Real Vision Investment Case Study

Transcription

1 Real Vision Investment Case Study For Amazon and Walmart Team SFSU Max Gerrit Zschoch Sargis Sargsyan Xiaorui Wang San Francisco State University November 2015

2 Table of Content Introduction... 3 Macro Economic Trends... 4 The Industries... 5 Retail... 5 Traditional Retail... 5 E-Commerce Retail... 6 Cloud Infrastructure Services... 6 The Companies... 7 Amazon... 7 Walmart Financial Forecasting and Valuation DCF Model Multiplier Investment Decision Appendix Forecasting WACC DCF Multiplier Method References

3 Introduction On July 23rd 2015, Amazon surpassed Walmart as the world s biggest retailer based on market capitalization. However, Wal-Mart still outperforms Amazon in regards to annual revenue by more than five times. Considering the ambiguity of these numbers as well as the 10-year stock holding period, we are compelled to valuate both stocks not only on their financial performance, but all the more on each company s current strategic direction and vision. This reports starts with a brief analysis of major macro-economic trends and becomes more detailed and tailored with every following chapter. After identifying global trends, we take a closer look at key industries and analyze both companies in regards to their business models in order to make educated assumptions. The subsequent financial forecasts will be based on our prior research and different global economic scenarios. We will present the results of our DCF Analysis, tailored to each company's strategic direction, before finishing with our final investment recommendation. 3

4 Macro Economic Trends We decided on three global aspects, which will have a significant influence on our investment. Increasing US interest rates, possibility of a global economic turndown and India as the next major market. We re expecting the end of cheap money within the next ten years, along with the effects it will have on our investment. Without going into much detail, we have to consider the effect on the stock market, the US GDP, and on borrowing rates. Readjusting our analysis will be necessary to maintain its accuracy. We also discussed a potential economic turndown, both domestically and internationally. Rising global debt and unstable political situations around the worlds are strong indicators for darker economic times. Considering its dramatic effect on our investment, we decided to forecast and calculate an additional scenario. India, as one of the fastest growing economies in the world, might be the most important market for long-term investment in the upcoming years. China is no longer in the center of the world s attention due to its decreasing economic growth rate. India in comparison has kept its GDP growth rate high and has a mostly undeveloped market. 4

5 The Industries Retail Global retail markets have maintained a steady growth over the past and developed similar to each country s GDP. After growth rates in China and Brazil decreased, India is once again in the global spotlight. 40% 30% GDP Growth Rate 20% 10% 0% -10% % -30% Brazil China United Kingdom India Mexico United States Traditional Retail We saw leading retailers such as Walmart and Carrefour entering global markets and implementing international expansion plans years ago. Traditional retailers experience mature domestic retail markets with low economic growth, aging populations, market saturation and the increasing operating costs. Globalization is a necessary step to take. Many emerging markets started to realize the importance of economic integration and are currently easing the easing limitation on foreign investment in retail business; therefore we are still mostly bullish for the future of retail. 5

6 E-Commerce Retail The growth of e-commerce has been dramatic, and it reflects people s new consumption behavior. E-commerce significantly reduces costs, reduces market barriers and makes it easier to control risk. While US e-commerce experiences a 16% growth rate, global e-commerce grows at only 6%. However, once emerging markets catch up in regards to IT infrastructure, we expect exponential e-commerce growth rates. Cloud Infrastructure Services The cloud infrastructure is expected to gain roughly 80B US-Dollars revenue in 2015, increasing by circa 30% compared to last year. The increase of internet-enabled business caused huge potential for the cloud industry, which is estimated around 180B US-Dollars by However, with cloud computing services booming and more companies joining the market, the competition becomes more intensive. We expect to experience a more severe battle for market share in the near future, including price cuts and lower margins. 6

7 The Companies Amazon Jeff Bezos founded Amazon in 1994 as an online bookstore, which quickly moved into a variety of media sales. Amazon now has the largest product variety of any e-commerce retailer worldwide. To further diversify its operations, Amazon also produces its own consumer electronics and is one of the main players in the growing cloud computing market. Amazon s business model focuses on long-term results, especially in regards to growth. Bezos stated repeatedly that Amazon is focused on its customers, not its competition or Wall Street or short-term profitability. He introduced the flywheel early on, that represents Amazon s underlying strategy. It is crucial to recognize the absence of profits. Amazon has never been a company that focused on improving of the bottom line; instead its growth rate has always been its biggest concern. Amazon divides its business segments based on region and distinguishes between EGM, Media and Other Sales. Since 2013, Amazon also discloses sales revenue from Web Services (AWS). Revenue from by Prime memberships is allocated between EGM Sales and Media Sales. 7

8 We analyzed Amazon s business portfolio and determined three major strengths, which have a significant influence on its future success. We believe that Amazon s marketplace, which is responsible for almost 40% of total sales, represents a major advantage in its business model. It plays a significant role in emerging markets, in which Amazon doesn't sell as an own entity yet. One of those emerging markets is India, in which current FDI rules prohibit Amazon from selling products directly to Indian customers, causing a disadvantage for Amazon in comparison to its Indian competitors. Despite legal restrictions, Amazon managed to be the third biggest e-retailer with a current market share of circa 15% by offering a bigger variety of products than its competitor. We can conclude that Amazon s global marketplaces are not only profitable business segments, but also trailblazer for entering new markets, in which FDI is heavily regulated. A savvy investor will pay close attention to Amazon s 1P/3P sales growth rate. Amazon 1P (Retail) vs. 3P (Marketplace) Y/Y Growth % 30% 25% 20% 15% 10% 5% 0% Q1_13 Q2_13 Q3_13 Q4_13 Q1_14 Q2_14 Q3_14 Q4_14 1P Growth 21% 22% 24% 20% 23% 23% 19% 12% 3P Growth 27% 22% 20% 20% 23% 28% 30% 33% 1P Growth 3P Growth If this trend continuous, resulting in further increases of 3P Sales/Total Sales ratio, we can expect higher operating margins as well as an improved bottom line. 8

9 Another major strength of Amazon is its Prime membership, which started as a discounted shipping program and now includes a variety of media streaming and other perks. Research shows that Prime customers not only spend roughly twice as much as their non-prime counterparts, they are also loyal customers with renewal rates of up to 95%. Prime is also strongly connected to Amazon s consumer hardware products, connecting its product portfolio with its service portfolio, causing additional customer retention. Investors are advised to pay attention to Prime s growth rates as well as on data that reflects Amazon s success with converting Prime memberships into sales. The third reason for Amazon s strong position is its relatively new cloud computing business segment, which showed higher operating margins and significantly higher growth rates than the retail segment. Several industry professionals consider AWS as the market leader with an estimated share of 30% to 40%. It is important to notice, that Amazon not only relies on lowerthan-competitor prices but also convinces its customers by adding substantial value compared to other services. However, considering Amazon s focus on market share and growth rates, we can assume that price cuts are an important instrument in Amazon s ambition to increase market share and any investor should be aware of the effects on operating profits. Despite the circumstance, AWS will be a major factor of Amazon s future stock price and its growth rate an important factor in every valuation. 9

10 Walmart In 1962, Sam Walton founded Walmart with the goal to create a small margin retailer. From the beginning he planned to profit from a high volumes and low operating costs. This mindset lived on in Walmart s philosophy and made it the largest global retailer, now operating over 11,000 stores in 28 countries. In its latest annual report, Walmart s management restated the strategic direction for the upcoming years, which includes Improving Customer Experience, Beat Competitors on Price, and Expand Product Assortment. This direction involves substantial restructuring of the existing store mix, resulting in the closure of discount stores and openings of modern neighborhood stores. The following graph shows how Walmart s store mix changed over time. Another crucial element of discussion is Walmart s strategic approach in regards to its e- commerce business. The retail giant recently announced to shift the strategic focus away from further expansion of its brick and mortar stores, in order to obtain a higher e-commerce penetration in the US and internationally. 10

11 Walmart s business is divided into three main segments, US Retail, International Retail, and Sam s Club. US Sales has been the strongest segment for Walmart, followed by International Sales and Sam s Club Sales. We analyzed Walmart s business portfolio and determined two major strengths and drivers for future success. The size of Walmart s store network is a huge asset. Considering that e-commerce is seen as an increasingly important retail market, Walmart takes active steps to leverage its network by creating an omnichannel retail strategy. Therefore, Walmart started focusing its investment on combining both channels to enhance the customer experience. A crucial element of this strategy involves new pick-up points, which allow customers to shop online and pick up their purchases at designated drive-through areas. Customers experience the comfort of at-home online shopping, without waiting for delivery or the hassle of in-store pickups. Every investor should pay close attention to the growth rate of Walmart s e-commerce business in comparison to its related CAPEX spending to determine the efficiency of Walmart s omnichannel approach. Walmart s supply chain and its mass suppliers are another strength, which attributed to Walmart s global success. Walmart established a supply chain that functions like a single firm, including suppliers, warehouses, and stores. By eliminating unnecessary intermediaries, Walmart was able to minimize costs at all parts of the value chain, passing savings along to its customers. The ability to source low-cost products is a significant advantage, especially in the e-commerce business, in which many consumers decide primarily on price. However, investors are advised to closely monitor future COGS data, since the effect of increased minimum wages in China is still uncertain. Over 70% of Walmart s suppliers are located in China and sourcing new suppliers in neighboring low-cost labor markets might be time consuming. 11

12 Financial Forecasting and Valuation Based on our need for intrinsic values, we chose to valuate both stocks using the DCF model as well as the Multiplier Method to verify our results. DCF Model Projected sales are the most crucial part of any DCF analysis, especially considering the given time horizon of 10 years. To arrive at reasonable and sound sales estimates, we considered not only current market shares and growth rates, but also analyzed industry trends as well as strategic shifts in each company s business model. To estimate Amazon s future sales as accurate as possible, we analyzed every product segment on its own, both domestically and internationally. The following chart illustrates our approach. (Focus on EGM Sales calculation to maintain clarity) Total US Sales EGM Sales Media Sales AWS Sales Other Sales Estimate EGM Sales as % of E-Commerce Market Estimate Media Sales as % of E-Commerce Market Estimate AWS Sales with predicted Growth Rate Estimate Other Sales with predicted Growth Rate Estimate E-Commerce Market as % of Total US Retail Market Estimate Total US Retail Market 12

13 We are expecting increasing EGM Sales in the US market, along with increasing market share, caused by Amazon s growing product portfolio, its growing marketplace, and large R&D investments (Drones, Dash Button, etc.). Prime also contributes to high customer retention. However, the rate at which Amazon is gaining market share will most likely decrease, due to more competition from other online retailers such as Ebay and Alibaba. More competition comes from offline retailers such as Walmart and BestBuy, which have significant financial assets and experienced supply chains. The transition to digital media had a huge influence on the whole market and Amazon s media sales. The market for digital media shows way less entry barriers than the traditional media market and attracts therefore a variety of new competitors. Amazon tried to counter with customer electronics such as the kindle and its Prime program in order to maintain market share. However, we believe that fierce competition from a variety of companies will affect Amazon s media sales negatively. As a result we predict a negative market share growth rate, resulting in media sales growing slower than the total market. Growth rates for Amazon s AWS business are very speculative and require close monitoring. This uncertainty is caused by a very dynamic and somewhat unpredictable industry, as well as by the fact that Amazon just recently started to release financial information about its cloud service segment. We estimated the AWS growth rate based on last year s financial performance and average industry estimates. Since the e-commerce market is considered to be rather global, we took a similar approach to calculate International Sales. Extra attention was paid in regards to the influence of e-commerce markets in China and India. 13

14 Since Walmart is a more mature company with a different business model, we decided to change our approach and concentrate more on its new store mix. The following chart illustrates our approach. (Focus on US Sales calculation to maintain clarity) Total Revenue US Sales International Sales Sam's Club Sales Membership Revenue Estimate Number of Stores Estimate Sales per Store Estimate SF per Store Estimate Sales per SF Walmart announced to decrease its new store growth rate to focus more on the improvement of existing stores and on its e-commerce business. Most of Walmart s new stores will also be of smaller size due to its shift to the Neighborhood Store format. As a result we re expecting a negative growth rate in regards to square foot per store and a decreasing expansion rate compared to previous years. Improvements in its existing stores, including higher employee motivation (Due to higher wages) and better shelf management, as well as more conveniently located stores inside cities are reason enough for us to believe in increasing sales per square foot. Walmart s focus on strengthening its e-commerce segment also supports our estimate. Our estimations for the international market differ slightly from those made for the US. Like in the US, Walmart also decided to slow down its new store expansion in most of its 14

15 international markets (Except of India). Sales per square foot were decreasing, mostly because of strong national competitors (UK: Tesco, China: Sun Art, etc.) and general economic conditions in respective countries. However, we believe that Walmart can profit from these conditions (Like it did in 2009 in the US) by offering continuously low prices. We therefore estimate small but positive sales per square foot growth rate in international market. Sam s Club sales have been very consistent over the last years. We estimate a small growth rate for its sales per square foot number, based on the growing interest of bulk purchasing by non-commercial customers. To estimate COGS, we look at each company s common-size financial statements. Historically, Walmart has cost of sales ranging from 74.5% %, leaving us with an average rate of 75. Amazon historically had lower and more volatile COGS, ranging from 66% - 80%. Considering its recent upward trend as well as increasing % of 3P and AWS sales, we estimate 70% COGS. The next biggest expense for companies is the overhead cost. Historically, Walmart has about 19% COGS, which we expect to increase by 50 basis points considering higher wages and more urbanized stores. Amazon showed much higher and very volatile overhead costs, ranging from 16% to 29%. Considering the historical trend and increasing AWS operations, we expect overhead costs of circa 26%. To calculate the Free Cash Flow to Equity (FCFE), we estimated depreciation and amortization expense as well as the change in working capital for each company (See Appendix). For Walmart, we estimate about 1.9% of depreciation expense as a percentage of revenue and about 5.5% for Amazon. To estimate the change in working capital, we considered historical trends and the respective business strategy to each constitutes of working capital. Furthermore, we estimate a 32% of tax rate for Amazon and a 29.5% for Walmart. 15

16 Further down in our analysis, we calculated the discount rate by using WACC. We chose historical stock prices, adjusted to dividends and stock splits, for each company and the S&P 500 since 2007 (See Appendix), to calculate the Betas. We then used CAPM to calculate cost of equity as well as the companies credit rating and debt yield to estimate the cost of debt. We added 4% risk premium to Walmart s WACC due to its risk in regards to international expansion and restructuring. We estimated 2% terminal growth rate for Walmart and 5% for Amazon. According to the first scenario, the Walmart s potential stock price is $96.92 (Currently Undervalued), whereas Amazon s stock price is $ (Currently Overvalued). 16

17 We re-estimated our numbers to consider the effects of a potential economic turndown. Our analysis shows that Amazon s stock will be affected more than that of Walmart. This assumption is conform to the historical data, including the financial crisis in 2008 (Beta of 1.24 vs. 0.31). Our DCF model shows that both stock prices are affected negatively. Walmart s stock price decreases by about 23% to $74.94, Amazon s by about 34% to $ However, Walmart remains undervalued and Amazon is still overvalued. The result is very consistent, if we consider that during the last financial crisis the number of customers for Walmart increased. It is worth mentioning, that our model is very sensitive to inputs and assumptions. Even small changes have a huge effect on the potential stock prices. 17

18 Multiplier To further improve our valuation analysis, we had a comparable transaction analysis for both Amazon and Walmart. For the last 12 months, we got 12.3x P/E and 6.6x EV/EBITDA, which were the lowest comparing with its competitors in traditional retail industry. Amazon on the contrary has the highest P/E of 942x and the highest EV/EBIT of in the last 12 months. As e-commerce retailer and high-tech company, Amazon has the highest valuation of both industries. 18

19 Investment Decision Since the investment horizon is 10 years and we will not have a chance to adjust our investment, we considered as many factors as possible. We decided to take a long position in WMT for 65% of our investment and a short position in Amazon. We believe that Walmart s main business line will be doing very well 10 years from now, in both domestic and international markets. Using 35% of our investment to take a short position on AMZN will further diversify our portfolio. We then plan to reinvest the proceeds from our short position in additional Walmart stock. Constructing our portfolio in such a way will result in a portfolio beta of almost zero and minimizes market fluctuations as much as possible; a major advantage in a period of economic turndown. 19

20 Appendix Forecasting Amazon: 20

21 Walmart: 21

22 WACC 22

23 DCF Amazon Scenario 1: Amazon Scenario 2: 23

24 Walmart Scenario 1: Walmart Scenario 2: 24

25 Multiplier Method Note: LTM: compare last 12 months from 2014Q2 to 2015Q2 Stock price as of Nov 7, 2015 Amazon: Walmart: 25

26 References Matilda, James. Handmade Goods: Another Reason for Shoppers to Stick to Amazon. Market Realist Online, 14 Oct Web 7 Nov Puneet, Sikka. Why Is Amazon Becoming More Bullish about India? Market Realist Online, 5 Aug Web 7 Nov Matilda, James. Amazon: Increased Focus on India. Market Realist Online, 28 Aug Web 6 Nov Puneet, Sikka. Amazon could enter the online travel market to boost its margins. Market Realist Online, 30 Dec Web 6 Nov Felix, Richter. Online Video - A Billion-Dollar Opportunity. Statista Online, 1 Sep Web 6 Nov. Zhixian, Ke. Global Powers of Retailing Deloitte Online, Web 5 Nov James Bourne. AWS, Microsoft, IBM and Google leave rest behind in cloud infrastructure market. Cloud Tech Online, 24 July Web 6 Nov Louis, Columbus. Gartner Predicts Infrastructure Services Will Accelerate Cloud Computing Growth. Forbes, 19 Feb Web 8 Nov All other information is from the official company reports of Amazon and Walmart. 26