The Economist Case Study Contest

Amazon vs Walmart
A Case for Proven Reliability Over Unbridled Enthusiasm

University of Portland
Manuel Rivera
YunFeng Pi
Samuel Gray

The Economist Case Study Contest
University of Portland
November 9, 2015

The Economist Case Study Contest

Amazon vs Walmart
A Case for Proven Reliability Over Unbridled Enthusiasm
1. Introduction ................................................................................................................... 1
2. The Companies ............................................................................................................... 1
Walmart ......................................................................................................................................................................................... 1
Amazon .......................................................................................................................................................................................... 2
Profit vs Growth ........................................................................................................................................................................ 3
3. Stock Price Models ......................................................................................................... 4

Amazon Stock Price ................................................................................................................................................................. 5

Walmart Stock Price ................................................................................................................................................................ 5

4. Discussion ....................................................................................................................... 6

5. Conclusion and Recommendation .................................................................................. 9

6. References ..................................................................................................................... 11
Appendices
A. Amazon Discounted Free Cash Flow Model
B. Walmart Discounted Free Cash Flow Model

The Economist Case Study Contest
University of Portland
November 9, 2015

ii

1. Introduction
The challenge presented is to decided between Amazon.com, Inc. (Amazon) and WalMart Stores, Inc. (Walmart) over a ten-year investment horizon. The long term view allows
company fundamentals and management philosophy to serve as the basis for the decision instead
of short term sentiment. On one side of equation is Walmart whom has a long history of stellar
profits, but is experiencing short term hardships. On the other is Amazon, whom has chosen high
growth over profitability, a strategy unproven over the long-term.
The fundamental difference between Amazon and Walmarts strategies is high growth
versus profit. Our investment thesis is to compare these strategies and decided which is more
sustainable over the long term. The decision was based on: 1) trailing ten-year performance, 2)
predicted stock price calculated using discounted free cash flow models, 3) current and planned
investments to advance growth/profit in the future, and 4) major economic and social risks facing
each strategy. Analysis revealed both companies are poised to be successful in the future. Given
the choice of only one, we will invest in the company who can deliver the highest return with the
least risk.

2. The Companies
Walmart
Founded in 1962 by the late Sam Walton, Walmart has a current market capitalization of
$180.5 billion. In 1970 Walmart became a publicly traded company and listed on the New York
Stock Exchange (WMT). Nearly 20 years after opening its first store, Walmart reached $1
billion in annual sales and little over a decade later had its first $1 billion sales week. The
stunning sales growth has allowed Walmart to expand to 11,500 stores in 28 countries, under 65

The Economist Case Study Contest
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banners. The company employs 2.2 million people around the globe through brick and mortar
operations and an expanding e-commerce platform.
In order to effectively compete in the internet age Walmart plans to invest $1.5 billion in
2015 to enhance their technological infrastructure. The bulk of their investment will be customer
leaning with enhancements to their mobile application, expansion of their Click and Collect
feature abroad, and increasing the number of products available on their various websites. Since
creating walmart.com in 2000, Walmart has made the websites growth an important component
in the companys evolving retail business. To support growth in online retail, Walmart is
investing in their supply chain, including distribution centers dedicated to online customers.
Walmart has highlighted their intent to focus on technology, however they must ensure their
investment allows them to compete well with ecommerce veterans, such as Amazon and eBay.

Amazon
The Seattle e-commerce giant, founded in 1994, is now the worlds largest retailer, and
investor confidence is soaring to all time highs. While the company has rarely turned a profit and
doesnt pay a dividend, those who invested in January 2015 have realized a return of over 100%.
Despite its expanding service offering and extensive geographical reach, Amazon has focused on
growth instead of consistent profitability. The principal reason for Amazons lack of profit is
their focus on the long-term reinvestment. Jeff Bezos, the Companys CEO, explains their
strategy:
If everything you do needs to work on a three-year time horizon, then youre
competing against a lot of people, but if youre willing to invest on a seven-year
time horizon, youre now competing against a fraction of those people, because
very few companies are willing to do that. [....] At Amazon we like things to work

The Economist Case Study Contest
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in five to seven years. Were willing to plant seeds, let them growand were
very stubborn. (New York Times, 2011)
Amazons philosophy and basis for its growth has led the company towards capital
intensive investments focused on an improved network of warehouses and enhanced cloudcomputing facilities. These investments have supported the development, growth and recently
successful Amazon Web Services (AWS). If sustainable, Amazons investment strategy has
great promise, albeit at the cost of short-term profits and high risk.
Capital investment dependent growth is difficult to maintain, and exposes the company
to potential risk. The low margins that permeate Amazons retail services create uncertainty
about its ability to generate profits and fully utilize the infrastructure it is developing. While the
volume of its transactions is nothing short of extraordinary, it is difficult to determine if similar
volume levels could be maintained if Amazon where to increase prices to drive profits. In order
to maintain the cash-flow to continue capital investments, the Company could face the need to
resort to external debt, exposing themselves to interest rate risk. The additional risk and cost of
financing, could slow down growth and negatively impact share price.

Profit vs Growth
A comparison of Amazon and Walmart requires the comparison of companies with
fundamentally different management philosophy and in different stages of life. Walmarts
management prioritizes profit, while Amazons seeks high growth. What makes Amazon unique,
is the fact it could generate profits if it chose to. The choice to pursue growth over profit is
clearly illustrated in Amazons P/E of 938. Amazons P/E ratio as well as those of relevant
technology and retail companies are presented in Figure 1.

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University of Portland
November 9, 2015

1000

Figure 1: P/E Ratio for Technology and Retail Companies

938

800
600
400
200

20.8

Google

110
Facebook

299

Netflix

Amazon

11.8

Wal-Mart

14.5

Best Buy

60.55
Alibaba

Many of Amazons technology peers have gone through an initial period with little to no
profit in order to foster growth. Since then, these peers have P/E ratios closer to Walmart than
Amazon. This suggests that while growth is essential for any business, profit has to be the
ultimate goal. Jeff Bezos has proven time and time again that he can make his vision for Amazon
a success. The other side of the coin are the remaining companies illustrated in Figure 1, that
gave up their initial high growth rates and have become profitable.

3. Stock Price Models

Discounted free cash flow models were created for each company. The models were
constructed using current annual financial data, historical trends and analyst expectations. Free
cash flow (FCF) was calculated as operating cash flow minus capital expenditures. Stock prices
were calculated using the sum of the present values of the FCFs plus cash, minus debt divided by
shares outstanding. The results of the model are included in Table 1. The models are included in
Appendices A and B.

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November 9, 2015

Table 1: Model Outputs

Stock Price (Nov 2, 2015)
Predicted Stock Price

Walmart
$57.61
$98.32

Amazon
$628.35
$836.11

Amazon Stock Price

The model assumes a five-year period of growth, followed by a five-year transition
period, then constant growth in perpetuity. In the first five-year period operating cash flow has
an annual growth rate of 45%, which while high relative to historical rates, is in line with analyst
expectations for earnings (Bloomberg, 2015). Capital expenditures were modelled with 42.1%
annual growth, conservative relative to observed long term growth, however reflecting growth
over the previous two years. Growth in the transition period was reduced to 67% of the initial
period. The growth rate in perpetuity is the weighted average cost of capital minus Bloombergs
estimate for long term growth (Bloomberg, 2015). The discount rate used in the model is the
required return (Re), which is calculated and defined in Appendix A.
Amazons current stock price is below the predicted value of $836.11. Current target
prices for the stock vary between $490 to $800, with a median of $727 (Yahoo Finance, 2015a).
Few doubt that Amazon will be able to grow moving forward. The difference between our
model, analyst expectations, and the current price can be explained by relatively small
differences in the assumed growth rate and expectations on how sustainable that growth can be
in the future.

Walmart Stock Price

The stock price for Walmart was calculated using a single growth rate for 10 years then
constant growth into perpetuity. Operating cash flow has an annual growth rate of 2.37%, the

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average growth rate for the last two years. This growth rate is below longer term averages,
however is thought to reflect of the current and likely short term reality. Capital expenditures
were modelled with 1.0% annual growth, a conservative estimate given observed long-term
growth rates near zero. The growth rate in perpetuity was the weighted average cost of capital
minus the long term revenue growth rate. The discount rate used in the model is the required
return (Re), which is calculated and defined in Appendix B.
Walmarts current stock price of $57.61 is significantly below the predicted price of
$98.32. The current depressed price likely reflects the poor short-term performance and
decreased company guidance (Walmart, 2015a). Even with the relatively poor year to date
performance and not overly optimistic 2016 forecast, growth in the medium term is expected to
be positive (Bloomberg, 2015a). Another consideration in the decision is Walmarts quarterly
dividend. In 2015 the quarterly dividend is $0.49/share or $1.96 annually. Over the last ten years
the dividend has grown by an average 9.6% annually. Walmart is notably proud of their
dividend, which has increase every year since it was introduce in 1974 (Walmart, 2015b).

4. Discussion
Recent market activity would indicate Amazon has been chosen over Walmart. This is
largely to be expected given Amazons surprise profits (3Q15 Investor Conference Call; Amazon
2015a) and Walmarts comparatively dour short term outlook (Walmart, 2015a). If the markets
have spoken, the question then becomes are the movements reflective of short-term phenomena
or long-term fundamentals. As noted above, the companies fundamentally differ in terms of how
the stocks derive their value. The sustainability of each approach given current and reasonably
likely economic climate will largely determine which is a better bet in the long term.

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Amazons value is derived from high growth, which has been driven by reinvesting all
free cash back into the company. Operating cash flows have a long term growth rate of 32.1%.
Analysts expected growth could be as high as 45% over the next 5 years. largely due to the rapid
growth of AWS and rising depreciation expense. With current expansion of AWS, revenues from
web services could exceed retail revenue within ten years (Business Insider, 2015). Depreciation
as a percentage of operating cash flow has grown from 16.3% to 69.4% between 2010 and 2014.
This growth in depreciation is directly tied to capital expenditures and Amazons overall growth.
The pitfall of depreciation representing a significant portion of free cash flow is the need to
sustain growth in depreciation in order to maintain growth in operating cash flow. As can be seen
in Figure 2, if growth in capital expenditure is held constant, Amazons share price is highly
dependent on maintaining growth in operating cash flow. A one percent increase or decrease in
growth of operating cash flow represents a 15.0% and 14.1% change is stock price, respectively.
Maintaining growth in capital expenditures fuels growth in AWS and the associated increases in
depreciation. Conversely, Amazon could maintain its growth by choosing to increase its margins,
however Jeff Bezos has indicated that is unlikely in the near future (Harvard Business Review,
2013).
Figure 2: Amazon Stock Price Elasticity from Estimated
Growth in Operating Cash Flow

Predicted Stock Price

$1,500
$1,000
$500

$0
40%

41%

42%

43%

44%

Predicted Stock Price

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November 9, 2015

45%

46%

47%

Annual Growth in Operating Cash Flow

48%

49%

Current Price ($628.35)

50%

Amazon needs to generate cash to fuel growth. With $14 billion in cash and expansion of
the high margin AWS, Amazon may be able to finance growth organically in the short to
medium term. However, if cash flow becomes squeezed due to decreased depreciation or other
some other unforeseen circumstance, Amazon may have to finance expansion with debt.
Amazons current rapid expansion has been in a period of zero interest rate. By the end of the
ten-year horizon for the proposed investment, interest rates will unquestionably be higher than
they are today, or we will be facing another economic down turn. Neither scenario represents an
environment ideal for rapid growth. The increased cost of money associated with higher interest
rates will mute the ability of Amazons available cash to fund capital expenditures and it will
increase borrowing costs for capital spending. Given Amazons small margins, there would be
limited room to service significant debt.
Walmarts stock price has decreased over the last six months as concerns over low same
store sales growth and increased labor costs have arisen. Addressing these concerns means
income over the short-term will decrease, however taking a long view these fixes will set
Walmart up for future success. Capital expenditure to improve the shopping experience include
developing smaller neighborhood stores (Yahoo Finance, 2015a) and improving the look and
feel of existing stores (Walmart, 2015a). Walmarts wage growth has largely resulted from
outside pressure to improve the employees standard of living. Walmart announced the increased
wages are estimated to cost $1.5 billion next year, and promptly saw its stock drop 10% (CNN
Money, 2015). However, using Costco as an example, raising wages increases productivity and
reduces turnover (estimated to cost 1.5-2.5x salary to rehire position; Harvard Business Review,
2006), both of which will increase the bottom line over the long term. While the concerns over

The Economist Case Study Contest
University of Portland
November 9, 2015

same store sales and wage increases have reduced Walmarts share price this year, both will be
beneficial ultimately.
Walmarts short-term operating cash flow growth of 2.37% is significantly below the tenyear average of 6.65%. Using the 2.37% as the forecast for growth in the price model results in
decreasing discounted cash flows over the next ten years (Appendix B). Decreasing cash flow
overtime is not a good sign for any company, however the significance of these predicted
decreases is largely dependent on two factors: confidence in Walmarts ability to return to
historical growth levels and whether interest rates and stock market growth will normalize,
effectively reducing the discount rate. Looking forward one has to decide if the current values
are the anomaly or the future. Our bet is on the anomaly.

5. Conclusion and Recommendation

The choice between Walmart and Amazon is a choice between proven reliability and
unbridled enthusiasm. Walmart has suffered over the short-term, however are positioning
themselves for the future and has a long-term record of stellar profits. Amazon has experienced
explosive growth over the short-term, but has an unproven record and potential difficultly
sustaining high growth. Walmart undoubtedly has issues to overcome, however with challenges
including, sustaining high growth and potentially increasing cost of capital, betting on Amazons
growth model over the long-term is risky.
Estimates from the models suggests both companies are undervalued relative to their
future free cash flows. The valuations for Walmart and Amazon represent price increases of
70.7% and 33.1%, respectively. In addition to the estimated price increases, the value of
Walmarts dividend after ten years assuming conservative 4.8% growth and a 6.0% return is
$33.08 or a 57% return on the current price. In order for Amazon to just match the return on

The Economist Case Study Contest
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November 9, 2015

Walmarts dividend it needs a share price of $956.51. The value of the dividend in addition to
potential increases in stock value clearly illustrates that over the long-term profits matter.
Over the ten-year horizon of the challenge, Walmart is in a more reliable position to
perform well. Given the low return on Walmarts debt is unappealing, our recommended
investment would be in Walmart common stock.

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University of Portland
November 9, 2015

10

6. References

Amazon (2015a), Third Quarter 2015 Investor Conference Call Presentation, retrieved from
http://phx.corporate-ir.net/phoenix.zhtml?c=97664&p=irol-presentations, November 2015.
Bloomberg (2015), Bloomberg LP, Retrieved on October 31, 2015.
Business Insider, (2015), DEUTSCHE BANK: One part of Amazon's business is leading 'the
biggest technology shift of our time, Bryan, Bob, http://www.businessinsider.com-/dbamazons-growth-story-of-decade-2015-11. November 3, 2015.
CNN Money (2015), Walmart: Wage Hikes are Killing Our Profits, http://money.cnn.com/2015/10/14/investing/walmart-outlook-wages/, October 15, 2015.
Harvard Business Review (2006), The High Cost of Low Wages, https://hbr.org/2006/12/thehigh-cost-of-low-wages, November 2015.
Harvard Business Review (2013), Jeff Bezos on Leading for the Long Term at Amazon,
Ignatius, Adi, https://hbr.org/ideacast/2013/01/jeff-bezos-on-leading-for-the.html, January 3,
2013.
Harvard Business Review (2014), At Amazon, Its All About Cash Flow. Fox, Justin. <
https://hbr.org/2014/10/at-amazon-its-all-about-cash-flow/>, October 20, 2014.
Market Watch (2015), Amazon's stock price target jumps to $800 at Deutsche Bank, http://www.marketwatch.com/story/amazons-stock-price-target-jumps-to-800-at-deutsche-bank-201511-03, November 3, 2015
New York Times (2011), The New York Times, Amazon Says Long Term And Means It.
Steward, James B. December 16, 2011. < http://www.nytimes.com/2011/12/17/business/atamazon-jeff-bezos-talks-long-term-and-means-it.html?_r=0>
Yahoo Finance (2015a), Same-Store Sales Trends for Walmart and Its Peers, Soni,
Phalguni,http://finance.yahoo.com/news/same-store-sales-trends-walmart-134727789.html,
August 31, 2015.
Yahoo Finance, (2015b), Analyst Opinions, http://finance.yahoo.com/q/ao?s=AMZN+Analyst+Opinion, November 2015.
Walmart (2015a), Second Quarter 2016 quarterly Report and Financials, retrieved from
http://stock.walmart.com/files/doc_financials/2016/Q2/FY-16-Q2-press-release-final.pdf,
November 2015.
Walmart (2015b), Historical Dividend Information, retrieved from http://stock.walmart.com/investors/stock-information/dividend-history/default.aspx, October 2015.

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11

22.7%
29.4%
129.0%

2005

2005

The Economist Case Study Contest
University of Portland
November 9, 2015
1

4.98%

13.63%
2.20%
12.69%
10.49%
1.09

13.12%
$240,076
96.20%
3.80%
3.67%
57.05%

WACC Calculation
Rwacc = [Re x E%] + [Rd x ( 1-Tc) x D%}
Market Capitalization
Percent Equity (E%)
Percent Debt (D%)
Cost of Debt (Rd)
Corporate Tax Rate (Tc)

$389,689
$14,557
$8,265
468
$846.11
$628.35

Discounted FCF

$6,842
$4,893
$1,949

2014

26.2%
-4.2%
5.9%

2006

2006
$10,711
$702
$216
$486

CAPM Inputs
Required Rate (Re) = (Rf) + Beta x [(Rmkt)-Rf]
Risk Free Rate (Rf)= 10yr US Treasury Yield
Expected Return 5 year S&P Technology (Rmkt)
Risk Premium = Expected return - Risk Free Return
Beta (Calculated against 5yr S&P Technology)

Enterprise Value
Cash (Dec. 31, 2014)
Debt (Dec. 31, 2014)
Shares Oustanding (in millions)
Predicted Stock Price
Current Share Price (Nov.2, 2015)

Long Term Growth

Discount Rate (Re)2

Rwacc

Operating Cash Flow

Captial Expenditures
Free Cash Flow

Category

$8,490
$733
$204
$529

13.63%
13.12%

45.0%
42.1%
--

Short Term Growth

Discounted Free Cash Flow

Revenue
Operating Cash Flow
Capital Expenditures

Historical Growth Rates

Revenue
Operating Cash Flow
Capital Expenditures
Free Cash Flow

Historical Free Cash Flow

Discounted Free Cash Flow Model: Amazon

$2,612

$9,921
$6,953
$2,968

2015

38.5%
100.1%
3.7%

2007

2007
$14,835
$1,405
$224
$1,181

$4,647

$20,859
$14,040
$6,819

2017

27.9%
93.9%
12.0%

2009

2009
$24,509
$3,290
$373
$2,917

$6,174

$30,245
$19,950
$10,295

2018

39.6%
6.2%
162.5%

2010

2010
$34,204
$3,495
$979
$2,516

$8,184

$43,855
$28,350
$15,506

2019

40.6%
11.7%
85.0%

2011

2011
$48,077
$3,903
$1,811
$2,092

1. Expected Short Term Cash Flow Growth (Bloomberg)

2. Discount Rate (Required Rate)
3. Transition Growth ( 2/3 of short term growth)
4. Bloomberg Long Term Growth Rate

Free Cash Flow (FCF) = Operating Cash Flow - Capital Expenditures

Enterprise Value = PV (Future Cash Flow)
Stock Price = (Enterprise Value + Cash - Debt)/ Shares Outstanding

$3,489

$14,385
$9,880
$4,505

2016

29.2%
20.8%
48.7%

2008

2008
$19,166
$1,697
$333
$1,364

--

30.0%
28.1%
--

Transition Growth

27.1%
7.1%
109.0%

2012

2012
$61,093
$4,180
$3,785
$395

$9,618

$57,019
$36,310
$20,708

2020

21.9%
31.0%
-9.0%

2013

2013
$74,452
$5,475
$3,444
$2,031

$11,292

$74,133
$46,506
$27,626

2021

19.5%
25.0%
42.1%

2014

2014
$88,988
$6,842
$4,893
$1,949

$13,243

$96,384
$59,566
$36,818

2022

20.70%
27.97%
16.53%

2yr Growth

$15,517

$125,313
$76,292
$49,021

2023

29.72%
16.19%
77.90%

5yr Growth

$18,165

$162,926
$97,716
$65,210

2024

29.30%
32.09%
58.87%

10yr Growth

$296,748

$211,828
$125,155
$86,673

Perpetuity

Appendix A: Discounted Free Cash Flow Model

12

2005
9.82%
17.22%
13.49%
38.55%

2005

Category

The Economist Case Study Contest
University of Portland
November 9, 2015

7.93%
2.10%
13.75%
11.65%
0.50

6.54%
$236,711
82.50%
17.50%
1.70%
32.01%

CAPM Inputs
Expected Rate (Re) = (Rf) + Beta x [(Rmkt)-Rf]
Risk Free Rate (Rf)= 10yr US Treasury Yield
Expected Return 5 year S&P 500 (Rmkt)
Risk Premium = Expected Return - Risk Free Return
Beta (Calculate against 5 yr S&P 500)

WACC Calculation
Rwacc = [Re x E%] + [Rd x ( 1-Tc) x D%}
Market Capitalization
Percent Equity (E%)
Percent Debt (D%)
Cost of Debt (Rd)
Corporate Tax Rate (Tc)

$360,113
$9,135
$50,381
3,243
$98.32
$57.61

Growth3

1.80%

Enterprise Value
Cash (Jan 31, 2015)
Debt (Jan 31, 2015)
Shares Oustanding
Share Price
Actual Share Price (Nov. 2, 2015)

$12,296
$16,945
$15,701

Captial Expenditures2
$12,174
Free Cash Flow
16,390
Discount Rate (Re)
Discounted FCF
Rwacc

2015

2007
11.67%
2.37%
-4.65%
26.83%

$344,992
$20,642
$14,937
$5,705

2007

1.00%
-7.93%
6.54%

2014

2006
9.75%
14.34%
7.82%
44.86%

$308,945
$20,164
$15,666
$4,498

2006

$29,241

Operating Cash Flow1

$281,488
$17,635
$14,530
$3,105

$28,564

2.37%

Est. Growth

Discounted Free Cash Flow

Revenue
Operating Cash Flow
Capital Expenditures
Free Cash Flow

Historical Growth

Revenue
Operating Cash Flow
Capital Expenditure
Free Cash Flow

Historical Free Cash Flow

Walmart Discounted Free Cash Flow Model

$12,543
$18,101
$14,399

$30,643

2017

2009
7.29%
13.40%
5.96%
20.75%

$401,087
$26,249
$12,184
$14,065

2009

$12,668
$18,701
$13,784

$31,370

2018

2010
4.45%
-9.93%
4.23%
-22.19%

$418,952
$23,643
$12,699
$10,944

2010

$12,795
$19,318
$13,193

$32,113

2019

2011
5.94%
2.59%
6.39%
-1.82%

$443,854
$24,255
$13,510
$10,745

2011

1. Expected Operating Cash Flow Growth (5 Year Historical Average)

2. Expected Capital Expenditure Growth (2 Year Historical Average)
3. Long Term Growth Rate (2 Year Historical Revenue Growth)

All prices expressed in millions of dollars except share price

Free Cash Flow (FCF) = Net Operating Cash Flow - Capital Expenditures
Enterprise Value = Present Value(Future Free Cash Flow)
Stock Price = (Enterprise Value + Cash - Debt)/ Shares Outstanding

$12,419
$17,515
$15,037

$29,934

2016

2008
8.36%
12.14%
-23.02%
104.17%

$373,821
$23,147
$11,499
$11,648

2008

$12,923
$19,951
$12,625

$32,874

2020

2012
5.59%
5.51%
-4.53%
18.13%

$468,651
$25,591
$12,898
$12,693

2012

$13,052
$20,601
$12,079

$33,653

2021

2013
1.63%
-9.12%
1.68%
-20.10%

$476,294
$23,257
$13,115
$10,142

2013

$13,183
$21,268
$11,555

$34,451

2022

2014
1.96%
22.82%
-7.17%
61.61%

$485,651
$28,564
$12,174
$16,390

2014

$13,315
$21,953
$11,051

$35,267

2023

2yr Growth
1.80%
6.85%
-2.75%
20.75%

$13,448
$22,656
$10,567

$36,103

2024

5yr Growth
3.92%
2.37%
0.12%
7.13%

$13,582
$493,375
$230,121

$36,959

Perpetuity

10yr Growth
6.65%
7.13%
0.02%
27.08%

Appendix B: Walmart Discounted Free Cash Flow Model

13