WALMART VS AMAZON - The Economist

[Pages:19]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

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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.

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Table 1: Industry Summary1

Industry

E-commerce and Online Auctions in the US

Warehouse Clubs & Supercenters in the US

Department Stores 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 stage:

Growth

Mature

Decline

Concentration Low ? HHI 250 Level:

High ? HHI 5,000

High HHI 2,000

Technology Change:

High

Medium

Medium

Barriers to Low Entry:

High

Medium

Threats

High reliance on shipping companies (FedEx, UPS, etc.).

Operating profits limited when oil prices are high. Membership (like Prime) limits ability to pass higher costs onto customers.

Gas stations generate large portion of industry revenue.

E-commerce sites are better positioned due to low overhead costs, offering lower prices and 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

, 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)

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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 , 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 Employees Shareholders

Walmart (WMT) Amazon (AMZN)

2.2 Million

154,000

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)

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Market Cap Revenue Net Income Dividend Dividend Yield Share Price

$187 Billion 486 Billion 15.5 Billion

1.95 3.33%

$58

$307 Billion 100.5 Billion

328 Million N/A N/A $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)

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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 the next 3 years.13 Despite this high growth rate, in 2019 e-

commerce sales will still only account 12.4% or $3.5 trillion of total retail sales of $28.5 trillion

(see Figure 1).14

Figure 1: Global Retail and E-commerce Sales Forecast in Trillions15

22.8

24.3

9%

25.7

10%

27.1

11%

28.6

12%

30.0

13%

31.4

14%

32.8

15%

34.3

16%

35.7

17%

37.1

17%

7%

93%

91%

90%

89%

88%

87%

86%

85%

84%

83%

83%

2015

2016

2017

2018

2019

Brick-and-mortar

2020

2021

2022

Retail e-commerce sales

2023 Total

2024

2025

As of 2014, China represents a $400 billion e-commerce market and is forecast to grow at more than 20% over the next few years (see Figure 2). The drivers for this growth include China's large population, growing internet penetration, and increase in disposable income with the forecasted rise of the middle class.

12 (Market Realist, 2015) 13 (eMarketer, 2015) 14 Ibid 15 (eMarketer, 2015)

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Figure 2: China Internet Penetration and Number of Users16

670

700

736

777

820

865

912

963

49%

51%

53%

56%

59%

62%

65%

69%

1,016 1,071 1,130

72%

76%

80%

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

# of users in millions

% population

Walmart is able to capture growth in Asian middle class

The growth in the Asian middle class will completely change the trajectory of retail sales. US

consumption drives US and the global economy, especially since the recent trend in savings

has resulted in US consumption growing faster than the US GDP.17 Representing $10 trillion,

US consumption accounts for under one-fifth of the world economy. This massive consumer

base is propped up by the US' large middle class. However, this trend is shifting as the middle

class is growing rapidly in populous countries around the globe, most notably, Asia. In 2000,

China's middle class represented 2% of the world's population and just 10 years later, it

represented 9%.18 China's consumers have the potential to drive global demand, particularly

in the next 10 years (see Table 3).

Table 3: Percent change in size of middle class by region19

Region Asia Pacific Sub-Saharan Africa Middle East & North Africa Central & South America North America Europe

2009-2020 25.10% 0.02% -0.61% -2.08% -8.07% -14.35%

2020-2030 12.56% -0.42% -0.33% -0.77% -4.41% -6.64%

16 Ibid 17 (Bureau of Economic Analysis, 2015) 18 (Brookings Institute, 2010) 19 IBID

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