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WALMART VS AMAZON Economist 2016 Investment Case Competition Sponsored by Realvision

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WALMART VS AMAZON Economist 2016 Investment Case Competition sponsored by RealVision Abstract Over the next 10 years Walmart stock will outperform Amazon because: • Combining brick-and-mortar with e-commerce is a winning strategy: Although the growth of e-commerce is impressive, brick-and-mortar stores still account for 90% of retail revenues. Walmart is better positioned as an omni-channel retailer given its global store network and strong online presence. • Early entry in China will pay dividends as country’s middle class booms: The growth of the Chinese middle class will alter global consumption trends in the next decade. Walmart has been laying the foundation to meet this demand and is accelerating expansion in China. • Earnings, not dreams, drive value: Walmart has proven it can deliver long-term profitable growth. Comprehensive strategy and operational excellence will continue to provide above average profitability. • Strong balance sheet and robust free cash flow provide low cost capital to support growth: Relatively low debt insulates Walmart from rising rates. • Undervalued stock will provide most value to shareholders: Conservative DCF model shows the market is significantly mispricing Walmart’s stock. Cole Buckley, Pete DeFina and Lindsay Root Table of Contents Walmart vs Amazon .................................................................................................................. 2 Industry Summary ...................................................................................................................... 2 Company Overviews .................................................................................................................. 3 Amazon .................................................................................................................................. 3 Walmart .................................................................................................................................. 4 Market Position & Analysis ....................................................................................................... 5 Walmart is positioned to become the leading omni-channel retailer ..................................... 5 Walmart is able to capture growth in Asian middle class ...................................................... 7 Walmart’s global network provides competitive advantage .................................................. 9 Financial analysis ..................................................................................................................... 10 Walmart has above average profitability and a strong history of profitable growth ............ 10 Walmart’s conservative capital structure makes it easy to raise capital and reduces impact of rising rates ........................................................................................................................ 11 Valuation .................................................................................................................................. 12 P/OIPS .................................................................................................................................. 12 Discounted Free Cash Flow ................................................................................................. 14 Conclusion ............................................................................................................................... 16 Works Cited ............................................................................................................................. 17 1 Walmart vs Amazon Amazon and Walmart have become ubiquitous, household names in the US and for good reason: both of these companies have revolutionized the way in which we shop. Amazon offers a convenient experience, and an ever-expanding selection of products whereas Walmart has a wide network of store locations and famously low prices. As investments, these companies highlight the dichotomous nature of the retail industry – brick-and-mortar vs e-commerce; high growth vs steady growth; US vs International; actual vs market expectations. To coalesce these stark differences, we will first summarize the industry and these companies, followed by an analysis of market position and financials, and finally an analysis of the firm valuation, all of which point to Walmart as the clear investment over the next 10 years. Investment decision: Buy WMT Industry Summary For the ease of comparison, we’ve grouped both Amazon and Walmart into retail, however, the industry forces that drive each of these companies are distinctly different and the firm that is best able to leverage these forces will ultimately make a better investment for the next 10 years. 2 Table 1: Industry Summary1 Industry E-commerce and Online Warehouse Department Stores Auctions in the US Clubs & in the US Supercenters in the US Key Drivers Per capita disposable income Number of mobile internet connections Percentage of services conducted online World price of crude oil Life cycle Growth Mature Decline stage: Concentration Low – HHI 250 High – HHI High HHI 2,000 Level: 5,000 Technology High Medium Medium Change: Barriers to Low High Medium Entry: Threats High reliance on shipping Gas stations E-commerce sites companies (FedEx, UPS, etc.). generate large are better portion of positioned due to Operating profits limited when industry low overhead oil prices are high. Membership revenue. costs, offering (like Prime) limits ability to pass lower prices and higher costs onto customers. wider inventories. Opportunities Disposable income levels determine quantity and quality of online purchases Integrate in-store and online for personalized customer experience Company Overviews Amazon Amazon.com, founded in 1994 by current CEO Jeff Bezos, is the largest internet-based retailed in the US. They maintain three different operating segments: North America, International, and 1 (IBIS World, 2015) 3 Web Services. In Q2 of 2015, Amazon reported $23 billion in sales of which North America represented 60%, International 32%, and Web Services 8%.2 Amazon currently sells over 300 million products in a variety of categories. Its retail operation encompasses many different business models – Amazon Retail, Amazon Marketplace, and Amazon Web Services. In Amazon Retail, the company purchases and takes possession of inventory in which it stores in one of its 743 distribution centers in the US. In Amazon Marketplace, third party sellers are able to list items on Amazon’s website and the seller pays a fee to Amazon. Amazon Web Services is cloud-computing platform providing services like online storage and virtual servers.4 Walmart Walmart, founded in 1962 by Sam Walton, was the world’s largest company by revenue5. Its operating segments include Sam’s Club, Walmart US, and International. In Q2 of 2015, Walmart reported $119 billion in sales of which Walmart US represented 62%, International 26% and Sam’s Club 12%.6 Sales are generated predominantly through one of its 11,526 stores throughout the globe. Walmart also generates sales through its website Walmart.com, however less than 3% of sales are generated online.7 Evolving to compete in the digital space, Walmart is moving from a traditional brick-and-mortar retail store to an omni-channel model which includes online sales.8 Table2: Selected Company Metrics9 Company Name Walmart (WMT) Amazon (AMZN) Employees 2.2 Million 154,000 Shareholders 250,000 2,744 2 (Amazon, 2015) 3 (MWPVL, 2015) 4 (Amazon, 2015) 5 (Fortune, 2015) 6 (Walmart, 2015) 7 (Forbes, 2015) 8 (Walmart, 2015) 9 (Mergent Online, 2015) 4 Market Cap $187 Billion $307 Billion Revenue 486 Billion 100.5 Billion Net Income 15.5 Billion 328 Million Dividend 1.95 N/A Dividend Yield 3.33% N/A Share Price $58 $655 Market Position & Analysis Walmart is positioned to become the leading omni-channel retailer Retailers have realized that the future of retail is offering goods and services through tightly integrated digital and physical channels. A 2014 study by A.T. Kearney found that a majority of customers prefer online shopping for product discovery and delivery, and physical stores for product testing and returns.10 In fact, two-thirds of the customers purchasing online use a physical store either before or after the transaction.11 The tradeoff in customer preferences between online and physical stores is driving an increasing amount of retailers to adopt an omni-channel model. Successful online retailers such as Microsoft and Athleta are now opening brick-and-mortar locations as part of a blended retail strategy. On the other hand, traditional brick-and-mortar retailers are making large investments to improve its online presence. Walmart CEO Doug McMillon said “I want us to stop talking about digital and physical retail as if they’re two separate things, the customer doesn’t think of it that way, and we can’t either.” McMillon went on to discuss Walmart’s plans to heavily invest in its vision of seamless integration between digital and physical shopping. Online sales currently make up only a small 10 (A.T. Kearney, 2014) 11 (A.T. Kearney, 2015) 5 percentage of Walmart’s total revenues, however with $12 billion in e-commerce sales in 2015 it is already one of the largest online retailers in the world.12 Indeed, Walmart has incredible upside potential in online retailing if it can successfully execute its omni-channel strategy. In 2015 the global e-commerce market was estimated to be $1.5 trillion which is forecast to grow at an average of 15% for
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