THE ECONOMIST INVESTMENT CASE STUDY COMPETITION
2015
Amazon vs Walmart
Team: InvesGo
Emory University Goizueta Business School
Arjun Agarwala (Class of 2016)
Vibhu Katiyar (Class of 2016)
Rohan Singh (Class of 2016)
Goizueta Business School
Table of Contents
1. ABSTRACT ............................................................................................................................................ 3
2. BUSINESS MODELS ............................................................................................................................ 4
2.1. Walmart ............................................................................................................................................ 4
2.2. Amazon ............................................................................................................................................ 4
3. THE ULTIMATE RETAIL WAR .......................................................................................................... 5
3.1. Why Walmart Stock is Attractive .................................................................................................... 5
3.2. Elusive Profitability Remains a Concern for Amazon ..................................................................... 6
3.3. Future of Retail Industry – Who is Better Prepared? ....................................................................... 7
4. WALMART: FINANCIALS AND COMPARABLES .......................................................................... 9
4.1. Relative Pricing .............................................................................................................................. 10
4.2. Profit Margins ................................................................................................................................ 11
4.3. Performance and Coverage Ratios ................................................................................................. 11
4.4. Share Repurchase ........................................................................................................................... 12
4.5. Earnings and Dividend Projections ................................................................................................ 13
4.6. Stock Valuation .............................................................................................................................. 14
5. INVESTMENT STRATEGY ............................................................................................................... 14
6. RISK CONSIDERATIONS .................................................................................................................. 15
7. APPENDIX ........................................................................................................................................... 16
REFERENCES ......................................................................................................................................... 19
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1. ABSTRACT
Over a 10-year investment horizon, Walmart stocks will provide greater value than Amazon through
consistent dividend payouts and steady share price appreciation, leveraging the company’s existing retail
model and renewed focus towards e-commerce.
Walmart has a 40-year history of increasing dividend payouts with a dividend yield of 3.03% at the
current price. Walmart’s P/E ratio, currently at 12.27, is extremely attractive and has ranged between
13.3 and 18.2 for the past decade. This signals that Walmart is currently selling at an ‘everyday low
price’, which we believe is a reasonable entry point for long-term investors.
A reasonable entry point, however, does not eliminate a possible volatility in stock prices in the shortterm. Walmart’s plan to invest $2.5B in employees and $2B in e-commerce over the next two years will
negatively impact earnings. Earnings will also be impacted by capital expenditures of over $23B for
store improvements. However, post 2018, these investments are estimated to yield significant returns
and enable the firm to reward investors. Walmart possesses the necessary infrastructure, capital,
customer reach, buyer’s power, and a focused management team to evolve and expand the firm into a
model that combines brick-and-mortar stores with a robust e-commerce platform. Walmart’s scale and
price competitiveness will further ease the firm’s transition into this omni-channel model.
Amazon’s story has been one of unparalleled success, with the firm going from strength-to-strength over
the past two decades. Its current ace-in-the-hole, Amazon Web Services, is estimated to grow from $7B
today to $46B by 2020 [1]. However, despite the firm’s impressive growth over the past few years,
investment plans in international markets, and expansion of offerings by launching services such as
Prime Now and Logistics, its bottom-line has never been an attractive proposition from an investment
perspective. Amazon’s belief in “failing fast” has driven investment in several products and services,
such as the Fire Phone and Amazon Destinations, which have not yielded expected returns. The launch
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of programs such as Prime Now, where the firm may not earn any returns in the near future, further
reduces the viability of Amazon as a 10-year investment opportunity.
2. BUSINESS MODELS
2.1. Walmart
Walmart is a discount retailing company that operates retail stores, supercenters, warehouse clubs,
Sam’s club, and websites – walmart.com and samsclub.com. It has over 11,400 retail units in 27
countries and e-commerce websites in 11 countries. It operates as Walmart in the U.S. and Puerto Rico,
Walmex in Mexico, Asda in the UK, Seiyu in Japan and Best Price in India. [2]
Walmart, the world’s largest retailer and employer, has taken over half a century to become the largest
company in the world based on almost half a trillion dollars in revenues. Over the decades, Walmart has
consistently outperformed other retailers in both profitability and growth. It has been able to generate
consistent profits and pay increasing dividends through efficiency in purchasing, distribution and store
operations.
Doug McMillon, current President and CEO of Walmart, leads a strong management team to deliver
Walmart’s mission of “saving people money so they can live better.” Under his leadership, Walmart is
bringing together its stores, logistics network and e-commerce capabilities to empower customers to
shop “whenever, wherever and however” they want. [3]
2.2. Amazon
Amazon is the world’s largest online retailer, with extensive operations in North America and is now
increasing global presence. The marketplace includes websites such as amazon.com, amazon.co.uk,
amazon.de, amazon.co.jp and amazon.in. [4]
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Amazon started as an online book retailer but rapidly diversified into a host of other product categories.
Today its business model has several moving parts. It maintains inventory and sells products with a
mark-up directly through its online store and also provides a platform to third-party retailers while
charging a small commission. Additionally, Amazon offers a subscription based model through its
Prime service as well as a small electronics product line. Finally, Amazon provides cloud infrastructure
to enterprise customers through Amazon Web Services. The firm has expanded its Prime offerings to
include content such as music, videos and web series, while also investing in Amazon Logistics, a
division aiming to reduce its dependence on UPS and FedEx.
Jeff Bezos founded Amazon.com in 1994 and is the CEO and Chairman of the Board. The company’s
mission is “to be the Earth’s most customer-centric company.” Since going public in 1997, Bezos has
believed that if Amazon grows revenues, the stock will take care of itself. [5]
3. THE ULTIMATE RETAIL WAR
3.1. Why Walmart Stock is Attractive
The current dilemma faced by investors about Walmart is due to a short-term focus on the firm’s ability
to generate profits and adapt in a changing retail environment. The recently issued negative guidance by
Walmart highlighted low revenue growth, higher operating costs and increasing capital expenditures. A
$1 increase in the firm’s minimum wage in July and an expected additional $1 increase, which would
bring minimum wages to $10 in February 2016, will increase expenses by $1.2B and $1.5B in FY2016
and FY2017, respectively. In addition to capital expenditures of $23.4B to improve stores, the firm plans
a $2B investment in e-commerce over the next two years. The guidance led to widespread
disappointment among investors. Skeptical about Walmart’s future as a low-cost brick-and-mortar
retailer, investors reacted by selling their positions causing the stock to lose 40% of its value over the
past year. Despite this, Walmart’s strong fundamentals and balance sheet, coupled with a long-term
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strategy well laid out by the management, enable it to become a compelling opportunity for a 10-year
investment horizon. The existing pessimism allows value investors to buy a premium dividend paying
stock at an attractive price. [6]
3.2. Elusive Profitability Remains a Concern for Amazon
Amazon has been very successful in gaining market share in the US and other markets, such as the UK
and India. Despite recently completing its 20th anniversary, Amazon still focusses on maintaining a startup culture. The firm has been investing aggressively in growth by raising debt and utilizing retained
earnings, without focusing much on profits and thus has not released dividends since its inception. This
culture, while necessary to maintain its innovative edge, has also resulted in several loss making
investments. Uncertainty in the profitability of their different ventures is enhanced by Amazon’s refusal
to release concrete numbers on segment subscribers, costs and revenues. 2015 marked a surprise with
AWS revenue being listed separately from US and International streams. To justify the current market
price, Amazon needs to increase margins. However, the most feasible strategy to facilitate this would be
to eventually increase prices, a difficult proposition in the retail business, where price competitiveness
drives purchases.
Currently, the business that provides maximum margins is Amazon Web Services, Amazon’s cloud
computing segment. AWS is growing at a rapid pace and is expected to generate $7B in sales for
FY2015 at a 25% margin. Analysts expect this revenue to grow to almost $46B by 2020 [1]. However,
the presence of traditional players such as Microsoft, Dell and Salesforce and the entry of firms such as
Google, IBM, and Oracle into the cloud space, point to an increasingly competitive industry with
shrinking margins. [7]
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3.3. Future of Retail Industry – Who is Better Prepared?
Despite the proliferation of e-commerce, traditional brick-and-mortar stores will continue to be the
preferred channel for many households for the next decade, in both the US and emerging markets. Stores
provide consumers a sensory experience allowing them to touch and feel products, immerse in brand
experiences, and engage with sales associates. Online purchases are also affected by the presence of
stores, in other words, the source of value creation (product awareness) is now de-coupled from the
place of value capture (sales transaction) [8]. The launch of Amazon Books, a physical book-store, also
supports the strength of the omni-channel model, suggesting that revenues from such a model might
exceed analysts’ expectations.
Walmart already has a significant advantage over Amazon in the physical realm. With approximately
4,700 stores in the US, 90% of the American population lives within 15 miles of a Walmart store [9].
7,000 international stores also provide Walmart a substantial reach in other countries. Thus, the focus for
Walmart becomes improving its online platform and delivering better customer experience, and the firm
has embarked on an ambitious turnaround plan in a bid to improve sales, operations and customer
service. Aggressive investments in the e-commerce platform, coupled with large capital availability and
a well-established brand name, allow Walmart to replicate Amazon’s model, with potentially lower
costs, and consequently lower prices for customers.
Walmart’s $2B e-commerce investment, focusing on integrating its online selection with stores, offers
them an even-footing with Amazon in the long-run. The recent test launch of a Walmart loyalty program
similar to Prime, albeit one costing $50 per year [10] as compared to Prime’s $99 per year charge,
highlights Walmart’s focus on replicating some of Amazon’s strategies. Walmart’s lower subscription
cost will rapidly attract new customers and may even cause some Prime members with insignificant
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annual purchases to switch loyalties. Walmart will also be able to leverage its existing infrastructure and
technical capabilities to scale at a brisk pace.
Walmart retains the ability to repurpose existing stores into potential distribution center-cum-store
hybrids that would reduce operational costs. This would give customers the ability to shop online or at a
store or even order online and pick up at stores, which could also handle online returns. Walmart’s vast
trucking fleet and distribution channel provide it close proximity to customers, which eventually might
facilitate one-day or even faster delivery of products and allow the firm to compete against Amazon
Prime, Prime Now, Pantry and Fresh. In comparison, Amazon has just over 50 distribution centers in the
US. It has struggled to make profits due to the relatively high cost of one- and two-day shipping. This
disadvantage will necessitate capital expenditures over the next decade on Amazon’s behalf, to match
Walmart’s strong network, further shrinking Amazon’s earnings. Thus, while Walmart does not
necessarily have to replicate Amazon’s model, Amazon may need to transform itself to the omnichannel Walmart model, requiring significant investment in the coming years.
Walmart’s plan of raising minimum wage constitutes 75% of the announced earnings reduction over the
next two years [11]. However, this step, along with store improvements will boost employee morale,
reduce turnover and provide improved in-store customer experience. Additionally, Walmart recently
started providing managers with tablets and mobile devices [12] to leverage real-time analytics and
enable the firm to realize higher operational efficiencies. On the other hand, workforce culture has been
one of the criticisms of Amazon of late [13] and despite preventive measures, turnover rate continues to
remain high, reducing efficiency and increasing costs attributed to training and severance packages.
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4. WALMART: FINANCIALS AND COMPARABLES
In recent interviews, Walmart’s CEO shared the road map for the firm’s future and the expected drop in
earnings in the next three years, with plans to return to substantial profit growth by 2019. Walmart
provides an earnings guidance every quarter and has an impressive track record of never missing the
low-end of the quarterly guidance over the past five years and has exceeded the high-end almost 50% of
the times. This suggests that Walmart is very thorough and intentional in providing guidance, and that
we can be comfortable with their FY2019 outlook. [14]
On the flipside, Jeff Bezos has often diverted attention from financials to metrics that favor the firm or
has raised questions over the time-frame used by analysts. This uncertain and almost evasive behavior,
raises our concerns over Amazon’s ability to deliver profits and dividends over the next decade. [15]
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4.1. Relative Pricing
Walmart stock is currently trading at 12.27x P/E, the lowest in the past 10 years. It currently trades at a
significant discount versus the S&P500 index, which has an average P/E ratio of 22.12x.We estimate the
intrinsic value of Walmart to be $82.411, while the stock is trading at $58.78, a 29.08% discount.
Amazon, however, is trading at an unrealistically high P/E of 944.66x with investors paying a premium
for the firm’s growth expectations, suggesting that Amazon is highly overvalued and a price correction
in the near future is possible. We estimate the intrinsic value of Amazon stock to be $549.802 against the
current price of $659.37. The price today is justified only if Amazon can achieve revenues of $450B at
an operating margin of approximately 5.5% by 2025.
Furthermore, the broader market is currently perceived to be overpriced given the high market P/E, and
expectations for the next ten years are not optimistic. This strengthens our belief in the future correction
of Amazon stock prices given its very high P/E. Even if the stock reverses its movement after the
correction, increased competitive pressures may cause Amazon’s growth to be slower than that over the
past few years.
1
2
Exhibit 1: Walmart Discounted Cash Flow Model
Exhibit 2: Amazon Discounted Cash Flow Model
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4.2. Profit Margins
As businesses mature, profitability becomes a significant concern for shareholders. Over the years,
Amazon has been phenomenal in building its revenues, however achieving reasonable profitability will
be a huge challenge, but a necessity for sustaining shareholders’ confidence. Walmart, however, even in
the current challenging period has maintained stable gross profit margins of around 24.7% historically.
Walmart is able to leverage its price competitiveness and operational efficiency to generate a strong
operating margin of 5.7%. Although Amazon's gross margin of 29.5% is higher than Walmart, its
operating margin at 0.2% is very low compared to the industry average of 5%.
Walmart’s EV/EBITDA multiple is less than one-fifth of Amazon's, which also supports our hypothesis
of Amazon’s stock being overvalued. Additionally, unlike Amazon, Walmart has a very healthy interest
coverage ratio, giving the firm more control in accessing capital.
4.3. Performance and Coverage Ratios
Walmart has a strong history of return on capital, with an average annual ROE of 21.42% and an ROIC
of 13.85%. Walmart’s interest expense and operating income have been relatively steady, resulting in a
stable interest coverage ratio of 11.66% over the past six years. When compared to similar retailers,
Walmart has the highest figures on three key ratios, ROA, ROE and ROIC, highlighting its ability to
convert capital into profitability with high efficiency.
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4.4. Share Repurchase
Since 2006, Walmart has decreased shares outstanding by 2.5% annually. Over the past ten years,
Walmart repurchased 22.5% of outstanding shares and has recently announced another repurchase plan
of $20B over the next few years. This indicates management’s confidence in the firm and its belief that
the stock is undervalued.
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4.5. Earnings and Dividend Projections
Under certain assumptions regarding revenue growth, SG&A, interest expenses and tax rates, we
projected Walmart’s earnings and net income for the next decade. Profits are hurt over the next three
years before rising again at a steady rate. Assuming Walmart spreads $20B of share repurchases over the
next three years as a 25%-50%-25% split, and adjusting for outstanding shares, we arrive at EPS figures
of $4.68, $4.90 and $5.123 for the next three years.
For the past decade, Walmart has increased dividends at an average annual rate of 14.1%. Currently, it
pays dividends of $0.49 per share, at a 3.03% yield. At its current $1.96 per share payout, the company
distributes almost 40% of its reported earnings through dividends, giving the firm the flexibility to
increase its dividends in FY2017 and FY2018.
The following charts project Walmart’s earnings and dividends under the aforementioned assumptions.
On the other hand, given Amazon’s track record of zero dividends, capital expenditures required over
the next few years, and the firm’s negligible operating margins, it seems reasonable to expect the firm
not to start paying dividends soon.
3
Exhibit 3: Walmart Projected Earnings and EPS
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4.6. Stock Valuation
With our projections of operating and free cash flows, we have an FCFF of $16.78B for FY2025. The
WACC for discounting cash flows is 5.10%4. We estimate the intrinsic value of Walmart to be $82.41
per share, while the stock at the end of Friday, November 6th was trading at $58.78, a 29.08% discount.
The net income in 2025 is estimated to be $19.44B, resulting in an EPS of $7.745. Based on Walmart’s
historical P/E and the industry’s current average P/E, we chose a P/E value of 18x, which yields an
estimated stock price of $140.02 in 20256. Thus, stock price appreciation itself provides an annual return
of 9.07% or 10.83% including dividends.
5. INVESTMENT STRATEGY
Buy Walmart today through the direct purchase method, via a DRIP (Dividend Reinvestment Plan).
During initial periods even if the stock price declines, the investment will create value as long as
dividend growth is higher than the rate of decline. Once the stock price rises, we will own a greater
number of shares (because of DRIP), to take advantage of the move.
Additionally, we could enter a covered call position by selling January 2017 Calls with strike price of
$62.5. Given the current undervalued stock price and a possibility of its decline in the short-term, we
expect these calls to expire worthless, netting us the option premium today7. This gives us the
opportunity to own stock today, while prices are suppressed and get paid while we wait for it to start
making the upward move.
4
Exhibit 4: Walmart Cost of Capital
Exhibit 3: Walmart Projected Earnings and EPS
6
Exhibit 2: Amazon Discounted Cash Flow Model
7
Exhibit 6: Covered Call Option Payoff
5
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6. RISK CONSIDERATIONS
Although our analysis suggest significant return potential for Walmart, there are few risk factors to be
aware of:

A potential increase in minimum wage to $15, a popular election agenda, will shrink earnings.

Employee healthcare benefits form a large percentage of Walmart’s expenses. Rising healthcare
costs may negatively impact earnings.

Understanding international consumers is important for long-term revenue growth and
profitability of Walmart. China, India and Africa offer vast markets, which have still not been
captured successfully by the firm.

If Amazon’s stock continues its 10 year rally in the long-term, Amazon may represent a better
opportunity.
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7. APPENDIX
Exhibit 1: Walmart Discounted Cash Flow Model
Model Assumptions - Walmart:
1. Revenue Growth over the next three years will be 2% and once the investments in e-commerce
and infrastructure (improved stores) start paying back, we assume the growth to increase to 4%
in gradual fashion before again stabilizing at 2% at the end of 2025.
2. Gross Margins will remain stable at the historical 10 year average of 24.7%.
3. Operating Margins over the next two years will be negatively affected due to increased SG&A
costs in the form of wage hikes. We assume the SG&A to grow for the entire period at their 6
year CAGR of 2.8%, and we also added $1.2B and $1.5B wage hike expenditures in the SG&A
for the next two years respectively.
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4. Interest expenses to grow at 2.12% at their average historical growth rate per annum.
5. Taxes have ranged between 32% and 33%, but we used the conservative figure of 33%.
Exhibit 2: Amazon Discounted Cash Flow Model
Model Assumptions - Amazon:
1. Revenue Growth over the next three years will be 20% and will gradually settle at 6% at the end
of 2025.
2. Gross Margins are currently low but we assume that in long-term it will stabilize at industry
average.
3. We assume that Amazon will slowly move to a stable capital structure at 85% Equity and 15%
Debt. In similar manner the cost of capital will change over next few years.
4. Taxes are assumed to be at 35%.
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Exhibit 3: Walmart Projected Earnings and EPS
Exhibit 4: Walmart Cost of Capital
Exhibit 5: Amazon Cost of Capital
Exhibit 6: Covered Call Payoff
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