Walmart vs Amazon

MBA Case Study Competition 2016 Real Vision Investment Case Study

Walmart vs Amazon

Team Single Voice Brigham Young University

Matt Drage Chace Jones Holly Preslar

MBA Case Competition 2016 Real Vision Investment Case Study

Introduction The internet has initiated a transformation in the retail industry that is affecting nearly every segment of the market. Amazon has historically dominated the online retail space, but Walmart is far from becoming irrelevant. In fact, insights into the retail market have shown that it is Walmart, not Amazon that is better positioned to be successful in an online era. Though online e-commerce is important, what is essential is a company's ability to integrate online techniques with a physical presence to provide customers with an "omnichannel" experience. Companies that are able to combine both aspects of shopping into an intertwined experience are those that will ultimately provide the most value to investors. Walmart's impressive global presence, its understanding of core customers, and its ability to continually provide profits and dividends to shareholders secure its position as the better long-term investment in an internet age. Company Profiles Walmart was founded in 1962 based on a model of providing low prices, creating economies of scale, and minimizing operating costs. Walmart experienced almost immediate success ? by 1970 it became a publicly traded company and by 1990 had spread internationally. Brick and mortar retail operations have remained incredibly strong through the decades ? Walmart has an imposing physical presence (11,526 retail stores and 158 distribution centersi) and has continued to develop and maintain a significant competitive advantage through that physical footprint. Financially speaking the company has also had a long history of providing positive earnings and dividend returns with a YoY growth of 3% on its stock price from 2000 to 2014ii. was founded in 1994 by its current CEO, Jeff Bezos. It became publicly traded in 1997 and has experienced impressive growth in both revenue and stock price from 2000 to 2014. Despite this growth, however, Amazon has yet to be considered profitable due to extremely low

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MBA Case Competition 2016 Real Vision Investment Case Study

profit margins that consistently hover around zero. Observed growth in stock price cannot be related to current profitability, since profitability has historically been nonexistent, but instead is a result of analyst expectations that, due in part to Amazon's proven track record of innovation, Amazon will continue to have high revenue growth and will soon begin to generate a profit. Financial Analysis Since January 2015, both Walmart and Amazon have experienced significant changes in stock price impacting the overall market value of each company. Amazon's stock price has risen 112% YTD as of November 6, 2015 while Walmart's price has dropped 32%. Amazon's trailing P/E ratio is 945 while Walmart's is 12iii. Based on this information it would appear likely that each company is mispriced ? Amazon overvalued, and Walmart undervalued. Surprisingly the conclusion of the analyses below shows that each is reasonably priced in relation to peer companies based on projected growth and earnings expectations. We have compared both Walmart and Amazon market multiples to five of the best comparable companies (see Appendix A for tables). This analysis placed Walmart on the low end of both the EV/Sales and EV/EBITDA multiples, when compared directly with its most relevant peers, suggesting undervaluation. In Amazon's case, when compared to selected peers, it is reasonably priced when looking at EV/EBITDA and is undervalued when looking at EV/Sales. The EV/Sales analysis does not account for a company's ability to generate profit, and can be misleading in this case given Amazon's current lack of profits. Amazon may wrongly appear undervalued using this method since the majority of Amazon's peers have higher profit margins despite lower sales. In order to better understand the effect of profitability and growth on these valuations, we have taken a two-variable approach and charted both Walmart and Amazon with a larger pool of comparable companies in the graphs below. The first is a graph of Walmart's and its comparable

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MBA Case Competition 2016 Real Vision Investment Case Study

companies' Enterprise Value (EV) to trailing twelve months (TTM) sales ratio, plotted against its TTM EBITDA margin. This is a direct comparison between a company's ability to sell product and its ability to generate profit. Companies with higher sustainable margins should sell for a higher price per dollar of sales; by using two variables this approach offers a better benchmark than simply comparing Walmart's sales multiple to the average. Walmart is just below the trend line of its peers signifying a reasonable price point based on this method (see the orange data point).

Company Name Costco Wholesale Corporation Target Corp. Best Buy Co., Inc. PriceSmart Inc. METRO AG Wumart Stores Inc. Olympic Group Corporation Companhia Brasileira de Distribuicao Dollar General DG US Equity Dollar Tree Inc DLRT US Equity Wal-Mart

EBITDA Margin EV/Sales

4.1%

0.6x

10.0%

0.8x

5.4%

0.3x

6.5%

0.9x

3.5%

0.2x

3.7%

0.2x

2.4%

0.4x

5.7%

0.3x

11.3%

1.2x

13.6%

2.3x

7.3%

0.5x

Wal-Mart Comparables - EV/Sales to EBITDA Margin

2.50

2.00

1.50

1.00

0.50

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0%

The second is a graph of Walmart's and its comparable companies' Enterprise Value (EV) to EBITDA ratio, plotted against its projected five year average analyst projected revenue growth provided by Bloomberg. This graph directly compares an ability to generate profit with an ability to grow. Companies with higher expected growth should sell for higher EBITDA multiples; again, by using two variables this approach is a much better method than simply comparing Walmart's EBITDA multiple to the average. Walmart is right on the trend line ? again signifying a reasonable price point (see the orange data point).

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Company Name Costco Wholesale Corporation Target Corp. Best Buy Co., Inc. PriceSmart Inc. METRO AG Wumart Stores Inc. Olympic Group Corporation Companhia Brasileira de Distribuicao Dollar General DG US Equity Dollar Tree Inc DLRT US Equity Wal-Mart

5 Yr Growth EV/EBITDA

7.8%

14.6x

1.8%

8.0x

1.5%

4.7x

9.3%

13.9x

9.2%

5.4x

8.0%

5.4x

15.8%

15.2x

14.8%

5.4x

9.0%

10.2x

26.2%

16.9x

2.2%

6.5x

MBA Case Competition 2016 Real Vision Investment Case Study

Wal-Mart Comparables - EV/EBITDA to 5 yr Growth

18.00

16.00

14.00

12.00

10.00

8.00

6.00

4.00

2.00

0.00%

5.00%

10.00% 15.00% 20.00%

25.00%

30.00%

To reiterate, both graphs demonstrate a comparison to peers that shows Walmart's reasonable price. We have performed this same analysis with Amazon and its comparable companies as shown in the two graphs below.

Company Name Alphabet Inc. eBay Inc. Facebook, Inc. Yahoo! Inc. Expedia Inc. Netflix, Inc. The Priceline Group Inc. Etsy, Inc. TripAdvisor Inc. MERCADOLIBRE INC ALIBABA GROUP HOLDING-SP ADR , Inc.

EBITDA Margin EV/Sales

32.5%

5.9x

29.9%

2.0x

43.5%

18.7x

12.9%

5.8x

13.9%

3.1x

5.8%

6.9x

37.2%

8.5x

6.7%

4.1x

28.2%

8.6x

30.9%

7.2x

36.3%

15.2x

7.6%

3.0x

Amazon Comparables - EV/Sales to EBITDA Margin

20.00 18.00 16.00 14.00 12.00 10.00

8.00 6.00 4.00 2.00

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Company Name Alphabet Inc. eBay Inc. Facebook, Inc. Yahoo! Inc. Expedia Inc. Netflix, Inc. The Priceline Group Inc. Etsy, Inc. TripAdvisor Inc. MERCADOLIBRE INC ALIBABA GROUP HOLDING-SP ADR , Inc.

5 Yr Growth EV/EBITDA

14.2%

18.7x

5.3%

7.3x

31.3%

42.8x

4.0%

60.6x

14.9%

27.2x

23.4%

120.2x

15.3%

22.8x

31.1%

224.3x

23.6%

34.0x

20.2%

23.4x

18.1%

45.8x

17.9%

42.5x

250.00

Amazon Comparables - EV/EBITDA to 5 yr Growth

200.00

150.00

100.00

50.00

-

0.0%

5.0%

10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

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MBA Case Competition 2016 Real Vision Investment Case Study

These two graphs show that Amazon is also reasonably priced in comparison to its most relevant peers. In addition to peer-based analyses, we created a discounted cash flow (DCF) model to evaluate the viability of Walmart's and Amazon's current stock prices. Please refer to Appendix B for details. This analysis shows that there is significant potential upside for Walmart based on low expectations currently priced into the stock. On the other hand, if Amazon can achieve the high expectations for sales growth and profit built into its stock price, then the price seems reasonable. These three analyses show that both companies are reasonably priced based on analyst projections and expectations. Walmart and Amazon are in very different stages of company life cycle ? Walmart is a mature company, and Amazon is still growing. Both view profitability as important, but for different reasons. Walmart's profitability is key to both increasing share price and providing dividends to shareholders. Amazon, however, uses operating profits generated from a few business segments to fund growth through investing in research and development. Profitability "matters" for Walmart because its investors expect it. Amazon's investors, however, are more concerned about growth and building a successful company through execution of real options ? for them, traditional profitability is much less of a short-term concern. Walmart has paid a quarterly dividend and has recognized positive net income for over 20 years. Walmart also has a share repurchase program, which increases the value of investors' shares. Although it recently announced a significant investment into wages and e-commerce, which will likely result in lower earnings per share (EPS) in the short-term, Walmart is still projecting positive earnings. Additionally, these investments will decrease costs related to employee turnover, improve customer service and brand image, and enhance the "omnichannel" experience. With the

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MBA Case Competition 2016 Real Vision Investment Case Study

current stock price at a three-year low and a P/E ratio lower than industry average, Walmart is a great value buy. Furthermore, history shows that lower P/E stocks tend to outperform higher P/E stocks in the long runiv. As a growth-focused company, Amazon places profits second in priority to revenue and market share growth and any profits achieved are generally reinvested in the company to fund new growth. For Amazon, profitability has not yet mattered ? historically, stock price has appreciated without a showing in profitability due to expectations for Amazon's continued growth. However, in Q3 of 2015 Amazon exceeded expectations by reporting a slight profit when a loss was expected. The market has realized that Amazon is indeed capable of generating profits and formerly patient investors will soon begin to expect profitability. If Amazon were to shift its focus to becoming profitable, it may not be able to innovate and pursue new businesses at the same level. An expectation of profits is not consistent with Amazon's current business model and that expectation could severely impact the growth projections of the company. Apple is an example of an innovative company that has recently struggled to generate successful new ideas. Many competitors have entered the market and are competing to develop inventive products. As competition increases, it will be much more difficult for companies to be first to market with consistently new and innovative products. However, in Apple's case, stock price has continued to grow despite a struggle to introduce innovative products. This price appreciation is primarily due to the company's impressive profit margins on key product segments. In contrast to Apple, Amazon does not have significant profitable segments to drive stock appreciation. If the company struggles to develop new, innovative, and profitable business segments the stock price will likely fall.

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MBA Case Competition 2016 Real Vision Investment Case Study

In summary, the financial analysis shows that both companies are reasonably priced based on peer comparables and current projections. However, the performance assumptions included within the stock prices are very different for Walmart and Amazon ? Walmart's price accounts for very low expectations, while Amazon's expectations are very high. It is much more reasonable to assume that a company will achieve and exceed low expectations, than that a company will execute with precision to an extremely high level of expectation. On a risk adjusted basis, Walmart is a better investment. Qualitative Analysis Financial analysis alone is not sufficient to fully consider the value of an investment over a ten year period. Investors must also consider qualitative factors that could allow or prevent a company from realizing market projections. As the retail industry has evolved into the internet age, the battle for online retail dominance has moved to center stage. However, this battle is only a sideshow to the true issue facing the industry, and store-based retail cannot be ignored. Last year, the global retailing market was valued at $14.1 trillion, and store-based retailing accounted for an enormous 91% of this valuev. A.T. Kearney recently explained that while the fight for e-commerce success is justified, "Physical stores remain the preferred shopping channel and where the most significant value continues to be created, as customers are able to touch and feel products, be immersed in brand experiences, and engage with sales associates. Two-thirds of the customers purchasing online use a physical store either before or after the transaction."vi To be truly successful in the internet age, companies must capitalize on physical presence to provide an "omnichannel" experience ? a mixture of both online and brick and mortar shopping. No company is better positioned to provide that experience than Walmart.

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