2015 WAL-­‐MART: THE LONG-­‐TERM SOLUTION ANALYSIS BY THE UNIVERSITY OF NEBRASKA-­‐LINCOLN: MATTHEW CLARE, DAVE FUXA, AND KATHERINE MITENKO PRESENTED TO REAL VISION 1 Table of Contents ABSTRACT ............................................................................................................................................ 2 FORECASTING GROWTH ....................................................................................................................... 2 AMAZON .............................................................................................................................................. 3 FINANCIALS ................................................................................................................................................. 3 EMPLOYEE WELFARE ..................................................................................................................................... 4 ANTICIPATED ISSUES ..................................................................................................................................... 5 Amazon Tax ......................................................................................................................................... 5 Improving Delivery ............................................................................................................................... 6 Lack of Focus ........................................................................................................................................ 6 AMAZON PRIME ........................................................................................................................................... 6 WAL-­‐MART ........................................................................................................................................... 7 CURRENT OPPORTUNITIES .............................................................................................................................. 7 FUTURE OPPORTUNITIES ................................................................................................................................ 8 Employee Welfare ................................................................................................................................ 8 Consumer Behavior .............................................................................................................................. 8 Branding and Consumer Perception .................................................................................................... 9 ANTICIPATED IMPROVEMENT ........................................................................................................................ 10 COMPETITION .................................................................................................................................... 11 CONCLUSION ...................................................................................................................................... 11 APPENDICES .............................................................................................................................................. 12 APPENDIX A .............................................................................................................................................. 12 APPENDIX B .............................................................................................................................................. 12 APPENDIX C ............................................................................................................................................... 14 APPENDIX D .............................................................................................................................................. 15 APPENDIX E ............................................................................................................................................... 15 APPENDIX F ............................................................................................................................................... 17 2 Abstract We recommend purchasing shares of Walmart to hold for ten years, as opposed to
Amazon. Wal-Mart stock is undervalued with little volatility, while Amazon is overpriced and
highly volatile. There is no doubt that Amazon’s revenues will grow over the next ten years, but
we have no confidence that they will meet expectations. Wal-Mart is the largest employer in the
US with reported sales of $486B and a net income of more than $14B in FY15. Amazon is a
rapid-growth company that grew sales by 19.52% from FY13 to FY14. Amazon has not shown
sustained profits. We believe profitability matters to long-term financial growth, as it affects free
cash flow. Amazon executives’ lack of focus or understanding of profits is concerning. Both
Amazon and Walmart will be the major players in the retail space over the next ten years but
Walmart’s stability and focus when compared to Amazon’s chaotic growth gives it the clear
edge.
Forecasting Growth The stock price calculations of Amazon and Wal-Mart are based upon assumptions as to
how the companies will perform over the next 10 years. Wal-Mart’s free cash flow was
calculated in each projected year by taking net income, plus depreciation, minus capital
expenditures, plus interest expense, multiplied by the tax rate. Amazon’s free cash flow was
calculated by taking net income, plus depreciation, minus capital expenditures. Free cash flow
was projected over ten years and a horizon value was calculated based upon a long-term growth
rate. A value of operations was calculated by taking the sum of the present value of free cash
flow plus the horizon value.
Estimated stock price was calculated by taking the sum of the value of operations and
horizon value in the projected 10 years, adding the value of non-operating assets and preferred
stock, subtracting debt obligations and dividing by the number of shares outstanding. For Wal-
3 Mart, the projected numbers were consistent with years past. Amazon was difficult to calculate
for, as Amazon has yet to turn a profit, but is projected to do so in the coming years.
According to this calculation, Wal-Mart stock is undervalued. It needs to increase
revenues at 1.50% each year over the next four years, and grow revenue by 2.00% for the
remaining six years to match the projections. Amazon is overvalued, and will need to grow
revenue at the rate of 20% per year in order for these projections to get even close to matching
the current stock price (Appendix A).
Note: all financial references come from respective company’s annual reports. Dated
April information comes from Amazon1 and Wal-Mart’s2 financial statements.
Amazon Financials
There is no doubt that Amazon will experience incredible growth over the next few years.
With news of streaming services, warehouse automation, and drone delivery, revenue growth is
inevitable. Revenue grew 21.87% from FY12 to FY13 and by 19.52% from FY13 to FY14. In
order for our stock price calculations to meet the current stock price, several assumptions were
made. Appendix B illustrates the projections in excel format.
• Short-term revenue growth of 20% over the next ten years, with a long-term growth rate
of 2% after the 10-year short-term period.
• As Amazon becomes more efficient internally, gross margins will grow to 32.4% in year
1, and reach a spread best 34.0% by year 10. Gross margin grew from 27.2% in FY13 to
29.5% in FY14.
• On a conservative basis, for the first year, operating expenses were kept static to match
historic levels of 23.4% in FY14. Operating margin will gradually improve due to
efficiencies with Amazon’s operations.
1
"Amazon.com, Inc." Yahoo! Finance. 09 Nov. 2015, from http://finance.yahoo.com/q?s=amzn&ql=1 "Wal-Mart Stores Inc." Yahoo! Finance. 09 Nov. 2015, from http://finance.yahoo.com/q?s=WMT 2
4 • Improvements in operations, coupled with revenue growth of 20% year over year, means
profitability will improve. In year one, net income will total $1.14B or 1.07% of revenue.
This will gradually increase to $28.43B or 5.16% by year 10.
Free cash flow was calculated by taking net income plus depreciation, minus capital
expenditures. It was assumed that capital expenditures would remain similar to that of historic
levels, so the average of the past three year’s capex was utilized. If Amazon invests in more
physical stores, capex drastically increases, which will decrease cash flow. It’s assumed that
Amazon won’t venture into the brick and mortar sector because it has claimed it will not do so
(even though they opened their first physical bookstore on November 4, 2015). Because of the
increase in profit, free cash flow will grow at steady rate year over year. After 10 years of
operations, it's calculated that Amazon’s value of operations to be approximately $307B
(Appendix A).
To calculate the stock price of $668.88, take the value of operations, plus non-operating
assets, minus debt, divided by shares outstanding. In order for this stock price to be accurate,
revenue has to grow at a rate of 20% each year for the next 10 years.
The biggest concern is Amazon’s lack of profitability. We are hesitant on Amazon having
enough sales growth and focus on efficiency to improve profitability. While profitability isn’t
necessary in periods of rapid growth, it is necessary for maturing businesses. Amazon’s lack of
profits on its more mature and core business segments is very concerning. Our model assumes
that profits will grow to approximately $28.43B or 5.16% of total revenue by year 10, but we do
not think this growth is attainable. See Appendix B for more details.
Employee Welfare
Amazon’s labor practices have reached news headlines recently. Reports of warehouse
workers fainting from heat exhaustion surfaced. Other employees in the U.S. claim that they
5 have not been paid and that Amazon employs tactics to avoid paying unemployment benefits.3
“Workers…were forced to endure brutal heat inside the warehouse and were pushed to work at a
pace many could not sustain. Employees were frequently…threatened with termination.”4
Amazon also faces employee dissatisfaction in their corporate offices. Amazon has strict
practices that one employee described as “purposeful Darwinism”. Employees are incentivized to
backstab coworkers in order to advance. They are encouraged to be negatively critical of other
employee projects and work off-hours without extra compensation. This has led to health issues
in some employees, such as ulcers and mental breakdowns.5
Amazon’s aggressive and controversial labor practices are not dissimilar to its competitor
Wal-Mart. The difference between the two has been reaction and public spotlight. While WalMart has invested in employee satisfaction Amazon has not and is not prepared for the negative
backlash. Amazon strategy has been entirely on business growth and has largely ignored public
perception and labor relations. Employee satisfaction is not a priority at Amazon and will
become an issue in the future.
Anticipated Issues Amazon Tax Amazon does not currently pay sales tax on any orders it fulfills but that is expected to
change. Many believe that this provides an unfair disadvantage to brick and mortar stores.
Amazon has actively lobbied against an online sales tax. If the tax passes, Amazon will have to
adjust their operations which would lead to more narrowed cash flow. The current US legislation
has called for tax reform and consumers can expect tax reform legislation within the decade.
3
Soper, S. (2012, December 17). Amazon warehouse workers fight for unemployment benefits. Retrieved November 8, 2015, from
http://www.mcall.com/business/mc-amazon-temporary-workers-unemployment-20121215-story.html 4
Soper, S. (2015, August 17). Inside Amazon's Warehouse. Retrieved November 8, 2015, from http://www.mcall.com/news/local/amazon/mcallentown-amazon-complaints-20110917-story.html 5
Kantor, J., & Streitfeld, D. (2015, August 15). Inside Amazon: Wrestling Big Ideas in a Bruising Workplace. Retrieved November 8, 2015,
from http://www.nytimes.com/2015/08/16/technology/inside-amazon-wrestling-big-ideas-in-a-bruising-workplace.html?smid=twnytimes&smtyp=cur&_r=4&gwh=1E42319B322AB719255F6C53B00CE8F7&gwt=pay&assetType=nyt_now 6 Improving Delivery Amazon is focused on the convenience aspect as they prioritize cutting delivery time.
Prime Now offers same-day delivery in sixteen US cities, including one-hour delivery in some
areas. Last year Amazon announced 30-minute or less delivery of an order via drone. Amazon is
currently hiring for a delivery-sharing program similar to Uber but for packages. There is a lot of
uncertainty around the profitability of these delivery options. Faster delivery incurs higher costs
and is unlikely to result in more expensive orders.
Lack of Focus Amazon recently opened a brick and mortar bookstore in Seattle. “The store is physically
odd. It betrays inexperience with retail.”6 This inexperience, combined with future sales tax
issues and a PR backlash is going to take a financial toll on the company. This leads to a question
destined to plague Amazon in current and future operations: how much diversification is too
much diversification? Amazon has drones, a brick and mortar store, data storage capabilities,
online movies subscriptions, the Kindle, Amazon branded items, etc. Amazon has been a first
mover for most of their businesses, but has largely been incapable of profiting in those segments.
All of Amazon’s core business segments are at risk of being imitated by its competitors.
Amazon Prime
Amazon Prime is Amazon’s loyalty program. Prime costs consumers $99 per year and
comes with the benefit of free shipping and instant streaming services. Prime has been
successful, with many analysts believing there are 40-50 million Prime members worldwide.
While customer breakdown isn’t available, Prime members are believed to spend four times as
much as a regular Amazon shopper annually.
6
Kurtz, D. (2015, November 4). My 2.5 Star Trip to Amazon's Bizarre New Bookstore. Retrieved November 8, 2015, from
http://www.newrepublic.com/article/123352/my-25-star-trip-amazons-bizarre-new-bookstore 7 While Prime includes access to this media, 78% of customers signed up for the free
shipping, not the other services.7 It might be shocking in saying that Amazon should drop
streaming services, but it makes sense from a business perspective. Prime has underpriced the
streaming services market for several years, yet hasn’t been able to pull customers from
competitors like Netflix or Spotify. Prime strays from Amazon’s core competency of efficient
and speedy delivery.
Wal-­‐Mart Current Opportunities
Wal-Mart has established itself as the price leader in the retail world. Wal-Mart’s rise has
been the result of an intense focus on minimizing operating expenses and leveraging its control
of suppliers. Their ability to buy and sell large volumes has allowed the company success despite
low margins. A mature international business segment also gives Wal-Mart an advantage. Their
global supply chain and logistics allow for lowest cost sourcing and distribution worldwide.
Wal-Mart has not become stagnant and is working to reinvent its image to consumers. In
their 2015 annual report, Wal-Mart stated that they were going to focus on growing their nonstore inventory online. By growing their available online inventory and leveraging their position
as cost leader, they should see some success in growing online business without cannibalizing instore sales.
7
Amazon Prime Members: Still in It for Free Shipping - eMarketer. (2015, November 5). Retrieved November 9, 2015, from
http://www.emarketer.com/Article/Amazon-Prime-Members-Still-Free-Shipping/1013196
8 Future Opportunities
Employee Welfare
Wal-Mart is making strides to improve their employee welfare, most notably recently in a
wage increase to $10/hour in 2017, a $2.5B investment over the next two years.8 This will
impact the current profitability levels and irritate investors. The emphasis on employee
satisfaction will boost Wal-Mart’s public image and yield long-term benefits.
Another way Wal-Mart is focusing on the long-term is by creating a consistent weekly
schedule as opposed to on-call hours that differ each week. A consistent schedule gives parents
more child care options and the chance to seek higher education, increasing employee
satisfaction.9 Wal-Mart has already faced many employee welfare issues that Amazon is
currently struggling with. This allows Wal-Mart to focus on other areas of the business. For
example focusing on having inventory stocked, and making stores cleaner.10
Consumer Behavior
While online shopping is not expected to slow down, independent stores will be boosting
their digital businesses to compete with Amazon.11 “Just 19% of Wal-Mart in-store shoppers
shop at Wal-Mart.com, compared to 53% of those who also buy at Amazon.com… 74% of WalMart.com shoppers also buy from Amazon.com, but only 18% of Amazon.com shoppers buy
from Wal-Mart.com.”12 Improving Wal-Mart’s online marketplace will improve sales.
Wal-Mart’s core customers, Baby Boomers and Generation X-ers, will remain loyal to
Wal-Mart over time because of their price-consciousness and low use of technology. Wal-Mart
8
Wal-Mart raises pay well above minimum wage. (2015, February 19). Retrieved November 9, 2015, from
http://money.cnn.com/2015/02/19/news/companies/Wal-Mart-wages/
9
Wal-Mart's other promise to workers: Better schedules. (2015, February 19). Retrieved November 9, 2015, from
http://money.cnn.com/2015/02/19/news/companies/Wal-Mart-wages-schedules/index.html?iid=EL 10
Pettypiece, S., & Boyden, C. (2015, October 30). Target seeks edge over Wal-Mart with free holiday shipping. Retrieved November 9, 2015,
from http://www.jsonline.com/business/target-seeks-edge-over-wal-mart-with-free-holiday-shipping-b99606685z1-339029871.html 11
Thau, B. (2015, January 8). 7 Retail Trends That Will Shape How You Shop This Year. Retrieved November 9, 2015, from
http://www.forbes.com/sites/barbarathau/2015/01/08/experts-predict-7-big-retail-trends-that-will-shape-how-you-shop-this-year/ 12
Cheng, A. (2014, April 4). Wal-Mart’s in-store shoppers prefer Amazon.com — not Wal-Mart.com. Retrieved November 9, 2015, from
http://blogs.marketwatch.com/behindthestorefront/2014/04/04/wal-marts-in-store-shoppers-prefer-amazon-com-not-Wal-Mart-com/
9 will see increased business from Generation Y and Millennials due to the disappearance of the
middle class, increasing inflation, and Wal-Mart’s internal shift to a focus on quality.13
Internationally, Wal-Mart will have a population surge to purchase goods. “Asia and
Africa will account for most of the population growth out to 2025 while less than 3 percent of the
growth will occur in the “West.”14Wal-Mart has a presence in developing countries, including
India, China, Mexico, and much of the African continent, which will be places with large
markets that appreciate low cost items.15 Wal-Mart already has a strong international presence.
Amazon is a worthy contender to Wal-Mart’s global hold, but that growth has been slipping. In
2014, 37% of Amazon’s total sales came internationally, but growth was half that of domestic
sales, at 12%.16
Branding and Consumer Perception Wal-Mart’s potential lies in the fact that they can imitate Amazon much more readily
than Amazon can imitate Wal-Mart. Wal-Mart is investing in a more attractive venue for higher
margin products and working to change customer perception about the brand. By paying
employees more and changing their working schedules, they are focusing on quality and
reducing turnover, while boosting their public relations. They are choosing to buy and sell
socially conscious brands instead of the cheapest.17 They are also entering niche markets by
opening Wal-Mart Neighborhood Markets that focus on quality goods.
13
Peterson, H. (2014, September 18). Meet The Average Wal-Mart Shopper. Retrieved November 9, 2015, from
http://www.businessinsider.com/meet-the-average-wal-mart-shopper-2014-9 14
Global Trends 2025: A Transformed World. (2008, November 1). Retrieved November 9, 2015, from
http://www.aicpa.org/research/cpahorizons2025/globalforces/downloadabledocuments/globaltrends.pdf 15
Our Locations. (n.d.). Retrieved November 9, 2015, from http://corporate.Wal-Mart.com/our-story/our-locations
16
Walmart Corporate & Financial Facts. (2015). Retrieved November 9, 2015, from http://corporate.walmart.com/_news_/walmartfacts/corporate-financial-fact-sheet 17
Monllos, K. (2015, May 29). Is Wal-Mart Trying to Brand Itself as Socially Conscious? Retrieved November 9, 2015, from
http://www.adweek.com/news/advertising-branding/Wal-Mart-trying-brand-itself-socially-conscious-165034 10 E-commerce and brand improvement is an opportunity rather than a threat for Wal-Mart.
Their core consumer in the low to middle class isn’t expected to change or leave. While
investment in improving their brand is necessary, they can focus on brand in conjunction with ECommerce. A brand overhaul would allow Wal-Mart to become a major player in E-commerce
without harming their core revenue stream.
Anticipated Improvement Wal-Mart will make several changes in the next ten years that will improve profitability.
The primary change discussed was the brand overhaul, which has already begun. As a part of
that, Wal-Mart will improve their E-commerce systems, increase employee welfare, continue to
keep prices low, and compete more effectively for more name brands so that they can improve
margins. Since Wal-Mart is partaking in this brand overhaul, the stock price is undervalued, as
profitability and free cash flow will improve over the next several years. According to
calculations, Wal-Mart’s stock should be valued at around $90.66/share (Appendix D, E, and F).
With the brand overhaul, Wal-Mart will be looking to do several things that will
eventually help improve efficiencies and create a more stable financial future. First, Wal-Mart
will improve its E-commerce system. As previously stated, this will somewhat cannibalize its
current revenue stream, however, it must capture additional online sales in order to compete on a
global scale. In 2014, E-commerce sales represented just $12.2B of its total $486B in sales.18
With a greater online presence, Wal-Mart can capture more outside customers and grow beyond
its current footprint.
Additionally, Wal-Mart has increased wages to current minimum wage employees. This
has affected stock price because of the effect on year-end operational cash flow and ultimately
18
Tabuchi, Hiroko. "Walmart, Lagging in Online Sales, Is Strengthening E-Commerce." The New York Times. The New York Times, 05 June
2015. Web. 09 Nov. 2015, from http://www.nytimes.com/2015/06/06/business/walmart-lagging-in-online-sales-is-strengthening-ecommerce.html?_r=0 11 free cash flow. However, a few years down the road, this will create efficiencies by decreasing
turnover and reducing training costs. An improved brand image will allow Wal-Mart to compete
for more brand name clients. Once more clients are secured, Wal-Mart will begin to recognize
improved margins. Competition
Both Wal-Mart and Amazon are struggling to find the answer to an apparent trilemma of
cost, convenience, and availability where only two are attainable. Wal-Mart’s struggles surround
availability and Amazon’s struggles surround cost. Amazon would appear to have the edge on
solving this trilemma with its innovative delivery methods but we are skeptical. Faster delivery
may grow revenues for Amazon but comes at a high cost. Teaching consumers to expect a quick
delivery will pull sales from physical stores but it will not be without problems for Amazon.
Amazon will be missing the days when its customers were thrilled that their package arrived in
two-days. For Wal-Mart to solve the trilemma, they must invest in non-store inventory and
customer perception.
Conclusion
Amazon has set themselves and consumers up for disappointment. There is no doubt that
Amazon’s revenues will grow over the next ten years, but we have little confidence they will
meet expectations. Conversely, we are very confident that Wal-Mart will meet and potentially
exceed expectations. Each company’s executives appear to be headed down different paths. WalMart’s executives have shown focus on the future of the firm by investing in higher wages and
beginning the steps for a brand overhaul. Amazon’s executives have shown a lack of necessary
focus or understanding in generating profit on core business segments. Amazon doesn’t face a
major threat but many smaller ones. The combination of E-commerce competition, a saturated
12 market, pending legislation, and management focus will ultimately prove too much to overcome
for Amazon leaving us to believe Wal-Mart is the better investment.
Appendices Appendix A Amazon’s Stock Price According to our Calculations Appendix B Amazon Projections for Sales Growth, Gross Margin, Operating Margin and Net Income Over the Next 10 Years
Note: Amazon’s sales growth was projected at 20% per year. At least, that was the number that we backed into in order to justify their stock price. Gross margin will improve, then begin to level out over the projection. Operating margin will improve greatly over the next 10 years as Amazon has made it a goal to operate as efficient as possible. Net income will improve from 1.07% of revenue to 5.16% of revenue. 13 14 Appendix C Historic Financial Trends of Amazon Over The Past Three Years
15 Appendix D
Historic Financial Trends of Wal-­Mart Over The Past Four Years
Appendix E Projections for Sales Growth, Gross Margin, Operating Margin and Net Income Over the Next 10 Years
Note: Notice that initially and throughout the beginning stages of the brand overhaul, Wal-­Mart’s projections are grim. Revenue will only increase initially at a rate of 1.50% per year for the first four years. Beyond that, we think that because of the brand overhaul and improved image, Wal-­Mart can increase revenue growth to 2.00% per year for the remaining six years. Gross margin will deteriorate in the first three years, as will operating margins and net income. Beyond year three, however, those figures will improve, as Wal-­Mart will secure more brand name materials to sell in its stores. By securing more brand names, Wal-­Mart will be able to capture a higher margin on its products sold in-­store and online. Not only that, but Wal-­Mart will also operate more efficiently due to the decreased employee turnover and reduction in training costs. 16 17 Appendix F Wal-­Mart’s Stock Price According to our Calculations