This Project involves answering the five questions of Real Vision investment case study. During

Transcription

1 Abstract This Project involves answering the five questions of Real Vision investment case study. During past few years, the representative retailers in the industries like Amazon and Walmart have experienced constant change. The battle between these two companies is a great case study to understand the modern retail industry which involves extensive information technology. Where is the future for Walmart? Are investors too optimistic on Amazon? How will both companies leverage their advantages? From our research we will a better understanding relative to these questions. Investor valuing stock price based on calculating present value of future profit and dividend. Financial Fundamental analysis Wal-Mart has a solid market share in retail space as showing in the following table from its financial report dated Wal-Mart Amazon Years Sales (millions) $482,229 $473,076 $465,604 88,988 74,452 61,093 Percent change 2% 2% 5% 16% 18% 18% Gross Profit Margin 24% 24% 24% 30% 27% 24.80% Operating Income (millions) 27,147 26,872 27, Despite a significant drop in 2014 it is fair to say that Wal-Mart s earning only fluctuate within a range of +/- 4%. According to the world s largest retail trade association, the National

2 Retail Federation, (2015) sales on retail industry should increase a solid 2.5% in the last quarter of Wal-Mart s earning is 1.5% higher than the sales from their forecast for November and December. The industry average gross profit margin is 23.27% in retail, and Wal-Mart is slightly higher than this level. Wal-Mart Annual report, 2015 Therefore our analysis is that basic products of necessity is what contributes the most to Wal-Mart s current sales. Based on this solid demand Wal-Mart is growing at a reasonable rate. In the short run, Wal-Mart has fallen out of favor with investors after it updated its financial outlook. Fluctuation of currency markets has had an adverse effect on sales for this current year. Further investment in e-commerce, digital marketing, and higher wages might cause a 6%-12% drop in earnings per share next year. We expect the shares to remain range-bound until the benefits from its investments begin to take hold. (Value Line, 2015) The number on net profit for Amazon shows an inverse trend with stock price. Operating income dropped 76% since 2014 and 73% compare to The main reason about this is Amazon spend $2,710 million on operating expense including research and development in addition to what they expensed on 2012 (SEC, 2015). On the other hand, Amazon.com reported strong top-line growth and a considerable improvement in share earnings. This is fairly

3 encouraging, as profitability at the company has been constrained in recent years by greater expenses associated with investment spending. Most importantly, we think these expenditures will pay off going forward. (Value Line, 2015). Wal-Mart Amazon Current Ratio 97% 112% Quick Ratio 24% 72% Cash Conversion Cycle Source from annual 10-k 2015 Both companies have strong ability to pay off their current debt in less than a year. After we peel off inventory, Amazon still has the ability to pay off current liabilities, but Wal-Mart has less ability due to only 24% quick ratio. Huge inventory will cause inventory carry cost to be excessive. An astonishing result on Amazon is on cash conversion cycle. The company could sell off inventory and collect sales before they pay off inventory they bought. In the result Amazon showing a negative number is a positive sign on financial data. Which company is mispricied? Amazon are trading roughly 18% higher in price. This uptick came after the company reported better-than expected financial results. Thanks to a solid rise in worldwide volumes as global active customer accounts continue to swell, revenues increased more than 23%, to roughly $25.4 billion (Value line, 2015). Additional benefits are stemming from new product offerings like the recently introduced Fire tablet, and Fire TV devices, as well as original series programming. The continued rolling out of Prime Now to eight metro areas allows members to

4 have tens of thousands of daily essentials delivered free within two hours, or within one hour paid. That service is now offered in 17 different locations around the world. At the same time, the company continues to expand its geographic footprint for its regular services. development. Following chart illustrates relationship between cash inflow from investor and industrial Stock price will be rising in the long-run, key point is whether or not Amazon would catch and take a ride with the market. Each cross point means a new step need to be taken and innovation has to place in a big role in this stage. Fortunately, Amazon took the step and released enormous high- tech news to encourage investor. Investors are not really concerned about the profits of the year, but future growing opportunity. And in this regard, Amazon is almost a perfect example. Earnings per share plays as reference. Since 2000 Amazon s stock price growth has been excellent, despite the volatility of earnings, but it does not affect the investor s value outlook.

5 US GAAP rules that the money spent on research and development and advertising must be fully deducted from the profit. But investors know that such spending is the real investment, will be gain in the future. Therefore, in the calculation of economic profit, consulting, research and development and advertising spending is regarded as the capital expenditures were five years and three years, respectively. Over the past five years of research and development and advertising spending has turned six times. According to accounting standards, these huge spending to stifle earnings per share, but their earnings are very prominent. Amazon is the real "strengthen the investment of intangible assets, self-ability and brand strength, in order to enhance its long-term value." What will Walmart do in the world of online sales? Online shopping becomes an unstoppable wave, the information technologies changed our way to get information faster, easier, thus this wave shuffle resources and structure of almost every industry. The theory and knowledge about retail store become powerless in front of welldesigned web pages. Walmart has $444 billion in revenue in 2012 was 16 times the revenue of Amazon, and equals to 3% of the U.S. economy. With 5 times revenue of Amazon in 2015, Walmart is still a giant in retail industry, but Amazon s revenue per employee is nearly 3 times that of Walmart, can Walmart still be this giant in next few years? Do we need more Supercenter? Walmart owns 5249 physical store in united states, 3445 of them are Supercenters, data from 2013 said Walmart Supercenter suffered a 0.3% same store sales decline in the second quarter compared with last year, foot traffic fell by 1.1%, also Supercenter near urban area has many limitations, such as high cost in labor, management and inventory, far away from customers especially in big cities. By contrast Neighborhood market doing good job in past 2 years, the sales and traffic keep increasing, many customers and Medias

6 give it positive review (Peterson, 2014). Because of better shopping environment and better accessibility. Compare to the amount of Supercenter, there are plenty of room for Neighborhood market to grow. (Kelleher, 2015) Unpleasant shopping experience in Supercenter is hurting Walmart from many aspects, a lot of customer complain about the shopping environment is not always clean and tidy, sometime bad store layout make customers work out in Walmart. Bad shopping experience not only affect sales but also make customers gives Walmart some tags that has no relationship with cool, high tech or quality. Trendy people who would never shop at a good retail outlet like Walmart. (Anderson, 2014). Compare with Amazon, they don t have to concern about those factors, including physical store lay out, real estate issues, etc. Apparently they dedicate themselves in improving online shopping experience. Here are some key word Walmart customer demographic, female, baby boomers, mid-low income, and white people. Walmart trying her best to catch up with Amazon, main reason is not because of the shopping pattern, technologies are tools after all. Some research think Walmart does not value the importance of E- commerce or not willing to invest new technologies, but truth is Walmart is always stand in the front row of new information technologies adopt new approaches in daily operations, they start to working on big data analysis and put that into use before everybody does. Then why Walmart E-commerce is fall behind, even when compared with Target? Walmart is like a musician has the best instrument but not very popular, wrong audience or bad performance are the reasons.

7 We know grocery sale is the advantage of Walmart, from the chart we learned that groceries sales account for over 55% in the past 3 years among all merchandise. Walmart has advantages in groceries among a lot of retailers. (Smith,2014) The chart above provides us a brief view that how online retail channel distribute by categories. How Walmart take advantage customers by looking at this chart? Customer can barely find fresh groceries if search food online, customers still prefer to buy groceries in physical stores. What if Walmart can turn their location advantage to profits? By using big data analysis to study people shopping behavior in area or even individual preferences, that will help different locations have more accurate forecast and provide better forecast, Based on market location over the country, it is easy for Walmart deliver good within 1 hour. Since Walmart has huge senior customer group, free deliver for them would encourage more senior people purchase

8 online and improve the brand image. We are not going to discuss all the possible approaches here, but the main idea is focus on the advantages and make resources play roles effectively. We saw Walmart online provide pick up or $50 free delivery, but the feedback is not very good, also the Mobile application s reviews are mixed. Those technology based services has plenty of room for improvement. Walmart has resources and ability to get rid of current situation, how to make each step count is the question Walmart need to think. Here are the opinions from us: Smaller physical like Neighborhood market has more advantage, it is easy to manage and better accessibility. Furthermore smaller also means more focus, focus on different generations, different races, that would help Walmart increase their awareness of potential online users, and more open to younger customer group. There are a lot of details can be the factors determine win or lose. By modify online and mobile applications to improve integration between physical store and online store, big data analysis help improve sales and customer service Amazon s strategy is based upon a closed loop approach that is centered on growth and where profits are reinvested into a lower cost structure and passed along as lower prices to consumers. The goal of this model is to enhance the consumer s experience and generate further growth in earnings rather than recognize a profit. Amazon s revenue has grown at an average of 27% a year since 2010 and produced almost 89 billion in revenue in Despite the increases in earnings, Amazon has posted a loss in two of the last five years and an average profit margin of.42%. These financials perplex analysts and bring into question Amazon s business model and valuation. The ability for Amazon to amass profits as an organization is based upon the ability for each product line to generate positive cash flow and the ceiling for future opportunities available for Amazon s continued investment.

9 Amazon has a broad set of offerings that include Amazon s Marketplace, Amazon Prime, and Amazon Web Services among others. To determine if Amazon can convert its revenues into profitability, one can analyze Amazon s offerings independently to determine their ability to create a profit. For instance, Amazon Web Services is currently profitable and growing. AWS posted a 17% operating margin in the first quarter of Amazon Web Services accounted for approximately 7% of Amazon s first quarter earnings of 2015 and generated $1.5 billion in revenue. Even though AWS represents 7% of earnings, it contributed 37% to Amazon s overall operating profit. The Amazon Web Services division is also growing 11% quarterly (Ronen, 2015). Additionally, Amazon s third-party marketplace is posting greater than expected margins. Amazon s third-party sales account for 20% of Amazon s revenue. Analyst attribute the strength of AWS and Amazon s third party marketplaces to reporting a $92 million second quarter profit. This was well above the 14 cents a share loss that analysts expected (Oreskovic, 2015). Because Amazon seems to spend what it makes, we can study cash flow to better analyze Amazon s ability to be profitable. Operating cash flow and free cash flow give analysts a picture of both Amazon s capital expenditures and its ability to generate cash. As of June 2015, Amazon created almost $4 billion in free cash flow for the previous twelve months. It also spent $2.75 billion on research and development in the first quarter of 2015 up 38% from one year ago and 99% of the R&D two years ago (Gottlieb, 2015). Amazon is also spending revenues to expand fulfillment capabilities. Amazon s property square footage has increased by over 300% since These investments are intended increase Amazon s efficiency and create even greater operating cash flow in the future (Evans, 2014). Amazon s investments in the future help provide clarity in how Amazon is deferring profitability in the present for that in the future.

10 Amazon s future opportunities for growth are promising. Since 2003, Amazon has gained over 1% of total retail sales in the United States. Additionally, e-commerce retail is consistently growing as a percentage of total retail (Evans, 2014). As of 2015, e-commerce accounted for 7.2% of retail sales. Amazon is accelerating its market share of ecommerce sales. As of January 2015, Amazon had 23% of e-commerce market share up from below 6% in E-commerce in the Unites States is projected to more than double from 2012 to 2018 to over $490 billion ("U.S. retail e-commerce sales from 2010 to 2018 (in billion U.S. dollars)", 2015). By studying Amazon s historical strategy, financial statements, and the future of e- commerce, you can conclude that Amazon will continue to reinvest their profitability into growing their market share. Amazon will continue to show relatively low net income, but profitability is less important than free cash flow when there are opportunities to postpone current profits for greater profits in the future. The value of a stock is based on the present value of future free cash flows. Amazon s long term approach is aimed at maximizing future earnings. Recognizing a profits in the current would essentially forfeit Amazon s ability to have a competitive advantage and maintain its leadership position in e-commerce. In Amazon s circumstance, profitability now does not matter as much as maximizing profitability in the future. In the long-run Wal-Mart s price has been understated, Appreciation Potential is 35%- 60%. Sales are expected to be the first line item to benefit. Wal-Mart management believes the top line will rise 3%-4% per year from 2016 through Earnings will likely take a little more time to bounce back. EPS is expected to be up 5%-10% year over year in fiscal 2018.Wal-Mart reinforced its commitment to returning cash to shareholders. The board of directors recently authorized a new $20 billion stock-repurchase program. This allotment, along with the $8.6

11 billion left on its prior authorization, is expected to be exhausted over the next two years. The e- commerce business is promising. Two new fulfillment centers should lower costs in the fourth quarter and have a more pronounced effect next year. A new platform that lets users shop for groceries online and pick them up in store is testing well. Wal-Mart is also testing a $50 unlimited annual shipping program similar to Amazon Prime. How would you structure your investment into your chosen company? Investing in Amazon would get higher return back. A quite pervasive observation is that investment by younger firms was affected by speculation much more than the investment behavior of older firms. Amazon would consider itself as a Venture capitalists (VC s). A pattern that emerges from this figure is that movements in VC disbursements are more volatile and more sensitive to a change in variance compared to changes in the aggregate investment to capital ratio. This suggests that speculation in the markets might be operating through a second channel, namely by relaxing financing constraints which are likely to affect younger firms more than established companies. On one hand, Wal-Mart is changing on Half-Way, Wal-Mart said the company focused on investment in the online business, the electricity supplier incremental investment in the first quarter accounted for $ 0.02 per share. On the other hand, Amazon has developed technical support and perfected ecosystem to becoming an internet server. Our invest target on amazon is using high-risk investment vehicle such as stock or option, risk can be carry by high return. Proposing long-term holding, growth stocks will be fluctuate short-term, but the long-term volatility should be a minor variable to consider.

12 Investing on Wal-Mart is low risk and growing in the 10 year period, in current year, return on equity is 20% compare to amazon -2%. Growth speed may not as fast as Amazon, but holding as a constant investment is reasonable. References Peterson, H. (2014, August 14). Wal-Mart's Supercenters Are Becoming A Major Problem. Retrieved November 8, 2015, from Anderson, G. (2014, July 10). Walmart Seeks Small Answers To Big Sales Problem. Retrieved November 8, 2015, from Rigby, D. (2011, December 1). The Future of Shopping. Retrieved November 8, 2015, from Evans, B. (2014, September 5). Why Amazon Has No Profits (And Why It Works). Retrieved November 4, 2015, from Gottlieb, O. (2015, June 15). Why Amazon is Growing More Powerful and More Dangerous. Retrieved November 6, 2015.

13 Oreskovic, A. (2015, July 23). Here's how Amazon generated the surprise Q2 profit that sent its stock soaring. Retrieved November 5, 2015, from Ronen, L. (2015, April 30). AWS Financial Analysis Unveils Its Importance To Amazon s Value Line. (Oct 30,2015). Wal-Mart report. Retrieved Nov 7,2015, from VL_ _VLIS_WMT_2814_01-4FPSDRU816EB3JQ5FE1URLDRO7&symbol=WMT - See more at: Profitability. Retrieved November 6, 2015, from Value Line. (Nov 1, 2015). Amazon report. Retrieved Nov 7,2015, from VL_ _VLIS_AMZN_496_01-5TS6BT2OMFCDV81BAS4G48TF07&symbol=AMZN - See more at: U.S. retail e-commerce sales from 2010 to 2018 (in billion U.S. dollars). (2015). Retrieved November 7, 2015, from

14 National Retail Federation. (2015). Omnichannel Retail Index Retrieved November , from - See more at: Securities and Exchange Commission. (2015). Annual Report. Retrieved November 08, 2015, from - See more at: Securities and Exchange Commission. (2015). Annual Report 10-k. Retrieved November 08,2015, from x10k.htm#s82C42D977EC F52F1D4A24BC7 Kelleher, K. (2015, September 18). Here's Why Amazon Is Killing Walmart Right Now. Retrieved November 9, 2015, from Smith, C. (2014, October 20). E-COMMERCE AND THE FUTURE OF RETAIL: 2014 [SLIDE DECK]. Retrieved November 9, 2015, from slide-deck-sai ?op=1