Real Vision Investment Case Study 2015
Lee Pusateri
Megan Shulby
Ricky Triana
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Executive Summary
In a highly competitive and evolving retail industry, Amazon.com and Walmart are two uniquely
different companies with strong potential returns on investment. After analyzing the past,
current, and future position of these two companies, we recommend purchasing Amazon’s stock
with a 10-year hold. Forbes Trefis Team indicates that Amazon’s upside potential is far greater
than the risk associated with the stock given their projected 19% CAGR for the company over
the next 10 years.
Walmart promises shareholders a safe and consistent option for a long-term investment. The
company’s revenues and operating profit is enough to warrant an investment, but its future
growth is projected to stay in the single digits. In addition, a changing retail environment that
places greater emphasis on e-commerce is a challenge that Walmart is having difficulty trying to
overcome. The company has already started to position itself as a player in online retailing, but it
will require investing large portions of their profits into expanding its distribution network.
Amazon has had significant revenue growth year over year, and continues to expand its
infrastructure in order to follow its strategic vision of personalized customer service and
innovation. The downside to the company is a poor profit margin due to its investment strategy.
This can be off-putting to many investors; however the market has shown confidence in Amazon
as its stock price has more than doubled throughout 2015. The rapid growth in its stock and sales
is expected to continue over the next 10 years.
Amazon’s history of growth investment and potential for continued gains are what make the
company so appealing to investors. The driving forces that will support this growth over the next
10 years will be the expansion of Amazon Web Services and Prime Subscriptions. It is these
factors that make this stock a great long-term investment.
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Introduction
The world of retail is a highly competitive area where new technologies in distribution, tracking,
and online commerce have changed the industry landscape. Two giants within this transforming
space are Walmart and Amazon.com. Walmart has largely stood as a pure retail wholesaler with
brick and mortar beginnings, which has leveraged its distribution network to become a dominant
global player. Amazon.com started as an online book seller that evolved into a diversified
conglomerate of services and products that continues to grow at an unbelievable rate. Both of
these companies have demonstrated an ability to please investors in their own unique ways. This
paper is aimed at decomposing both firms’ strengths and weaknesses to determine which would
be a better 10 year hold investment of stock.
Retail’s Golden Child vs Its Golden Years
The Golden Years
Walmart’s success is rooted in its efficient supply chain processes that help drive down operating
costs. This in turn allows Walmart to compete with other retailers for the lowest prices which has
created loyalty to their brand amongst consumers. Their Everyday Low Prices (EDLP) pricing
strategy has differentiated the Walmart value proposition from many other retailers, helping
sustain their industry leading revenue streams. In 2014, Walmart had $486 billion in revenues
seeing a sales growth of 1.9 percent from 2013. In addition to revenues, the company posted an
operating profit of $27 billion (5.59% margin). Walmart’s ability to generate large profits allows
them to reinvest those funds into their expansion into the e-commerce space. Their profits also
help management continue to increase dividends to $1.96 per share in 2014, representing 42
consecutive dividend increases. Walmart’s financial statements are a testament to their core
competencies and will allow the company the opportunity to remain competitive in the future.
In order to stay competitive, Walmart has begun to invest in their e-commerce platform. In 2016,
they will be opening four new U.S. e-commerce fulfillment centers. These fulfillment centers
will be dedicated to their online sales and indicates an investment strategy in their infrastructure
to better compete directly with Amazon. Walmart registered $12.1 billion in online revenues
globally in 2014 and management has been committed to continued future growth in this
segment of the company. These investments and change in strategy show that Walmart is
attempting to transition as consumers migrate from brick and mortar stores to online shopping
platforms.
Although Walmart is showing signs of strategy changes, there are threats to their business model
that may hinder bottom-line growth. This past year Walmart allocated an additional $1 billion
dollars for employee compensation and will be raising their minimum wage from $9 per hour to
$10 per hour. However, this may not be enough as the federal government has become
increasingly involved in raising the minimum wage. There is the potential, especially when
looking at the next 10 years, that Walmart will see a decrease in its operating margin. This could
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threaten their stock in the future if their management does not come up with a strategy to
mitigate these losses.
Overall, Walmart has been a consistent and safe option for investors. Their beta is currently 0.27,
indicating a low level of risk when compared to the market. With consistent dividends and a
strong bottom-line they will continue to be a leader in the retail industry. However, it is
important to note the downward trend their stock has been on in addition to slow projected sales
growth. Investing in Walmart provides a low risk option, but will also likely not have significant
returns compared to other high growth stocks.
The Golden Child
Amazon’s transformation as a company from its inception to present day is embedded in its
company culture. Amazon’s strength is its forward looking strategy to be the “most customer
centric company on earth”. This vision clearly communicates Amazon’s plan to continue
reinvesting funds in order to expand its product and service offerings. In 2014, Amazon saw an
increase in revenues to $89 billion and forecasts indicate similar growth for the next ten years.
The company is also becoming more efficient as it has seen its cost of sales decrease from 75
percent to 70 percent over the past three years. Although Amazon’s operating income was only
$178 million, investors showed confidence in the company. At the beginning of the year
Amazon’s stock was priced at $310 per share. Throughout this year the stock price rose to $660
per share, more than doubling from January. Without dividends and a strong bottom-line,
Amazon continues to gain buy-in into their long-term vision. In addition to their strategic plan,
they possess a strong balance sheet and statement of cash flows. This allows the company to
continue the expansion of its distribution network as it strives to achieve its goal of one-day
delivery.
Amazon is poised for future success at this current time, but investors should be cautious of the
company’s stock. The question surrounding Amazon is when will they turn a significant and
consistent profit? In addition, will investors want Amazon’s management to spin-off its more
profitable segments such as Amazon Web Services? The risk with Amazon is that the answers to
these questions are not apparent. So it does make for a riskier investment given their income
statement challenges.
Overall, Amazon has the assets and resources needed to continue pursuing the company vision.
Questions regarding their bottom-line will eventually be answered, but the strategic investments
that they are making should continue to boost investor confidence. Amazon’s capabilities to
innovate and adapt to consistently changing market trends factor into the economic confidence
reflected in its soaring stock price. The growth trajectory that Amazon is on will allow the
company to be very competitive moving forward and it should be expected that the stock price
follows along this path as well.
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The Present Retail Landscape
Today, the old world of brick-and-mortar faces the new world of online retail on the battlefield
of customer engagement and consumer loyalty. Walmart, a traditional hegemony of “everyday
low prices,” superb supply chain management and 11,000+ physical store locations finds itself in
competition against a digital upstart whose disruptive business model is grounded in
personalized online service platforms and diversified product selection, Amazon.com.
These two companies operate in a rapidly evolving space, where e-commerce and the growing
expectations of customers are market forces that require careful analysis for decisions on future
growth strategies. E-commerce sales rates continuously increase year after year. According to
Bloomberg, these rates grew from 0.6% of total retail sales in 1999 to 7.0% in early 2015 and are
projected to rise to 11% of total retail sales in 2018. These increasing ecommerce rates are
derived from changing customer expectations and evolving user dynamics of the online
experience. Lowest available price and product quantity no longer hold first priority to customers
in today’s changing retail space. Customers now strongly factor the personalization degree of
retail platforms, both online and in-store, and the effectiveness of customer service departments
into their overall shopping experience equation.
The Golden Child Gets Ahead, the Golden Years Gets Left Behind
Both Walmart and Amazon have created unique business models that disrupted traditional
standards in the retail industry. In the 1960s, Walmart revolutionized the system of supply chain
management in the retail space by creating an enhanced system of product distribution and
company profitability. This system reigned supreme for four golden decades, allowing Walmart
to grow into one of the largest companies in the world. With the dawn of the internet era came a
new source of disruptive innovation: Amazon.com and the concept of online, personalized
shopping.
By using data obtained from customer engagement activities and purchases, Amazon is able to
forecast future consumer shopping habits and enhance the personalization of its platforms.
This new business model rocked Walmart’s firm grasp on commercial shopping and set forth a
new series of customer-facing expectations that have been quickly adopted as the standard.
Walmart’s strategic innovations of the past have shaped the company and defined the retail space
where it dominates, the offline in-store experience. Amazon’s platform model slowly emerged as
the forerunner in the online consumer space. Walmart’s inability to capitalize on their supply
chain prowess in these online markets has left them a laggard in today’s market. Walmart’s
complacency with its business model and use of profits to boost consistent dividend increase has
resulted in stagnation. There is no innovation. They now face an uphill battle to gain position in
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an evolving landscape. Online shopping revenues are not only growing, so are the expectations
of customers. The changes necessary would require major investment into new technology and a
costly adoption period, just to compete with the likes of Amazon and similar entities. Such an
enhancement of the customer experience in omni-channel selling will require immediately
planning. This might cause slowing of divided growth to investors, which could signal panic for
a company with consistent dividend increases.
As Amazon continues to explore new customer-facing services and enhance its established
portfolio of diverse businesses, Walmart attempts to stir its homogenous behemoth self along a
new course of action to play catch up and take over. Walmart’s sheer size and grounded system
indicates slow shifts in adopting new business models as reflected in Nasdaq’s projected growth
rate of Walmart at 8.15% over the next ten years. On the other hand, Forbes’ Trefis Team
projected Amazon to have an annual growth rate of 19% for the next ten years. This view is even
considered conservative by some, like GuruFocus, who position Amazon growing at a nearly
30% compounded growth rate.
Wal-Mart’s success over the past few decades has stemmed from its strategic use of its
distribution network. Its use of satellite technologies helped Wal-Mart create Retail Link and
grow its own brand of Vendor Managed Inventory solutions. Today the use of strategic vendor
partners, investment in transportation technology, cross docking, RFID usage in warehouses, and
its Retail Link satellite network have made Wal-Mart the supply chain hero.
Possessing these constant components of success, Walmart is a consistently homogeneous
behemoth within the sea of retail. It is a naval carrier of standardized distribution practices and
offline product efficiency that has significant trouble slowly correcting course as the storm of ecommerce and customer personalization approaches. All this while, Amazon is dodging the
scaling waves of the ever-changing retail environment as a nimble speed boat, having learned the
same components as Walmart’s infrastructure in just twenty years and improving with agility,
flexibility and adaptability.
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Investment Recommendation
Recommendation
Without exercising options, derivatives, calls, or other hedging measures we believe this
challenge to inquire on the mutually exclusive choice of either Wal-Mart or Amazon stock for a
pure 10-year hold. After review of the future prospects for each company, we come to the
recommendation to purchase Amazon.com’s stock over Wal-Mart’s. The market today has had
a consistent hesitation to make this recommendation due to over application of classical
valuation models. However, when examining other factors such as free-cash-flow, e-commerce
trends, and new business growth areas unique to Amazon, the anticipated gains from this
investment greatly outweigh the risks.
Structuring a Wal-Mart stock hold would have included the reinvestment of dividend yield into
stock repurchase or a DRIPS tactic. There is no indication that Amazon would begin offering
dividends in the future, so the strategy would not include reinvestment into stock. However, if
Amazon began a divided it would surely be used to acquire bonds and short calls to reduce
overall risk especially in the event of a stock split.
Amazon’s Differentiating Factors
The analysts who have been calling Amazon bearish have been wrong for 2 decades.
It depends on how one examines the company. A GAAP standpoint vs a Free Cash Flow analysis
show 2 opposing views. In the case of Amazon, Price to Free Cash Flow is a better valuation
metric than Price to Earnings. The P/E of Amazon is currently at 944.66, which indicates a
significant premium compared with the average of 574.94 for the Internet & Catalog Retail
industry.
Looking from the Price to FCF ratio valuation for the forthcoming 10-year period, shows a
company that uses its FCF for investment and demonstrates their commitment to growing and
improving services. Amazon’s PFCF ratio is 57.45 (Nov 8th,2015) which is above the industry
median of 19.53. While this would have been cause for concern in the past, the future revenues
from Prime Members and Amazon Web Services alone will cause this number to head towards
their historic low of 15.52 because of the rise in FCF.
At a projected revenue growth of 19% for the next 10 years, a share of AMZN at $659.37
(11/6/15) would be worth $3,752.89. At the current diluted outstanding shares of 478 Million
the company would have a Market Cap of $1.79 Trillion dollars. We anticipate this may cause a
stock split in the future to stabilize the market. Investors today could see a potential 568% ROI
going with an Amazon stock hold.
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Drivers of Amazon’s future growth:
Prime Members- In the USA, as of November 2015, there are an estimated 40 million Prime
Members or 12.5%. That number is projected to grow to 45% of America’s 350 million
population by 2025 or 157.5 Million Prime Members. Their network of services will include 30minute shipping, streaming video, unlimited cloud storage, grocery delivery, online education
academies and potentially mobile carrier services.
AWS- Amazon Web Services, Amazon’s
cloud computing solution has posted y-o-y
growth of 81% for Q2 and 79% for Q3 of
2015. (Q2 and Q3 financial reports,
http://phx.corporate-ir.net). These figures
are expected to grow to $23 billion in
annual revenue by 2020, with projected
growth of $80 billion by 2025.
(ZDnet.com, AWS Financials). This will
account for a growing percentage of
Amazon’s reported profits. While a spinoff
is considered, a restructuring akin to
Google’s Alphabet is a more likely
scenario, as AWS is part of the system that
helps to run the company's own operation.
Concluding Thoughts
The same strategies that have made Walmart a retail giant, have also made the retailer unable to
stay agile and adapt to the new consumer landscape. Major investment into e-commerce will
negatively affect future dividend increases. The looming approach of higher minimum wage
rates will threaten their ability to maintain strong profits. As the conservative stock option,
growth in the best of times would see a moderate yield on investment. The biggest downside of
Walmart is their inability to grow revenue above 2% for the forthcoming decade.
Amazon on the other hand is poised for 19% growth for the next 10 years, and this is the
moderate projection. AWS, Prime membership and brand equity that traverses international
boundaries will sustain this revenue growth while Amazon continues to invest in a ubiquitously
encompassing ecosystem of services. Amazon will not only become one of earth's largest eretailers, but also its largest cloud computing, resource management, and on-demand services
provider. When Amazon has completed its mission, it truly will be “Earth’s Most CustomerCentric Company.”
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APPENDIX
Amazon Financial Reports- Q2 and Q3 2015. <http://phx.corporateir.net/phoenix.zhtml?c=97664&p=irol-reportsother>.
Greene, Jay. "Sky-high Expectations for Release of Amazon Web Services' Numbers." The
Seattle Times. N.p., 15 Apr. 2015. Web. <http://www.seattletimes.com/business/amazon/skyhigh-expectations-for-release-of-amazon-web-services-numbers/>.
Dignan, Larry. "AWS Financials on Deck: The Road to 3 Million Servers in Operation | ZDNet."
ZDNet. N.p., 12 Apr. 2015. Web. <http://www.zdnet.com/article/aws-financials-on-deck-theroad-to-3-million-servers-in-operation/>.
Peterson, Hayley. "The Key Differences between Wal-Mart and Amazon in One Chart."
Business Insider. Business Insider, Inc, 13 July 2015. Web.
<http://www.businessinsider.com/amazon-vs-wal-mart-in-one-chart-2015-7>.
Forbes Magazine, Trefis Team. "Here's Why Amazon Could See Market Share Growth In The
International Markets." Forbes. 6 Oct. 2015. Web.
<http://www.forbes.com/sites/greatspeculations/2015/10/06/heres-why-amazon-could-seemarket-share-growth-in-the-international-markets/>.
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