Walmart or Amazon? Which is the better investment over 10 Years

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Warren Powers
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1 Walmart or Amazon? Which is the better investment over 10 Years Kogod School of Business American University The Economist Case Study Competition November 2015

2 Table of Contents Abstract... 2 Introduction... 2 Company Overview: Walmart... 3 Company Overview: Amazon... 4 Undervalued or Overvalued?... 4 Opportunities for Walmart... 5 Global Expansion... 6 Drone Delivery D Printing... 6 Does Profitability Matter?... 7 Investment Decisions... 7 Amazon risk:... 8 Conclusion... 9 Bibliography... 10

3 Abstract After comprehensive consideration and comparison between Walmart and Amazon, we choose to invest in Walmart common stock in next ten years. The evaluation includes market valuation, expectation, and growth opportunities. The premise of our argument is based on valuation. From our work, we concluded that Amazon s ten year revenue growth rate is 17.32%; Walmart 10 years revenue growth rate is 2.1%. Using these calculated growth rates, $1 of amazon stock invested for ten years at a 17.32% growth rate, would result in a return of $4.94 ( [1*( %) 10 ] and $1 of Walmart stock invested for ten years at its 2.1% growth rate, would result in a return of $1.23 ( [1*(1+2.1%) 10 ]. It would appear that Amazon is the best investment given these simple calculations,. However do these numbers reflect reality? Our test is to identify which company will likely beat implied expectations. The objective of this paper is to present evidence that Walmart while not the logical investment is the best choice given the data and analysis conducted. Introduction Walmart and Amazon are retail behemoths dominating the industry with market capitalization in excess of $225 billion. While similar in a number of ways including size, these two companies could not be more different when evaluating investment opportunities. Amazon only just recently produced a nominal profit while Walmart reports net income around $16 billion. Walmart, however, has experienced reduced growth due to

4 growing competition, whereas Amazon s market value continues to skyrocket at astronomical rates. With these two companies have been moving in very different directions, many analysts have suggested the sky's the limit for Amazon and it will soon displace Walmart as the largest retail company. However, after careful analysis we caution those analysts that suggest Amazon will continue its growth pattern over the next decade. As you will see through our analysis, we have found Walmart to be the more reasonable investment option over the next decade due to risk, dividend yield, and slow but steady growth. As such, it is our recommendation to structure an investment decision of common stock purchase, in Walmart over the next decade. As explained in our analysis below, Walmart is presently undervalued, carries minimal risk, and with a few minor technological modifications can continue to compete with Amazon. We further address many of the risks associated with investing in Amazon including inflated value, profitability, and historical growth comparisons. Company Overview: Walmart Walmart is the low cost driver of the retail industry with a well-known motto Low Prices Everyday. In fiscal year 2015 Walmart reported total consolidated revenue of $486 billion resulting in $1618 billion in net income (Market Watch, 2015). The company comprises three divisions including: Walmart, Walmart International, and Sam s Club with its Walmart division being the largest resulting in 60% of net sales for the company in In an October 26, NPR News article a Walmart spokesman stated, there was a Walmart within 5 miles of 70 percent of all American households (Wagner,

5 2015). This creates some interesting opportunities for technology and business modifications. Operating in 27 countries Walmart International has opportunities to further expand globally, especially given that 28% of sales come from international operations. This should be a focus for Walmart and a competitive advantage over Amazon, which might not have the ability to enter emerging markets due to current online competitors and government regulations, which Amazon is not equipped to mitigate. Company Overview: Amazon Amazon is the leading online retailer in the United States with a growing presence globally. Amazon s net sales account for 6% of all retail transactions domestically according to the company s annual report. Amazon is currently split between its retail division which encompasses web sales, the amazon market place, and most recently physical retail locations. Amazon boasts an impressive stock valued at per share. However, until recently the company has not posted a profit. This certainly draws into question the importance of profitability which many investment analysts indicate is not important to Amazon s success. As the leading online retail platform in the United States, can Amazon leverage its ubiquity into profits without sacrificing current business operations? Undervalued or Overvalued? Walmart has lost about 32.16% YTD on its share value. It specially took a sharp turn downward on October 14 after it announced that earnings for the coming year would be

6 flat. This drop was mainly influenced due to the strengthening of the dollar and low projections of sales. In our opinion this is the perfect time to invest on the retail giant as it allows us to join the company cheaply and invest on what we believe is the future of brick and mortar for the retail giant: Neighborhood stores locally and expanded international expansion by leveraging supply chain know how and the ability to take advantage of an over digitized world. Amazon s stock has increased by a massive 109.2% YTD. According to our analysis the company as of now is currently being priced by over 15% on its ability to grow in the future. It is our believe that Amazon will not be able to seize these forecasts due to its inability to create profit in all of its business units which will ultimately end up cannibalizing its profitable areas as its spreading itself too thin. We also believe that Amazon will not be able to hit their profitability targets as they will face multiple infrastructure, tax, and local environmental problems as it expands internationally and also as it covers more and more of the international market. Opportunities for Walmart Walmart has invested significantly in technology infrastructure and global expansion in the last fiscal year to provide mobile and online platforms which should enhance customer interaction. There are many opportunities for Walmart to better compete with Amazon over the next 10 years. These include; drone delivery, 3-D printing, and international expansion.

7 Global Expansion Walmart has entered over 27 different markets mostly through mergers and acquisitions allowing them to leverage their expertise in retail store management abroad while keeping a local focus and a well rounded network of suppliers for the local market. Doug McMillon, CEO of Walmart has been quoted in Bloomberg saying that they are in all the emerging markets they would like to operate in and are now focusing on expanding them and focusing on improving operations and expanding in the market. We strongly believe that this will be their strong suit and will account for over 40% of their revenue during the next 10 years. Developing economies are where Walmart s advantage over Amazon is clear, many of the countries in which Walmart is expanding lack the necessary currier infrastructure that Amazon has used in the United States to thrive Drone Delivery In October 2015, Walmart applied to the Federal Aviation Administration to begin testing drone delivery services. While Amazon has already applied for similar permission, drone delivery better benefits Walmart due to the proximity of store to the American consumer. If Walmart is successful with drone delivery they can reduce other traditional transportation costs, expedite shipping times, and provide better customer service which should enhance net income. 3-D Printing Repeated throughout Walmart s 10-K is the risk of rising transportation costs included in the cost of sales. These costs can further exacerbate the company s already small margins earned on sales. However, as technology continues to evolve Walmart can implement 3-D

8 printing to reduce transportation and acquisition costs. This transition would vertically integrate the company into its large supply chain which allows for better control of product quality, costs, and development. This would result in increased revenue margins and more control over their business resulting in direct impacts to their stock value. Does Profitability Matter? The answer is of course. Profitability shows the company's ability to create value from the money stockholders have invested in the directors of the company so that it may be well distributed throughout the organization. Historically, companies have been able to use the stock market as a way of financing their operations and investors are willing to take the risk associated with companies running on debt. This mentality has changed and therefore the line has become more gray but the truth is that this should be the ultimate measure of performance whether it be forecasted or actual. In the case of Amazon we have a company that is trading on its future abilities and what its expected growth will be but a lot of these are based on assumptions that may not be materialized throughout time. The company has the ability to meet expectations, however given historical precedence, we find it unlikely to do so. Investment Decisions Our decision is to invest in Walmart through purchases of common stock which we will hold for the next 10 years. Focus on three major business model: Wal-mart U.S., Walmart international and Sam s club. The revenue structure is currently: 60% from the US market, 28% from the international market and Sam s club 12%. Walmart US has the highest profit margins

9 followed by Sam s club which has a lower gross profit rate due to their membership fees. We forecast that Walmart US impact on revenue percentage is going to reduce as developing economies manage to be more profitable as time goes by and developing on yet to form business synergies. Sam s club will also increase as they expand this business model abroad and catch up to what competitors like Costco are doing throughout Latin America and the world with great results. Walmart is creating the most value of international expansion and it is doing it in the way it is going to be the most impactful, by adapting its business model to the culture. Amazon risk: On the other hand, Amazon has many business units which are trying to leverage capabilities from their successful e-commerce website in order to participate in new markets such as its venture to smartphones with the Amazon Fire Phone where they seeked to leverage their success with their Kindle which resulted in a loss of money and could not penetrate the market. Amazon is a company desperate to reach the goals they have been set out by an over confident market impressed of their ability to transform the retail industry. Amazon may experience with international expansion a number of barriers, including government regulations and reliability of products authenticity. As black market items become more prevalent on Amazon, many adopters in emerging countries may be reluctant to utilize online platforms as a means for online shopping. This is where Walmart has an advantage. Consumers generally trust retail organizations they are familiar with and can physically see the products they are buying.

10 In addition to black market items, regulations and customs may make it difficult for expansion internationally. In the United States it is easy to have a package delivered next day or even in 5-7 business days. This is not the same in many countries where transportation and shipping is unreliable and often significantly more expensive. Perhaps Amazon is planning to mitigate this risk through drone delivery, however without data or historical experience it is unlikely that this will alleviate all risks associated with delivery and expansion outside of the United States. Conclusion In conclusion, Walmart provides investors with a safer more reliable option, Amazon is a risky and prone to bubble bursting investment. Over the 40 years only a small number of companies have been able to manage the levels of growth Amazon has experienced within recent years. The difference however between companies such as Apple and IBM which have managed to post eye-popping growth figures, is profitability. As we discussed previously, profitability is still the most important metric in measuring a business. While Amazon only recently posted a profit, much of its market value is based on expectations that Amazon will continue to post profits and be able to innovate semi-annually. This expectation is unrealistic and unsupported by historical precedence. Therefore, it is our recommendation for investors to purchase common stock in Walmart and hold for a period of 10 years. This decision will provide the best stable results.

11 Bibliography Market Watch. (2015, June 30). Market Watch. Retrieved November 9, 2015, from Annual Financials for WalMart Stores Inc.: Wagner, L. (2015, October 26). the-two way: breaking news from NPR. Retrieved November 9, 2015, from NPR News: Boyle, M. (2011, October 12). Wal-Mart Says M&A Strategy Will Focus on Existing Markets. Retrieved November 9, 2015.

12 Appendix Amazon Date CASH_FLOW _GROWTH NET_INC_ GROWTH EPS_GR OWTH SALES _GRO WTH NET_D EBT_T O_EBI TDA EARN _YLD EBITD A EBIT IS_EP S PE_RA TIO SALES_ REV_TU RN GRO SS_M ARGI N NET_I NCO ME CF_N ET_I NC PX_ LAS T 12/31/95 N/A N/A N/A N/A N/A #N/ A N/A N/A N/A 12/31/ N/A N/A N/A #N/ A -5.8 N/A 12/31/97 N/A N/A N/A /31/ N/A N/A /31/99 N/A N/A N/A /31/ N/A N/A #### 16 12/31/ N/A /31/02 N/A /31/ N/A N/A /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ N/A N/A /31/ N/A N/A /31/ N/A N/A N/A

13 Walmart CASH_FL OW_GR OWTH NET_INC _GROWT H NET_DEB T_TO_EB ITDA SALES_R EV_TUR N EPS_GRO SALES_G EARN_YL EBITD IS_ PE_RATI GROSS_ NET_INC CF_NET_ Date WTH ROWTH D A EBIT EPS O MARGIN OME INC PX_LAST 1/31/87 / /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ EQY_D VD_YL D_IND

Charles M. Holley, Jr.

Charles M. Holley, Jr. Executive Vice President and Chief Financial Officer Simple philosophy Our philosophy has always been simple: We are agents for our customers. Sam M. Walton Discount retail Membership