A Shareholder’s Guide to Understanding Wal-Mart’s Executive Compensation System
Nowadays, few investors actually bother to read financial filings and associated footnotes. Though describing financial transactions should be relatively straightforward, our experience is that these are generally written in such a way as to make simple things complex. Wal-Mart’s description of its executive compensation program is exceedingly complex (read it in the Proxy). This year it took 29 pages of legal and financial jargon to explain how its executives are compensated. Ten years ago it took a mere 5 pages to explain. Apparently, the consultants who designed the compensation system get paid by the word.
Generally, the ingredients for an effective compensation program are:
1. Executives are incentivized to own and hold stock.
2. Cash bonuses are tied to operating performance, not short-term stock price performance.
3. Performance is based on some combination of growing earnings, profit margins, and return on investment without taking undue levels of risk.
Wal-Mart’s 5 senior executives participate in the program. Let’s examine, in turn, how Wal-Mart’s plan compares with good practices:
Ownership. Each Wal-Mart executive is required to own 3 times his base salary in stock 5 years after becoming an executive. As CEO, Mike Duke must own 5 times his base pay in stock. It’s good that they have to risk their own money by holding the stock, but this is a low hurdle to clear because annual stock grants are typically 5-10 times the executive’s average annual salary.
Cash Bonuses. By design, cash salaries are low and range from $800k - $1.5 million, though Wal-Mart exec’s can (and did) earn 2x to 4x their salary in cash bonuses. Payout is driven by achieving pretax profit growth and divisional operating income goals. In FY2009 and in rough numbers, executives started earning cash bonuses of nearly 1x their salary once Wal-Mart’s pretax profits grew at least 1.1%, reached a 2x bonus when pretax profits grew 4.5%, and could top out at 5.8% pretax profit growth. Simply put, executives can maximize their cash bonus with 5-7% growth in pretax profits.
Performance Shares. This is the biggie as it provides executives with the ability to earn 5x to 10x their base salary in annual stock grants. And if they are meeting their performance goals, the stock price should be growing in value as well, providing a double benefit. Though it varies by individual, the plan essentially combines and weights 3 metrics: return on investment (ROI) (60%), comp-store sales (30%), and International revenue growth (10%). Using 2009 as a guide, executives had to achieve 18.6% ROI, 0% Comp-store sales and 5% International revenue growth to get 50% vested on their shares. To max-out they need to achieve 19.5% ROI, 4% comp-store sales growth and 13% International revenue growth. These are challenging goals, so no one can just show up and collect a paycheck. As an example, and excluding his existing holdings and stock options, CEO Mike Duke has $30 million in unvested stock grants that are dependent upon the company meeting its performance goals. And, since Dukes’ bonus has a 40% weighting to International revenue growth, we would expect to see a strong focus in this area.
New and Notable in this Year’s Proxy:
New—A disclosure has been added for Doug McMillon’s sister, Lorie Haynie. Mr. McMillon was named President & CEO of Wal-Mart International earlier this year, prompting disclosure of this related party transaction. Ms. Haynie is an executive officer of Mahco which supplied nearly $33 million in sporting goods to WMT in 2009. Accordingly, no mention was made of Mahco’s sales to Wal-Mart in last year’s filings.
Notable—Few companies are able to keep a lid on audit fees, yet Wal-Mart kept its audit fees equal to last year. Given the publicity issues surrounding Wal-Mart’s tax benefits associated with paying itself rent and avoiding state taxes, it is understandable that fees for tax advice would increase somewhat. All told, WMT paid its auditor $18.4 million last year, a slight increase over last year. That’s pretty good compared to the $133 million GE shelled out to its auditors.
Suppliers Continue To Drive Shareholder Value Via Inventory Reduction
Several leading CPG companies have reported first quarter results. Not surprisingly, as retailers worked down inventories, consumer product manufacturers saw production volumes and margins decline. Despite the slowdown, recent efforts by CPG companies to reduce inventories appear to be paying off. Since cash flow ultimately drives shareholder value, as investors we are encouraged to see many suppliers operating more efficiently via reduced inventories.
Suppliers we have examined thus far have brought inventories down an average of 10% compared to the same quarter last year. And as de-stocking and SKU rationalization among retailers continue, many suppliers expect further reductions as the year progresses. For example, we were encouraged to hear Irene Rosenfeld, CEO of Kraft, state that the company has initiatives in place to further shorten their supply chain and keep inventory levels near just one week. In addition, management at Kimberly-Clark achieved a seven day reduction in inventories during the first quarter of 2009, and expects to continue to push inventories down in the second quarter. Some of this was achieved by eliminating overflow storage at outside warehouses, while continued SKU reduction is expected to drive further gains. The bottom line for investors is this—as the economy recovers, many CPG companies will emerge leaner and create more value for shareholders with each sales dollar. Source: Company reports
Beverages: Making Cheap Wine Taste like a Fine Vintage
A Chinese Scientist has discovered that using electrical charges can accelerate the aging process for wines. It takes at least six months for a wine to become drinkable and 20 years for some wines to reach their peak. With the new process, lower grade wines can move up the quality scale and years of aging in oak casks can be shortened – speeding up the time to market and cutting the cost of storage. With over a decade of research and stunning results from experts’ blind taste tests, scientists may be on to something. In essence, the electrical charge speeds up the complex chemical processes that occur during the aging process (read it here). Turn the voltage up too high or for too long and the wine becomes worse than the untreated original. Source: www.NewScientist.com
We’re Not Gonna Take It!
Americans average 14 vacation days per year compared with 26 for Brit’s and 37 for the French. Nearly one-third of Americans don’t even take all of our allotted days off, says the Wall Street Journal, concluding that we give back 460 million days to our employers. And for this, they eliminate our 401(k) match and abolish Tuesday morning “donut day.” Source: www.expedia.com International Travel Deprivation Survey.
Stuff White People Like
We’re not big fans of this website’s name, but it is spot-on identifying major consumer trends and funny to boot. Check the list out here. A sample: #16 Gifted Children, #22 Having two last names, #49 Vintage stuff, #62 Knowing what’s best for poor people, #87 Outdoor performance clothes, and #111 Pea coats.
And One More Thing…
Bowling is seemingly a game whose heyday has passed, yet it is reported to be the fastest-growing high-school sport in America and over 200 Colleges offer bowling as a varsity or club sport. Why the renewed interest? Technological changes and some slick work have caused a 10-fold increase in perfect games. A ‘300 game’ is achieved by bowling 12 strikes consecutively. Between 1979 and 2008, the number of bowlers has shrunk by half to 2.4 million. Yet, the number of perfect games skyrocketed from 5,373 to 52,229 in the latest year. Nothing influences the number of strikes more than the application of oil on the lanes; bowling alley owners figured out that spreading more oil in the center of the lane greatly improves the scores. Lesser oil on the sides of the lane causes more friction, and the balls respond by hooking back toward the center. As well, new balls were designed with more porous surfaces, which enhance their response to the oil on the floor. Source: The Wall Street Journal
"Life is tough...it's even tougher if you're stupid."
--John Wayne
Have a thought or comment? Give us a call or email.
Scott Alaniz, CFA
scott@bostonmmm.com
Joe Chumbler, CFA
joe@bostonmmm.com
Fayetteville (479) 251-8400
Rogers (479) 366-4474
Information in this report has been obtained from sources that we believe to be reliable. Boston Mountain Money Management does not guarantee its accuracy or completeness and assumes no responsibility for actions taken with respect to information contained herein. The authors held a position in Wal-Mart Stores and Kimberly-Clark at the time of this newsletter.
