HOFSTRA CIA

12 Pages·2015·0.27 MB·English

by  Dinesh Reddy Depuru

HOFSTRA CIA

James Lewandowski
Mengxia Sun
Dinesh Reddy Depuru

Hofstra University

Case Study Competition 2016
Real Vision Investment Case Study
Table of Contents
1. Introduction 02
2. Amazon 02
2.1 Ubiquity vs Profitability 04
2.2 Fundamental Analysis 06
3. Walmart 07
3.1 Walmart and Internet Age 08
3.2 Fundamental Analysis 09
4. Structuring The Investment 10
5. References 11

1
1. Introduction
For this case study a question was proposed to us. Which stock would you choose to
invest in if you couldn’t sell it for a decade: Amazon or Walmart, and why? This question is
very challenging because many factors can come into play if you are thinking about the future.
Whether it is the interest rates, global turmoil, or even political power shifts. Even seemingly
random events can affect the company in a positive or negative way. The way we approached
this question was to gather information from various sources ranging from news events to the
SEC1 filings and even Bloomberg stock data. All data taken from Bloomberg was taken as of
October 28th 2015.

2. Amazon
Amazon is an outstanding online retailer and a pioneer in the industry with 21 years of
history. Amazon sells expertise to major store groups. Many retailers from all around the world
provide Amazon with products like electronics, clothing and footwear, cosmetics etc. One
significant advantage for Amazon is that many big retailers have joint ventures or collaborations
with Amazon. For instance, Target, Toy-R-Us and NBA2 have cooperation with Amazon.
Amazon is a profitable organization with lower profits compared to other companies.
However, Amazon does not need to consider as much about profit, as other companies need to,
because its low profits can keep the company above their breakeven. Other companies not only

1 US Securities and Exchange Commission
2 National Basketball Association
2
need retail stores, but also need warehouses with many employees. Most of the time, Amazon
provides products from other companies that will not drastically affect their budget.
Amazon is a unique company with a unique business model that others cannot duplicate.
Amazon provides online products, online services and their own brand items. Amazon is
supported by Customers Relationship Management and Information Technology that provides
data about customers’ behavior to identify their preferences which can be used into offering
individuals items specifically picked for them. Amazon has approximately 270 million annual
number of worldwide active customer accounts in 2014 after 2 decades of development and
growth which allows them to expand their market. Amazon also provides “2-days free shipping”
for Prime members which can be a good choice for someone who needs an item but can’t get to
the store to purchase it. Amazon may have up to 80 million prime members worldwide. In the
21st century, online business is unavoidable and is filled with tremendous potential. Another
reason why Amazon can continue to expand is that they are reliable and cheap and no other
similar big company can compete with them.
It is really hard for Amazon to expand the company’s scale with low profit. Without
considerable profit, there is no way to invest in other projects like building their own brand
products. Even though the stock price of Amazon continues to increase, it may be overvalued.
There are many companies that want to disrupt Amazon in its many endeavors. For instance,
some companies provide price match services to all online customers, while others may provide
a return policy that requires no reason and no expiration date. Walmart has been steadily
increasing its digital efforts and has caught up to Amazon’s steep discounts. Another example is
Google. Google makes money when people search products online. Google may direct
customers to other websites instead of Amazon which could hurt the profits of Amazon.
3
It becomes more and more difficult to differentiate the brand from its competitors
because Amazon sells a lot of similar products that any company can have. It may also be hard
for Amazon to win the battle in competing with other companies in other countries. For
instance, Alibaba is the biggest online pioneer in China. With a population of 1.3 billion,
Alibaba has built an unshakable position in the Chinese market. The products that Amazon sells
tend to be bought as gifts, especially during Thanksgiving and Christmas holiday season.
However, this may not be compatible in overseas markets with different cultures and languages.
People will buy more stuff when they go to local retailers, however, they may just buy one cheap
item from Amazon with free shipping that will hurt the profit margin. It will be a disaster for
Amazon if many other formidable companies which are well established decide to join the
competition. Their stock keeps increasing with no dividend payouts, and with low ROE3, ROA4
and ROI5 it is hard to see this trend continuing into the future. In the foreseeable future, the price
of Amazon stock may reverse its current trend and experience a significant correction.
2.1 Ubiquity vs Profitability
Even though Amazon’s price has skyrocketed in the past three quarters, Amazon has
come under sharp criticism for its lack of focus on profitability. Amazon continues to chase a
myriad of growth opportunities in diverse sectors like e-commerce, hardware, entertainment and
consumer packaged goods. Amazon has continued to lower their operating margins consistently
over the past three to four years. Its low-price strategy is one of the reasons for its low profit
margins. But the strategy gave the competitive edge to Amazon in its business sector. Unlike
Walmart, Amazon doesn’t have many stores which helps it avoid huge operating costs. Amazon

3 Return On Equity
4 Return On Assets
5 Return On Investment
4
owns majority of its inventory that it sells on its website which adds to fulfillment and
warehousing costs. Amazon’s high investment in fulfillment and warehousing, technological
upgrades, hardware and content products is factors for the increasing pressure on its profitability.
Its Fire phone was a failure that resulted in net profit margin pressure in 2014. Its Kindle tablet
has also failed to pay off and has generated little to no profits in recent quarters. It had a loss of
$170 million in Q3 of 2014 related to the Fire phone inventory write-down and supplier
commitment costs. These profitability trends show that technology, content, marketing and
fulfillment costs have risen sharply over the past years. Though Amazon’s gross margins are
increasing, operating expenses are expected to stay high for several years in the future.
Amazon’s ubiquity has been a failure leaving more operating costs than profits.
Amazon is investing more in technology, its product Echo looks promising which can potentially
bring some profits. Right now amazon may not need to worry about its profit margins as its
stock price has doubled in the span of three quarters. But profitability will be a huge concern for
amazon in the near future to attract more investors. Amazon needs to try converting its ubiquity
into profitability. With more investments in technology and content, Amazon can develop better
products in the future and products that can perform better compared to what the Kindle and Fire
has done for them. According to a report by Wells Fargo, Walmart and Target’s prices online
could be around 5% - 10% lower than Amazon’s prices in the four major categories of clothing
and footwear, electronics, house wares, and health and beauty. These four categories constitute
more than 50% of the US retail business. However the study doesn’t show the shipping and
handling expenses, where Amazon has a competitive edge. Amazon’s Prime membership is the
reason behind its competitive edge over Walmart and Target. The lower prices of Walmart and
Target can push back forcing Amazon to increase their prices to a minimum extent in order to
5
stay competitive. This will further hurt the profit margin of Amazon. Leading to the conclusion
that Amazon cannot come out of its Low Price Strategy in those 4 categories, Amazon’s ubiquity
can be the only way to increase its profitability by bringing better products into the electronics
market.
2.2 Fundamental Analysis
Amazon’s stock data was very intriguing to look at. Their major competitors that we
compared them to included Alibaba and EBay. The price of Amazon has soared recently to
$617.10. On January 2nd 2015 Amazon’s price was 308.52. This is a steep increase in what can
be considered a relatively short period of time. Several numbers stand out more than the rest
when looking into Amazon’s stock. The first number that jumps out is the P/E6 ratio which
currently sits at a robust 892.928. Compared to their direct competitor’s average of 214.98
Amazon’s number is over 4 times larger. Amazon’s sales growth has increased by a minimum
of 14.4721% per month for the past 10 years showing incredible growth over this time period.
One of the major concerns with Amazon is with their profitability numbers. Specifically,
profitability measures such as ROI, ROE and net Profit margin are concerning. Their current
Net Profit Margin is 0.326% compared to the average for their industry at 14.83%. This is
worrisome to investors because in the long run it may impact Amazon more if their sales fall for
any reason. Amazon currently has a Return on Invested Capital below 0% which falls well
below the average for their competitors which sits at 4.85%. Their ROE sits at 2.88% while their
competitor’s average is at 17.72%. Amazon has also had a very minimal EPS growth over the
years.

6 Price-Earning Ratio
6
3. Walmart
Walmart is one of the biggest retail giants in the US. Walmart enjoys a great customer
loyalty for its cheaper prices on a wide range of products. Walmart has a large number of
physical stores making it closely available to its customers.
Walmart is one of the top 10 international companies in the world. It has a good
reputation with a long history of around a half century long. It attracts billions of people into
their stores because of their cheaper prices. Customers always buy a lot of items when they go to
Walmart. Walmart has developed a loyal customer and employee base that no other company
can compare too. They offer flexible hours, competitive wages, health insurance and discounts
on purchases for workers. In the past year, the price of the stock has dropped significantly;
however, it may now be undervalued. There is room for the stock price to increase as it is
currently undervalued according to the FCFF7model of valuation. The FCFF model currently
has the intrinsic value of Walmart's stock at $76.33 which is above the current stock price.
Walmart has many local retailers that give people opportunities to go to the store to choose what
they want. They may buy more items than they actually intended to because the price is really
attractive. If they decide to use drones to deliver products it would benefit them greatly in the
battle to deliver products to consumers faster. Drones can deliver products in a few hours without
labor expenses. This could increase profitability. Walmart entered into the online marketplace
only a few years ago. They will become a more powerful online company after several years of
experience and with their profitable base of retail stores. The high profitability of Walmart
supports the company’s research and development. The globalization strategy can foster strong
growth as the US market matures. The company operates 4,068 units in 14 countries. Walmart

7 Free Cash Flows to the Firm
7
provides a wide array of products among retailers, including many well-known brand names and
its own private label brands.
Walmart is exposed to political problems in the countries where they are operating in.
These problems include but are not limited to illegal dumping and illegal immigrant workers.
Theft is a large problem for Walmart. Walmart generated nearly $300 billion in revenue in the
United States in the past fiscal year with 1 percentage of losses from theft by customers and
employees. Walmart hires 40% part time workers who will not be provided with any benefits.
Walmart provides a variety of products and cannot have the flexibility of some of its more
product specific competitors. Walmart sells the cheapest products in the market; however, some
products are of inferior quality, which will hurt the brand value.
3.1 Walmart and Internet Age
Online shopping is increasing and Walmart is still lagging in e-commerce. Although
Walmart is posting a decent Profit Margin, it has high operating costs due to the large number of
stores which leads to property taxes, store maintenance costs, and employee wages. Walmart
should expand in the e-commerce business by taking purchase orders from its customers, through
its website and mobile applications, and deliver it directly to their homes. Walmart is conducting
in-house testing on drones and is trying to acquire rights for the outdoor testing from the Federal
Aviation Authority. The usage of drones will take a long time for implementation. Like
Amazon’s Prime, Walmart should start a membership program, like its Sam’s Club membership,
and deliver products with free shipping. Since most of the customers of Walmart make a
minimum purchase of $35, Walmart can deliver the products at free of cost by setting a
minimum amount for the purchase. Walmart has recently increased its employee minimum
8
wages to $9 and it’s going to increase it to $10 in February 2016. This increase the operating
expenses of Walmart by billions of dollars. Walmart should come up with better e-commerce
ideas to keep its operating expenses under control.

3.2 Fundamental Analysis
Walmart is a company that is most associated with the industry of Mass Merchants.
Their major competitors we compared them to included Target and Costco Wholesale. Recently
their price has been on the decline, falling all the way to $57.7. At the beginning of this year on
January 2nd 2015 their stock was at $85.9. Their P/E ratio currently sits just below 12 while their
competitors’ average is 19.7. Walmart has a Return on Equity of 19.78 while its competitors’
average is 13.47. Walmart’s net income margin is actually higher than its competitors’ average
3.19 to 2.59. Walmart’s Return on Invested Capital is also higher than its competitors’ 13.16 to
11.99. These numbers show that compared to their Industry direct competitors Walmart has
above average profitability numbers. This shows some strong potential even though their price
has fallen recently.
Walmart has had some struggling numbers as well even with the above industry average
profitability. Walmart has had an up and down EPS growth that has dropped below 0% several
times over the past 10 years. However, even with the sporadic EPS over the last 10 years
Walmart’s EPS increased on average around 6.87% monthly. Their competitor’s average for the
current year is 5.2% while Walmart sits at 2.87% growth. A cause for concern can also be that
Walmart's Sales growth this year has been right around 0%. This can be a potential red flag for
their stock and could contribute to why their stock has declined over the past year. All this data
9