PDF 10 Years Later…Walmart, or Amazon?

[Pages:27]10 Years Later...Walmart, or Amazon?

Prepared for The Economist Case Competition

Prepared by The Tulane Valuation Team:

Ryan Cohagen Kris Khalil

Ruiqing Zhang

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TABLE OF CONTENTS

Abstract ................................................................................................................................3 1. Recent Performance, News, Industry Overview..................................................................4 1.1. Amazon ................................................................................................................................4 1.1.1. Recent Performance .............................................................................................................4 1.1.2. Recent News ........................................................................................................................4 1.2. Walmart ................................................................................................................................5 1.2.1. Recent Performance .............................................................................................................5 1.2.2. Recent News ........................................................................................................................5 2. Valuation Comparison..........................................................................................................6 3. Changes WMT Must Make to Compete in the Internet Age ...............................................8 4. Converting AMZN Ubiquity to Profitability .......................................................................9 5. Does Profitability Matter?..................................................................................................10 5.1. Related Companies ............................................................................................................12 5.2. Institutional Ownership Stake............................................................................................13 6. Investment Rationale .........................................................................................................14 6.1. Rationale ............................................................................................................................14 6.2. Primary Long Strategy .......................................................................................................14 6.3. Leveraging Options............................................................................................................14 7. Sources ...............................................................................................................................16 8. Exhibits ..............................................................................................................................16

A. 3 Year Percentage Growth of Stock Price ....................................................................16 B. 10 year AMZN to DJIA % Change ..............................................................................16 C. 10 year WMT to DJIA % Change ................................................................................17 D. Pro Forma Financial Comparison ................................................................................17 E. Wal-Mart Discounted Cash Flow Valuation ................................................................17 F. Amazon Discounted Cash Flow Valuation ..................................................................18 G. Analyst Recommendation Trends ................................................................................18 H. Wal-Mart Multiple Valuation Model............................................................................18 I. Wal-Mart Month Covered Call Option Return Model.................................................19

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Abstract Wal-Mart has recently announced a period of earnings stagnation, thus changing the market's sentiment towards WMT from being a blue-chip growth play, to being a stalwart in the years to come. The market is also expressing its skepticism on a low cost brick-and-mortar retailer in an increasingly digitized world where companies like Amazon are drastically locking up market share. Moreover, people are becoming more willing to pay an extra price for a better experience and better food as is the case with Whole Foods Market. In our opinion, the recent decline in WMT share price is a huge overreaction, and should be exploited by any long-term investor. It has created a great opportunity for the patient value investor to buy a blue-chip industry leaded with a 3.3% dividend yield at a conservative price.

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10 Years Later...Walmart, or Amazon?

1. BUSINESS DESCRIPTIONS

1.1 Amazon (AMZN) , Inc. was founded in 1994 and is headquartered in Seattle, Washington.

Amazon operates internationally as an online retail giant. The company serves consumers through websites such as , amazon.ca, and .mx, which include merchandise and content purchased for resale from vendors and those offered by third-party sellers. In addition, the company serves developers and enterprises through Amazon Web Services that provides compute, storage, database, analytics, applications, and deployment services in start-ups, enterprises, government agencies, and academic institutions. Further, it manufactures and sells electronic devices and provides Kindle Direct Publishing. Additionally, the company offers Amazon Prime, an annual membership program, which provides free shipping of various items; access to instant streaming of movies and TV episodes; and access to books to borrow and read on a Kindle device, as well as provides publishing, digital content subscriptions, and advertising services; and co-branded credit card agreements.

1.2 Walmart (WMT) Wal-Mart Stores, Inc. was founded in 1945. The company was incorporated in Delaware

in 1969. Walmart operates brick-and-mortar retail stores in various formats worldwide, as well as an online retail store. The company's segments include Walmart U.S., Walmart International, and Sam's Club. experiences on average 60 million visits a month and offers access to approximately 8 million SKUs.

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Walmart U.S. does business in the following six strategic merchandise units, across various store formats, including supercenters, discount stores, Neighborhood Markets and other small store formats, as well as . The Walmart U.S. segment also offers financial services and related products, including money orders, prepaid cards, wire transfers, money transfers, check cashing, and bill payment. The company also markets lines of merchandise under its privatelabel store brands.

2. RECENT PERFORMANCE, NEWS, INDUSTRY OVERVIEW

2.1 Amazon i. Recent Market Performance

Amazon's stock has been skyrocketing over the most recent one year from $290.74 to $654.18. Amazon provided returns of 35% in 2013, a decrease of 1.2% in 2014, and 86% in 2015 YTD. AMZN has been one of the main hedge fund darlings in the market as of late, and analysts project no change in the near future. As seen in Appendix 2, AMZN is up 1,470% relative to the Dow Jones Industrial Average which is up 71% over the last 10 years. ii. Recent News

Amazon reported third-quarter earnings of 17 cents per share on $25.36 billion in revenue. Analysts expected Amazon to post a loss of 13 cents per share on $24.91 billion in revenue, according to a consensus estimate from Thomson Reuters. These positive results were driven by strength in Amazon Web Services and its Prime ecosystem. With the data center pricing environment becoming more rationalized, AWS could continue to drive near-term growth. As for the medium-term, AMZN's Prime ecosystem is continuing to gain steam with some estimated 60-80 million users globally, and the higher purchase frequency as well as larger order size from the Prime users will likely to be supportive of AMZN's fourth quarter numbers

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during the upcoming holiday season. The Company's strong outlook suggests that near-term strengths in ecommerce and AWS are sustainable.

It's worth noting that AMZN's success is partially driven by the strength of its `members', a model that is also adopted by Alibaba, with its focus on mobile payment, media, quick delivery and internet finance, which is one of the reasons behind its competitive position in China. In terms of competitive outlook, we expect AMZN to remain the dominant leader in North America in the medium term. However, the long-term outlook could be less optimistic given the increased focus BABA has on the US market. The recent partnership of BABA and the US Postal Office and the ramp up of its data centers are all good indicators that BABA is building its infrastructure in the US, and this will eventually compete head-on against AMZN. 2.2 Wal-Mart i. Recent Performance

Wal-Mart's stock has been on the decline over the last year, with analysts predicting no foreseeable changes in the near future. WMT has provided returns of 9% in 2013, 17% in 2014, and decrease of 30% in 2015 YTD, as seen in Appendix 3, WMT is up 21% relative to the Dow Jones Industrial Average which is up 71% over the last 10 years.

ii. Recent News Wal-Mart posted 2nd quarter earnings of $1.08 per share, down from $1.21 a share in the

year-earlier period. Revenue edged up to $120.2 billion from $120.13 billion a year ago. Analysts expected earnings of $1.12 a share on $119.72 billion in revenue, according to a consensus estimate from Thomson Reuters. Wal-Mart's stock price took a beating after they provided recent negative guidance on EPS at their recent stockholder meeting.

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Wal-Mart said its profits were being weighed down by a decision to increase the hours of store greeters and stocking positions, part of its push to improve customer service. We believe that the recent plunge in the market value of Wal-Mart is a great opportunity for the long-term investor to buy a supreme heavyweight at a value price. Below are a few key reasons why WalMart's stock has lost so much value recently and why we feel it is a great long-term buy:

The fierce battle with Amazon and other retailers has forced WMT to increase investments in its online shop. Noted in their most recent 8-K filing, in 2017 WMT will invest approximately $1 billion in its online store. We actually see this as a long-term positive for WMT, as they are currently well-behind Amazon in online retail sales.

WMT also has committed to investing substantial capital in improving its stores, making way for an improved customer experience, increased trips to the stores, and longer time spent at the stores.

WMT will increase wages going forward for its employees, resulting in higher costs for the Company. WMT has been heavily criticized in the past for its compensation policies & treatment of employees. In the current fiscal year, the average hourly wage will be increased to $9, and then $10 in 2017. This increase alone will result in extra costs of $1.2B in 2016 and $1.5B in 2017. This wage will constitutes 75% of the announced EPS reduction. Again, this is where `bad news" for short-term investors can turn out to be fantastic news

for long-term investors. With lower employee turnover and increased motivation through higher wages, WMT is seeking to improve the customer experience and long-term profitability as well. The employee turnover in US retail is currently 5% per month - a very high turnover which in turn gives WMT a lot of problems.

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3. PRO-FORMA AND VALUATION COMPARISON

3.1 Market share in ten years is the foundation behind our valuation assumption In our DCF valuation model, we assume that, in ten years, both companies can keep their

current growth pattern for five years and then turn to stable. behind the assumption, we expect that Walmart will be successfully adapt its operation model with internet retail era and defend their current market share, in other words, Walmart can successfully extend their maturity stage but not enter declining stage, and that amazon will successfully implement its strategy, sacrificing current profitability, investing in growth, and earn long-term profitability, in other words, Amazon will be able to successfully compete in market share expansion, enter the maturity stage of internet retail model and successfully become one of the industry leaders. 3.2 Investor's expectation of the future growth rate led to different P/E ratio

Amazon has a high P/E ratio, which is 944.66x on Nov. 8, 2015, while Walmart P/E ratio is 12.27x. Different P/E ratios are result from investor's different expectations onto the growth rates of both companies. Prices of both companies have big differences with the result of our DCF model. For Walmart, our target price $286.9, which is 4.92 times of current market price: $ 58.37. For Amazon, the price we turned out is $447.35, which is 67.85% of current market price: $659.37. By comparison, we conclude that market expect amazon will have higher than current growth rate, and Walmart will have lower than current growth rate. 3.3 Pro-forma financial performance comparison

In order to make both companies' future financial performances are comparable, eliminate our team's biased preference onto each of companies, and based on our fundamental market share assumption, we projected the financial statements from Q4 2015 through 2025 in

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