target Corporation. After the firm released its 2014 financial statements, you are faced with an important decision. The first agenda item at the next board meeting is whether to retain or dismiss the company's chief executive officer. As head of the board, you will introduce this issue, state your position, and moderate the ensuing discussion. As you contemplate this important recommendation, you consider the following items about your company and its industry. Target Corporation is a Minnesota company incorporated in 1902. Target described itself in its 2014 annual report by stating, \"We offer our customers everyday essentials and fashionable differentiated merchandise at discounted prices.\" Target is the second largest discount retailer in the United States behind Walmart when measured by sales revenues, total assets, and market capitalization. Retailing is the economic sector that links the producer of products to end-use customers. It is the largest segment of the American economy. The totality of retail transactions constitutes about two-thirds of the gross domestic product (GDP) in the United States, according to U.S. Department of Commerce. Financial analysts view merchandising as a mature industry, defined by intense competition, low profit margins, and business consolidation. Numerous economic factors affect retailers. Notable among them are real changes (inflationadjusted) in GDP, levels of disposable income, and consumer confidence. In short, people shop when they have money, and they are confident that they will have it in the future. Consequently, retailers tend to thrive during economic expansions and suffer during economic contractions. The 2007-2009 economic down turn hurt sales for all retailers. Sales have rebounded in the five years after the recession, but many analysts feel that industry performance remains sluggish. Marketers note the post-recession watchword for retail customers is value. Consumers, regardless of economic standing, want quality at a relatively low price. A recent threat to traditional bricks and mortar retailers, such as Target, has been the rise of online retailing. Firms such as Amazon have taken sales and market share away from Target, Walmart and others who primarily sell their goods at fixed locations. In addition to this general industry threat, Target has faced numerous company issues. The primary ones are an ill-fated attempt to launch stores in Canada, an extensive data breach to its customers' information, and the erratic performance of its Target credit card business. More importantly, some analysts have criticized Target from losing sight of its objective as the upscale discounter; a purveyor of cheap chic, which differentiated the firm from its competitors. You turn your attention to Target's four most recent income statements, balance sheets, and statements of cash flows excerpts: Target Corporation Income Statements (in millions of dollars) 2014 2013 2012 2011 Total revenues $ 72,596 $ 73,301 $ 69,865 $ 67,390 Costs of sales 51,160 50,568 47,860 45,725 Gross profit 21,436 22,733 22,005 21,665 Operating expenses 17,207 17,362 16,683 16,413 Operating income 4,229 5,371 5,322 5,252 Net interest cost 1,126 762 866 757 Income before income taxes 3,103 4,609 4,456 4,495 Income tax expense 1,132 1,610 1,527 1,575 2,929 $ 2,920 Net income $ 1,971 $ 2,999 $ Target Corporation Balance Sheets (in millions of dollars) 2014 2013 2012 2011 Assets: Cash $ 695 Accounts receivable $ - 784 $ 794 $ 1,712 5,841 5,927 6,153 Inventories 8,766 7,903 7,918 7,596 Prepaid expenses and other 2,112 1,860 1,810 1,752 Total current assets 11,573 16,388 16,449 17,213 Property, plant, & equipment, net 31,378 31,663 29,149 25,493 1,602 1,122 1,032 999 $ 44,553 $ 48,163 $ 46,630 $ 43,705 $ $ $ 6,857 $ 6,625 Other assets Total assets Liabilities and Shareholders' Equity: Current liabilities: Accounts payable 7,683 7,056 Other current liabilities 5,094 6,975 7,430 3,445 Total current liabilities 12,777 14,031 14,287 10,070 Long-term liabilities 15,545 17,574 16,522 18,148 Total liabilities 28,322 31,605 30,809 28,218 Contributed capital 4,523 3,979 3,543 3,370 Retained earnings 12,599 13,155 12,959 12,698 Shareholders' Equity: 2 Other shareholders' equity (891) (576) (681) (581) 16,231 16,558 15,821 15,487 $ 44,553 $ 48,163 $ 46,630 $ 43,705 2014 2013 2012 2011 5,434 $ 5,271 Total shareholders' equity Total liabilities & shareholders' equity Cash Flow Data Cash flow from operations $ 6,520 $ 5,325 $ Fixed asset purchases 3,453 3,277 4,368 2,129 Cash dividends 1,006 869 750 609 As a competitive benchmark, you also gather the last four years financial statements for Walmart: Wal-Mart Stores Income Statements (in millions of dollars) 2014 2013 $ 476,295 Costs of sales 358,069 352,297 335,127 315,287 Gross profit 118,225 116,354 111,823 106,562 Operating expenses 91,353 88,629 85,265 81,020 Operating income 26,872 27,725 26,558 25,542 2,216 2,063 2,160 2,004 24,656 25,662 24,398 23,538 8,634 8,663 8,699 8,663 Income before income taxes Income tax expense Net income $ 16,022 $ 468,651 16,999 $ $ 446,950 2011 Total revenues Net interest cost $ 2012 15,699 $ $ 421,849 16,389 Wal-Mart Stores Balance Sheets (in millions of dollars) 2014 2013 2012 2011 Assets: Cash $ 7,281 $ 7,781 $ 6,550 $ 7,395 Accounts receivable 6,677 6,768 5,937 5,089 Inventories 1,909 1,551 40,714 36,318 460 37 1,774 3,091 61,185 59,940 54,975 51,893 115,364 113,929 109,603 105,098 28,202 29,236 28,828 23,672 Prepaid expenses and other Total current assets Property, plant, & equipment, net Other assets Total assets $ 204,751 Liabilities and Shareholders' Equity: Current liabilities: 3 $ 203,105 $ 193,406 $ 180,663 Accounts payable $ 37,415 $ 38,080 $ 36,608 $ 33,557 Other current liabilities 31,930 33,738 25,692 24,927 Total current liabilities 69,345 71,818 62,300 58,484 Long-term liabilities 54,067 49,549 55,345 50,932 123,412 121,367 117,645 109,416 Contributed capital 2,685 3,952 4,034 3,929 Retained earnings 76,566 72,798 68,691 63,967 Other shareholders' equity 2,088 4,808 3,036 3,351 Total shareholders' equity 81,339 81,738 75,761 71,247 Total liabilities Shareholders' Equity: Total liabilities & shareholders' equity $ 204,751 Cash Flow Data Cash flow from operations $ 203,105 $ 193,406 $ 2014 2013 $ 23,257 $ 25,591 13,115 12,898 13,510 12,699 6,139 5,361 5,048 4,437 Fixed asset purchases Cash dividends 2012 180,663 $ 2011 24,255 $ 23,643 You make a few final mental notes about the financial statements. First, Target did not report any accounts receivable in 2014. That is because Target sold its credit card business to TD Bank at the end of 2013. Second, the fiscal year end for Target and Walmart differ. Like most retailers, Target and Walmart end their fiscal years at the end of January, after the holiday selling and return season ends. In its annual reports, Target refers to its fiscal year in which the 11-month majority took place. For example, Target's 2013 annual report referred to the year started on February 1, 2013 and ended on January 31, 2014 as 2013. Walmart, on the other hand called that same fiscal year 2014. To avoid confusion in your analysis, you have recast Target's financial statements on a comparably-dated basis as those of Walmart. Required: (1) Complete the following tables by computing the required 2013 and 2014 ratios for Target and Walmart. Target Corporation 2014 2012 2011 Return on equity 18.5% 18.9% Return on total assets 11.4% 12.0% Operating profit margin 4.2% 4.3% 1.50 1.54 Asset turnover 2013 Working capital 2,162 7,143 Current (working capital) ratio 1.151 1.709 4 Inventory turnover 6.04 6.02 Days in inventory 60.4 60.6 Accounts receivable turnover 11.8 11.0 Days in accounts receivable 30.96 33.33 Operating cycle 91.35 93.96 Accounts payable turnover 6.98 6.90 Days in accounts payable 52.29 52.88 Net cash conversion cycle 39.06 41.08 Debt to capital 0.66 0.65 Debt to equity 1.95 1.82 Times interest earned (earnings coverage) 3.38 3.86 Cash flow adequacy 1.06 1.93 5 Wal-Mart Stores 2014 2012 2011 Return on equity 20.7% 23.0% Return on total assets 13.7% 14.1% Operating profit margin 3.5% 3.9% 2.31 2.34 (7,325) (6,591) Current (working capital) ratio 0.882 0.887 Inventory turnover 8.23 8.68 Days in inventory 44.3 42.0 Accounts receivable turnover 75.3 82.9 Days in accounts receivable 4.85 4.40 49.19 46.45 Asset turnover Working capital Operating cycle Accounts payable turnover 2013 9.15 9.40 Days in accounts payable 39.87 38.85 Net cash conversion cycle 9.32 7.60 Debt to capital 0.61 0.61 Debt to equity 1.55 1.54 Times interest earned (earnings coverage) 7.27 8.18 Cash flow adequacy 1.31 1.38 Required: (2) Decide whether Target should retain or fire its chief executive officer. Write your rationale for the recommendation that you will read to Target's Board of Directors. 6