amazon.com began as an online book ... - the economist2015, producing a market capitalization of...

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I. Company Focus and a Touch History

A. ...is for Amazon

Amazon.com began as an online book bookstore in 1994, went public in 1997, and has

since grown to one of the largest retailers on the globe and, thanks to what seems to be a never

ending stream of acquisitions, boasts one of the widest array of brands and services of any

company. Founder and current CEO, Jeff Bezos, boasts a long-term vision focused heavily in

growth over profits, and has delivered on his message for more than two decades while building

a brand that symbolizes excellent customer service. In recent years, the company has moved into

a variety of other areas such as web services, digital streaming content (Amazon Instant Video,

Twitch), and hardware via the Fire Table, Fire Stick, and Fire Phone. Amazon trades on the

NASDAQ stock exchange and closed at $659.37 as of 11/6/15, having more than doubled in

2015, producing a market capitalization of $309 billion.

B. From Five-and-Dime to $500 Billion

Sam Walton opened his first five-and-dime store in 1950, and used his discount retail experience

to launch Wal-Mart in 19621. The company has since grown in to one of the largest retailers on

the planet with more than $500 billion in annual sales and is the single largest employer in the

world2. As noted in Figure 1 below, and reiterated by current CFO Charles Holley during the

latest earnings presentation, Wal-Mart has grown its dividend every year since 1974. This is an

absolutely staggering streak that cannot be ignored, if for no other reason than it is a load-bearing

pillar of Wal-Mart’s image of stability. Some have recently begun to question the sustainability

of Wal-Mart’s dividend growth in these dire times but, as we will later demonstrate, the dividend

1 http://corporate.walmart.com/our-story/our-history 2 http://www.usatoday.com/story/money/business/2014/08/24/24-7-wall-st-biggest-employers/14443001/

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is quite safe. Not only that, but it will continue to grow as Wal-Mart continues to generate ample

cash to plow back into the business.

Both Amazon and Wal-Mart strive to be price leaders in a multitude of product types and

squeeze what costs they can from their supply chains. This, however, is where the similarities

seemingly end as the focus of each continues to diverge. Amazon continues to invest heavily in

technology and expand into new arenas, and it is very possible that the company’s primary focus

ten years from now may be a product/service that does not presently exist. Wal-Mart, on the

other hand, seems to be doubling down on its tried-and-true grocery retail strategy and continues

to expand into new international markets with a variety of locale-specific strategies.

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II. Fe-Fi-Fo-Fumble

3 It is no secret that Wal-Mart has faced some adversity in 2015. The common stock is

down more than 30% year-to-date on slowing same-store sales, and recently suffered a 10% one-

day decline on news that earnings per share would decrease for the second straight year for the

first time in Wal-Mart’s history. The drop is driven primarily by management’s pledge to

increase wages of employee’s to at least $9/hour in the U.S. and $10/hour by 2018. A

commitment to the tune of $1.1 billion to build-out an extensive e-commerce and omni-channel

platform was also divulged at the quarterly update. In our eyes, these changes are absolute

necessities in order to curtail the bleeding of retail sales into alternate online channels, as well as

to stay one step ahead of the low-wage criticisms that have undoubtedly driven Wal-Mart’s

history of poor talent retention of hourly workers. Unfortunately, these investments will deal a

sizable blow to earnings over the short-term, as evidenced by Figure 1 above. However, these

outlays will also allow Wal-Mart to capture a larger portion of e-commerce spending, which

totaled a measly $12.12 billion in 2014 compared to total sales of roughly $475 million in 20144.

In conjunction with the newly proposed $20 billion share buyback plan, these projects should

drive sales to management’s 3-4% annual growth target and bolster EPS in subsequent years.

3 Figure 2 displayed as slides 4 & 9 of management’s October 14th, 2015 presentation 4 Internet Retailer | Company Filings

Figure 1

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III. Change of the Future – Data vs Distribution

A. Logistics Mastery

5 Since 1971, Wal-Mart has leveraged a unique network of distribution centers to gain a

logistics advantage over the competition6. The spoke-hub network of more than 150 one-million

square foot distribution centers, thousands of warehouses, and more than 5000 U.S. retail stores

across the United States are the backbone of Wal-Mart’s business empire, and the greatest driver

of its formidable economic moat. Wal-Mart’s distribution centers receive and ship inventory to

retail outlets within a 24-48 hour window, which limits inventory holding costs considerably and

the retail store saturation strategy has

allowed a Wal-Mart to spring up within

15 miles of 90% of the U.S. population.

Even more important is the leverage

this extensive distribution network and

saturation strategy provides leverage for

an aggressive in-store pick-up and

home delivery strategy. In the latest quarterly

update, management specifically noted that funds

had been earmarked for strategic investments in e-

commerce and Omni-channel strategies, including

all-important grocery items, which now account

for more than half of sales7. Management also

5 Figure 2: http://www.mwpvl.com/html/walmart.html 6 http://corporate.walmart.com/our-story/our-history

Figure 3

Figure 2

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noted the continued expansion of its small-store format, and plans to add several hundred of the

“mini-Marts” annually. This is when Wal-Mart’s negotiated network with suppliers of

pharmaceuticals and produce items, all of whom deliver directly to Wal-Mart stores, becomes

truly valuable. Wal-Mart’s distribution facilities are excellent at moving massive freight across

vast distances to retail locations, but gearing a distribution center to deliver directly to a retail

consumer is entirely different beast. Thankfully, e-commerce growth trends for grocery and

health items are two of the only segments that will not witness a significant shift to online over

the next decade (less

than 8% online by

2020). Wal-Mart’s

established

supplier and

vendor relationships and

respectable negotiating

leverage will allow

them to more easily

pivot to an in-store

pick-up option more quickly than would otherwise be possible under complete distribution

facility restructuring. By the end of 2015, Walmart plans to have online grocery shopping with

free in store pickup available in 20 markets.8

The United States will continue to be Wal-Mart’s bread and butter, it is clear that that

Wal-Mart should be shifting its focus to the international stage to source its growth. While total

8 Figure 5: http://www.businessinsider.com/the-future-of-retail-2014-slide-deck-sai-2014-3?op=1 US Census

Figure 4

Figure 5

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sales have grown at a compound annual growth rate (CAGR) of 4.9% since 2004, international

sales have grown at a CAGR of 8.4%9. Luckily for shareholders, this has not gone unnoticed by

top brass, as Wal-Mart has already established more than 2000 stores, roughly half of which

under the Bodega Aurrera name, in Mexico and continues to set its sights on South America.

Further still, in October 2015 Wal-Mart appointed Brett Biggs as CFO as of January

2016. Brett previously headed all international financial operations and operations, and this

trend follows the promotion of Doug McMillon, former CEO of Wal-Mart International, to the

top-spot in the C-Suite. These changes will undoubted bring a renewed international focus from

the top-down.

9 http://scdigest.com/assets/firstthoughts/12-07-26.php?CID=6047 | One Source

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B. Is Amazon’s growth-phase past its prime?

Amazon is a phenomenal growth story that will be the focus of cases studies and business

classes for decades to come, and will almost certainly continue to grow sales and operating

margins at a formidable rate over the next several years. This growth is being driven primarily

by two secular trends: growth in e-commerce and the continued rise in cloud-computing.

Amazon is able to leverage its extensive customer base and brand to grow third-party sales,

which come with higher margins due to the associated fee structure, at a rate in excess of e-

commerce growth trends. However, there is reason for concern as barriers to entry are

considerably lower in the online retail arena than in traditional retail outlets. While Amazon has

been growing in excess of the industry rate for essentially the entirety of its twenty-one year life,

the rate has slowed considerably, from nearly 3x the industry growth rate in 2011 to 1.5x in

201510. Its ability to grow sales faster than industry norms will require continued growth in

market share (a fleeting trend) and sustained wage growth in its primary customer demographics.

Unfortunately, this seems to be an unlikely scenario, as wage growth is forecasted to hover

around 5.3% through 2025.11

10 http://www.bloomberg.com/news/articles/2015-01-29/amazon-s-growth-no-longer-far-ahead-of-north-american-e-commerce 11 http://www.tradingeconomics.com/united-states/wage-growth/forecast

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The lack of meaningful wage growth domestically implies that Amazon will be forced to

source new patronage abroad. While this is certainly an attainable goal, it’s clear that Amazon

will need to source the majority of it sales through international avenues, as opposed to the ~40%

if currently receives, if it wishes to maintain its growth trajectory.

C. History Repeating

The growth that Wal-Mart experienced in its first two decades raised a lot of eyebrows,

and it was inevitable that competition would come knocking. Twenty-one years after Sam

Walton opened his first outlet this competition arose in the form of club-model retailers such as

Cost Co. Coincidentally, Amazon turned 21 years-old in 2015, and the model seems to have

attracted a slew of its own direct competitors. E-Commerce trends created a multitude of success

stores in the early 2000’s, but many of the online retailers were forced to abandon growth or sell-

out to larger competitors such as Amazon, in the midst of the 2008 financial crisis. This allowed

Amazon to wipe the online retail slate clean, gobbling up direct competitors such as Diapers.com

and Zappos that might otherwise have posed as long-term rivals.

However, the continued growth in e-commerce and general expansion of the U.S.

economy since the financial crisis has afforded many an entrepreneur the opportunity to revamp

their business ideas and find funding for growth. Jet.com is a prime example of just a scenario.

Marc Lore, who originally founded Diapers.com, was forced to sell out to Amazon for more than

$500 million12 after the 2008 downturn left the company unable to continue its ongoing price

war with its current owner. However, after having served for a time at Amazon, Marc resurfaced

with the launch of Jet.com in the summer of 2015 under the Costco club membership model with

12 http://www.bloomberg.com/news/features/2015-01-07/amazon-bought-this-mans-company-now-hes-coming-for-them-correct

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the aim of competing directly with Amazon on the retail front. Even if these businesses are

unsuccessful in the long haul, they’ll almost certainly serve to undercut Amazon’s margin

improvement as retailers battle for the lowest online price.

D. Profitability or Ubiquity

Amazon is as infamous for its historical lack of profits as it is famous for its growth. Amazon

posted a surprise quarterly profit for the 3rd quarter of 2015 thanks mostly to a foreign currency

translation adjustment, but has slowly improved margins on all fronts in recent years as growth

accelerated. We feel as though Amazon’s lack of profitability has been greatly overemphasized.

If investments in marketing and growth prospects were curtailed, then operations would

undoubtedly generate a sizable profit. However, Amazon’s choice to focus on sales growth over

profits has led to an all-encompassing, but seemingly double-edged, saturation strategy. These

investments serve as Amazon’s V8 engine for growth. However this diversity of the holdings

also leads to a much greater risk of failure (i.e. Fire Phone). As such, it seems as though

Amazon will eventually be forced to focus on the solid businesses it has built and allow certain

pet-projects to go by the way-side as competition increases in online retailing and cloud-

computing. In the end it comes down to a choice between profitability or continued cross-

segment saturation; a choice that could be difficult, if not impossible, for Amazon’s management

to accept.

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IV. Valuation & Potential Return

A. Valuation Approach

Several factors impeded a direct price multiple comparison in this scenario. The first, and

perhaps most obvious, is the current stage of each company in their respective life-cycles.

Amazon continues to operate in a growth phase; possibly one of the greatest ever witnessed by

the market. Its valuations are sky-high by nearly any conventional metric, but does even this

seemingly unstoppable growth justify the current multiples?

We think not. Even under the most optimistic scenarios of sustained revenue growth in

excess of industry trends and success in web-services, Amazon’s valuation falls short of the

hype. From the downside perspective, if Amazon’s growth in sales or margins is negatively

impacted by the inevitable flood of competitors its valuation would suffer greatly. Walmart, on

the other hand, has most certainly reached an age of maturity, but that is not to say that this

stalwart is over the hill. On the contrary, Wal-Mart may well be marking yet another milestone

in its history of adaptation and growth. Despite the limitations in direct comparability, we were

able to formulate what we consider to be a logical and realistic approach to the comparison using

a discounted cash flow methodology with what we consider to be conservative assumptions and

growth estimates.

Wal-Mart’s heavy presence in consumer staples allows for a fairly stable revenue stream,

even in times of economic downturns. Even if Amazon executes on all of its stated financial

Multiple Comparison2007 2008 2009 2010 2011 2012 2013 2014 2015 10 yr Avg

AMZN P/S 2.6 1.2 2.4 2.4 1.8 1.9 2.6 1.7 3.1 2.1WMT P/S 0.5 0.6 0.5 0.5 0.5 0.5 0.5 0.6 0.4 0.5S&P 500 P/S 1.5 0.9 1.2 1.3 1.2 1.3 1.7 1.8 1.8 1.4

AMZN P/CF 27.9 13.1 18.1 23.5 25.5 27.2 37.0 25.2 31.8 24.7WMT P/CF 10.0 10.6 8.3 7.7 8.6 8.5 11.3 11.0 7.1 9.5S&P 500 P/CF 11.6 6.8 9.1 9.3 8.5 9.2 11.2 11.5 11.6 9.7

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objectives, which involve growing faster than e-commerce as a whole while meeting or

surpassing the operating margin target of ~7% by 2019, the valuation falls slightly short.

Only by achieving accelerated free cash flow growth over the next ten years will Amazon be able

to continue to drive shareholder value. The following table shows the historic and projected free

cash flow growth rates in order to reiterate the conservative and aggressive estimates for Wal-

Mart and Amazon, respectively.

B. Dividend Safety and Forecast

Perhaps the most attractive feature of Wal-Mart’s stock is the stable return of capital by

way of ever increasing quarterly dividends. As previously noted, Wal-Mart has increased its

dividend for 42 consecutive years and we believe that management will continue to do so over

the next decade. Even when taking management’s lower earnings guidance into account, the

payout ratio will not exceed 45% in any period over the next ten years due to projected earnings

growth and share repurchases.

Previous 10 Years 10-Year ForecastAMZN 11.90% 17.59%

WMT 4.91% 3.22%

Base Case Free Cash Flow CAGR

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C. Profit Potential

While there appears to be ample room for appreciation of Wal-Mart’s common stock, the

true profit generator is Wal-Mart’s consistent dividend stream. The dividend has grown at a

CAGR of roughly 12% over the previous decade. Based on our net income forecast and

projections of shares outstanding we contend that it will continue to grow at the conservative rate

of at least 2.6% over the next ten years; well below the historical dividend growth rate. Based

on these figures, and the assumption that dividends will be reinvested at the prevailing price,

Wal-Mart would serve to nearly double the principle investment over a ten year period.

We believe the margin of safety provided by Walmart’s forecasted total return makes for

a comfortable investment with a high probability of delivering outsized returns versus AMZN on

an absolute and risk-adjusted basis regardless of whether dividends are reinvested, as can be seen

below.

Buy in Price $58.78 $58.78 $58.78 $58.78Zero Growth Base (w/o RD)* Base High Growth

Annual Dividend $1.96 1.96 $1.96 $1.96Dividend CAGR 0.00% 2.60% 2.60% 3.00%Stock CAGR 0.00% 3.94% 3.94% 6.50%Price Target $50.14 $86.65 $86.65 $110.42Dividends $23.43 $26.40 $26.40 $28.47Total Return 38.1% 99.8% 99.8% 151.9%*Base (w/o) RD assume all dividends are taken as cash and are not reinvested

WMT Dividends and Total Forecasted Return

Buy in Price $659.37 $659.37 $659.37Low Growth Base High Growth

Stock CAGR -5.9% -0.6% 2.2%Price Target $358.55 $623.50 $821.45Total Return -45.6% -5.4% 24.6%

AMZN Total Forecasted Return

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V. Investment Strategy & Risk Reduction

A. Market Sentiment

We believe that Mr. Market’s underpricing of Walmart and overpricing of Amazon has

afforded an incredible opportunity for the patient investor. The growth of Amazon has made it

the darling of Wall Street, but has also allowed the company’s valuations to rise to dangerous

levels. It would seem as though Amazon is on the unfavorable side of the investor sentiment

cycle, at least in the near and mid-term time

horizons. Wal-Mart investors, on the other hand,

look to be in full-blown panic mode after the

company failed to invest more heavily in e-

commerce to ride tailwinds of the last decade. This

opens the door of opportunity for incredible returns, but will also require a strong stomach for

wide price-swings and potential paper-losses in the next 12 months.

B. Risk Reduction

This volatility through Wal-Mart’s so-called “turn-around” phase (perhaps the most

profitable “turn-around” company the world has ever witnessed) requires an investor to employ

techniques beyond a traditional buy-and-hold strategy. As with most value plays, we

recommend utilizing a covered call strategy to add an extra income stream in order to afford an

investor additional investment options (cash, ability to diversify, reinvest in underlying). In this

scenario, selling a call approximately one-month out at a strike price that is out-of-the-money by

~4-5% is likely best. A one-month rolling covered call approach, as opposed to a longer time-

horizon, reduces the probability of the underlying being called away. It may be required to shift

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your call strategy slightly from month to month, as volatility and liquidity for options in these

ranges can vary enough to materially to change the risk-return relationship. It should also be

assumed that any shares called away will be repurchased on the open of the following market

day and that no covered calls are held at the time of earnings.

Figure 5

Generally speaking, however, this monthly covered call strategy is merely in place to

generate funding for an at-the-money “straddle” strategy to be deployed throughout the calendar

2016 and 2017 earnings seasons. Alternatively, a slightly out-of-money strangle strategy may be

more appropriate if implied volatility (IV) sends the ask-price to unpalatable levels. The lack of

certainty surrounding earnings, margins, and future capital expenditures will almost certainly

lead to increased volatility in the short run, and these two strategies, used in conjunction, offer a

cheap, or even, free method to eliminate downside risk in the event of a large earnings miss

while maintaining unlimited upside should earnings surprise to the upside.

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VI. Conclusion

Sentiment on Wall Street has sent the stock prices of Amazon and Wal-Mart in vastly

different directions, and it has created an incredible investing opportunity. With the sustainable

competitive advantages produced by an unparalleled distribution network, international presence,

and an ability to generate ample cash for Omni-channel and e-commerce investments, Wal-Mart

seems poised to continue to dominate the retail space with an increased emphasis on grocery

products. At current price levels we contend this is a superior investment option.

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VII. Appendix

A. Wal-Mart Base Model Assumptions

1. Income Statement Free Cash Flow Forecast

[Revenue]: Our base scenario called for Wal-Mart’s sales growth to come in roughly at the level

of US GPD over the next ten years, which meets the very low end management’s sales guidance

through 2019. Sales are forecasted to grow roughly 3% through 2018, and slow by 3-5bps over

the next 6 years.

USD in millions 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025Revenue $476,294 $485,651 $500,075 $513,877 $527,443 $540,946 $554,524 $568,276 $582,142 $596,229 $610,539 $625,070Cost of revenue $358,069 $365,086 $375,929 $386,305 $396,503 $406,654 $416,861 $427,199 $437,622 $448,213 $458,970 $469,893Gross profit $118,225 $120,565 $124,146 $127,572 $130,940 $134,292 $137,663 $141,077 $144,519 $148,017 $151,569 $155,176Operating expenseSG&A $91,353 $93,418 $97,251 $100,339 $103,428 $106,516 $109,605 $112,693 $115,781 $118,870 $121,958 $125,047Add'l Opex $2,500 $5,150 $4,000 $3,700 $3,500 $3,250 $2,500 $2,300 $2,200 $2,100Total operating expenses $91,353 $93,418 $99,751 $105,489 $107,428 $110,216 $113,105 $115,943 $118,281 $121,170 $124,158 $127,147Operating income $26,872 $27,147 $24,395 $22,083 $23,512 $24,076 $24,558 $25,134 $26,238 $26,847 $27,411 $28,030

Interest Expense $2,335 $2,461 $2,472 $2,525 $2,577 $2,630 $2,682 $2,735 $2,787 $2,840 $2,892 $2,945Other income (expense) $119 $113 $116 $120 $123 $127 $131 $135 $139 $143 $147 $151Pretax Income $24,656 $24,799 $22,039 $19,678 $21,058 $21,573 $22,007 $22,534 $23,589 $24,150 $24,666 $25,236

Provision for income taxes $8,105 $7,985 $6,964 $6,218 $6,654 $6,817 $6,954 $7,121 $7,454 $7,631 $7,794 $7,975Minority interest $673 $692 $712 $732 $751 $770 $790 $809 $829 $849 $869 $890Other income $673 $692 $712 $732 $751 $770 $790 $809 $829 $849 $869 $890Net income from cont. ops $16,551 $16,814 $15,075 $13,460 $14,404 $14,756 $15,053 $15,413 $16,135 $16,518 $16,871 $17,262Net income from disc. ops $144 $285 $279 $287 $294 $302 $310 $317 $325 $333 $341 $349

Other Expense ($673) ($692) ($712) ($732) ($751) ($770) ($790) ($809) ($829) ($849) ($869) ($890)Net income $16,022 $16,407 $14,642 $13,015 $13,947 $14,288 $14,573 $14,921 $15,631 $16,002 $16,343 $16,721Earnings per Share $4.90 $5.07 $4.65 $4.29 $4.77 $5.07 $5.26 $5.39 $5.65 $5.78 $5.90 $6.04Operating Income $26,872 $27,147 $24,395 $22,083 $23,512 $24,076 $24,558 $25,134 $26,238 $26,847 $27,411 $28,030Tax $8,105 $7,985 $6,964 $6,218 $6,654 $6,817 $6,954 $7,121 $7,454 $7,631 $7,794 $7,975NOPAT $18,767 $19,162 $17,431 $15,865 $16,858 $17,259 $17,604 $18,013 $18,784 $19,215 $19,616 $20,055Depreciation & Amort. (+) $8,870 $9,173 $9,304 $9,985 $10,365 $10,745 $11,126 $11,506 $11,887 $12,267 $12,647 $13,028CAPEX (-) $13,115 $12,174 $12,400 $11,000 $11,304 $11,593 $11,884 $12,179 $12,476 $12,778 $13,084 $13,396Free Cash Flow $10,142 $16,390 $14,335 $14,850 $15,919 $16,411 $16,846 $17,341 $18,195 $18,705 $19,179 $19,687

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[Operating Expenses]: Operating expenses are expected to increase at approximately double the

rate of sales growth in 2016 and 2017 as management increases wages for hourly workers. The

increase in wages costs are expected to be sustained as minimum-wage laws are instituted across

the US. Growth in these additional expenses reverts to sales growth after 2019.

[Capital Expenditures]: Wal-Mart’s capital expenditure are expected to increase $1billion to

roughly $12.5billion in calendar 2016. Capital expenditures fall to ~$11billion in calendar 2017

as per management’s guidance, and increase at varying rates of sales growth through 2025.

[Shares Outstanding & Earnings per Share (EPS)]:

After calculation the net income based on the previous revenue and expense assumptions, it was

necessary to compare this to the number of shares that would be outstanding at various stages of

management two current share buy-back programs. It is assumed that shares are repurchased at a

constant rate over the repurchase plan time frame at the projected price. Shares outstanding are

calculated using the mid-point averages. Shares outstanding are expected to remain constant

after 2019 under the assumption that management opts not to repurchase shares above the 25%

margin of safety fair value of ~$65.

YearProjected

Stock PriceProj. Yield %

Forecasted EPS ($)

Shares O/S Mid-Year (Based on current open

repurchase plans)

Projected Net Income

Payout Ratio Annual Div $ Div Growth

2016 $60.18 3.29% $4.65 3147.51 14,641.62$ 42.6% $1.98 1.0%2017 $62.68 3.19% $4.29 3033.22 13,014.74$ 46.6% $2.00 1.0%2018 $65.29 3.12% $4.77 2923.94 13,947.30$ 42.8% $2.04 2.0%2019 $68.00 3.07% $5.07 2819.46 14,287.75$ 41.2% $2.09 2.3%2020 $70.83 3.03% $5.26 2768.39 14,572.58$ 40.8% $2.15 3.0%2021 $73.77 3.01% $5.39 2768.39 14,921.16$ 41.3% $2.22 3.5%2022 $76.83 3.00% $5.65 2768.39 15,631.04$ 40.8% $2.30 3.5%2023 $80.03 2.99% $5.78 2768.39 16,002.28$ 41.3% $2.39 3.8%2024 $83.35 2.97% $5.90 2768.39 16,342.66$ 41.9% $2.48 3.6%2025 $86.65 2.95% $6.04 2768.39 16,720.51$ 42.4% $2.56 3.4%

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2. Cost of Capital (WACC)

Cost of Capital figures were produced using a risk free rate of 2.16% based on the 10-year

treasury yield. The market risk premium of 7.57% was calculated based on the 30 year historical

returns of the S&P 500 minus the 10-year historical risk-free rate. This produced a weighted

average cost of capital (WACC) of 7.01%.

3. Discounted Cash Flow Scenarios

The following table summarizes the free cash flow, cost of capital, and terminal growth rate

assumptions for the Base, No Growth, and High Growth scenarios.

Equity Weight 81.18%Risk-Free Rate 2.16%Market Risk Premium 7.57% Cost of CapitalBeta 0.72 Price $58.78Cost of Equity 7.61% Total Value $232,137,153,200

Equity $188,445,153,200Weight of Debt 18.82% Debt $43,692,000,000Interest Expense $2,709,000,000 WACC 7.01%Tax Rate 28.56%Cost of Debt 6.20%

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a. Base Scenario

[Base-Scenario Assumptions]: The Base scenario is calculated using figures forecasted in the

income and cash flow statement’s above. FCF is expected to grow at a CAGR of 3.22% under

the base scenario.

Initial Cash Flow (FCF): $15,379,000,000Terminal Growth Rate: 2.0% Discount Rate: 7.01%Shares Outstanding: 3,205,940,000

Debt & LT Leases Level: $43,692,000,000 Margin of Safety: 25%

Year Flows Growth Present Val2016 14,334,508,134 0.0% $13,395,273,0022017 14,849,614,212 3.6% $12,967,394,3542018 15,919,261,985 7.2% $12,990,601,2232019 16,410,870,076 3.1% $12,514,304,0432020 16,846,200,444 2.7% $12,004,548,5572021 17,340,578,576 2.9% $11,547,187,7262022 18,194,797,001 4.9% $11,322,142,8712023 18,704,702,358 2.8% $10,876,796,2172024 19,179,060,776 2.5% $10,421,885,5402025 19,687,217,815 2.6% $9,997,055,055

FCF CAGR = 3.22%Terminal Year $20,080,962,172

Intrinsic Value (IV): $86.65Margin of Safety IV: $64.99

% from Terminal Value 63%

WMT Discount Cash Flow--Base

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b. Zero Growth Scenario

[Zero-Growth Assumptions]: The base model was modified in several way to produce the Zero-

Growth scenario. Wal-Mart is expected to maintain zero sales growth even in recessionary

environments due to its heavy focus on consumer staples. The terminal growth rate was also

reduced to zero.


Debt & LT Leases Level: $43,692,000,000 Margin of Safety: 25%Year Flows Growth Present Val2016 14,334,508,134 0.0% $13,395,273,0022017 14,334,508,134 0.0% $12,517,579,0572018 14,334,508,134 0.0% $11,697,393,9552019 14,334,508,134 0.0% $10,930,949,5642020 14,334,508,134 0.0% $10,214,724,6502021 14,334,508,134 0.0% $9,545,428,6992022 14,334,508,134 0.0% $8,919,986,8002023 14,334,508,134 0.0% $8,335,525,5202024 14,334,508,134 0.0% $7,789,359,6982025 14,334,508,134 0.0% $7,278,980,115

FCF CAGR = 0%Terminal Year $14,334,508,134

Terminal Value: $103,812,051,429Intrinsic Value (IV): $50.14Margin of Safety IV: $37.60


WMT Discount Cash Flow--Zero Growth

21

c. High-Growth Scenario

[High-Growth Scenario Assumptions]: The high-growth scenario involves Wal-Mart succeeding

with its Omni-channel and e-commerce platforms domestically as well as success in global

markets such as India, China, and especially Mexico. This produces a FCF CAGR of 3.98%

over the period, which is still well below the historical growth rate.

4. Terminal Growth Rate Assumptions

We believe that domestic/international sales mix (~75/25) of revenue sourced within the States

makes the long-term US GDP growth rate an excellent proxy for a terminal rate. A 20bps

modifier was added to the long-term forecasted growth rate of 1.8% to account for Wal-Mart’s

increasing focus on international expansion.






WMT Discount Cash Flow--High Growth

22

B. Amazon Model Assumptions

Income Statement and Free Cash Flow Forecast

[Revenue]: Our Revenue assumptions for Amazon’s base scenario involve expansive growth in

excess of e-commerce trends through 2021. Historical revenue growth has grown between 2.5x

and 1.5x faster than e-commerce as a whole, but has persistently slowed in recent years. We

project sales at roughly double the forecasted industry growth rate through 2019, with the growth

multiple falling to just above industry growth trends by 2025.

[Gross Margins]: We forecast Amazon’s gross margins to persistently improve through 2020 as

the rate of third party sales, which carry higher gross margins, become a larger portion of the

sales mix. Gross margins are expected to stabilize thereafter.

USD in millions except share dat 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025Revenue $88,988 $111,266 $141,818 $179,780 $224,725 $269,670 $307,424 $344,315 $378,746 $412,833 $445,860 $477,070Cost of revenue $62,752 $75,818 $94,362 $116,790 $142,484 $168,131 $193,351 $218,486 $240,335 $261,965 $282,922 $302,727Gross profit $26,236 $35,448 $47,456 $62,990 $82,241 $101,539 $114,073 $125,829 $138,411 $150,868 $162,938 $174,344Operating expensesSG&A $16,650 $20,781 $25,522 $31,261 $38,138 $44,850 $50,376 $55,696 $60,597 $65,396 $70,000 $74,312Other operating expenses $9,408 $12,692 $13,500 $16,572 $20,217 $23,776 $26,705 $29,525 $32,123 $34,667 $37,108 $39,394Total operating expenses $26,058 $33,473 $39,022 $47,833 $58,356 $68,626 $77,081 $85,221 $92,720 $100,064 $107,108 $113,706Operating income $178 $1,975 $8,434 $15,157 $23,885 $32,913 $36,992 $40,608 $45,691 $50,805 $55,830 $60,638

Operating Margin % 0.20% 1.77% 5.95% 8.43% 10.63% 12.20% 12.03% 11.79% 12.06% 12.31% 12.52% 12.71%Interest Expense $210 $502 $499 $598 $698 $797 $896 $995 $1,094 $1,193 $1,292 $1,391Other income (expense) ($79) ($284) ($73) ($75) ($77) ($79) ($81) ($83) ($85) ($87) ($89) ($91)Income before income taxes ($111) $1,271 $7,862 $14,484 $23,111 $32,037 $36,016 $39,530 $44,512 $49,525 $54,449 $59,155

Provision for income taxes $167 $844 $2,484 $4,577 $7,303 $10,124 $11,381 $12,491 $14,066 $15,650 $17,206 $18,693Other income $37 ($34) ($47) ($48) ($49) ($51) ($52) ($53) ($55) ($56) ($57) ($59)Net income from continuing ope ($241) $394 $5,377 $9,907 $15,808 $21,914 $24,635 $27,039 $30,446 $33,875 $37,243 $40,462Net income ($241) $394 $615 $675 $735 $796 $856 $916 $976 $1,036 $1,097 $1,157Earnings Per Share -$0.51 $0.84 $1.31 $1.44 $1.57 $1.70 $1.83 $1.95 $2.08 $2.21 $2.34 $2.47Operating Income $178 $1,975 $8,434 $15,157 $23,885 $32,913 $36,992 $40,608 $45,691 $50,805 $55,830 $60,638Tax $167 $844 $2,484 $4,577 $7,303 $10,124 $11,381 $12,491 $14,066 $15,650 $17,206 $18,693NOPAT $11 $1,131 $5,949 $10,580 $16,582 $22,789 $25,611 $28,116 $31,625 $35,155 $38,624 $41,945Depreciation & amortization (+) $4,746 $7,091 $8,047 $9,507 $10,968 $12,428 $13,888 $15,348 $16,809 $18,269 $19,729 21189.48CAPEX (-) $4,893 $5,310 $6,163 $7,153 $8,301 $9,634 $11,182 $12,977 $15,062 $17,481 $20,288 $23,546Free Cash Flow $1,949 $6,396 $7,834 $12,935 $19,249 $25,582 $28,318 $30,487 $33,372 $35,943 $38,065 $39,588

23

[Operating Expenses]: Amazon’s management team has noted a commitment to growing

operating margins considerably over the next several years, and we project operating margins to

improve significantly through 2018 before stabilizing at roughly 12% after 2020.

[Capital Expenditures]: We expect capital expenditures will be roughly 4.5% of sale in 2016

and grow at just under the rate of sales through 2019 due to accelerating revenue expansion.

Capital expenditure growth, as a percentage of sales trends back towards the historical rate of 5%

as time progresses.

2. Cost of Capital (WACC)

Cost of Capital figures were produced using a risk free rate of 2.16% based on the 10-year

treasury yield. The market risk premium of 7.57% was calculated based on the 30 year historical

returns of the S&P 500 minus the 10-year historical risk-free rate. This produced a weighted

average cost of capital (WACC) of 11.90%.

Equity Weight 96.12%Risk-Free Rate 2.16%Market Risk Premium 7.57% Cost of CapitalBeta 1.34 Price $659.37Cost of Equity 12.30% Total Value $321,568,687,500

Equity $309,079,687,500.00Weight of Debt 3.88% Debt $12,489,000,000Interest Expense (TTM) $418,000,000 WACC 11.90%Tax Rate 41.00%Cost of Debt 3.35%

24

3. Discounted Cash Flow Scenarios

The following table summarizes the free cash flow, cost of capital, and terminal growth rate

assumptions for the base, low growth, and high growth scenarios.

a. Base Scenario

[Base-Scenario Assumptions]: The Base scenario is calculated using figures forecasted in the

income and cash flow statement’s above. This produces a FCF CAGR of 17.59% over the

period, which is still well above Amazon’s historical FCF growth rate.

Initial Cash Flow (FCF): $15,379,000,000Terminal Growth Rate: 4.0% Discount Rate: 11.90%Shares Outstanding: 468,750,000





AMZN Discount Cash Flow--Base

25

b. Low Growth Scenario

[Low-Growth Scenario Assumptions]: The low-growth scenario is based on the assumption that

Amazon will continue to outpace e-commerce trends in 2016 and 2017, but that growth will slow

considerably after this point as increased competition pressures sales growth. This produces a

FCF CAGR of 11.78% over the period, which is roughly in-line with Amazon’s 10-year

historical growth rate.






AMZN Discount Cash Flow--Low Growth

26

c. High-Growth Scenario

[High-Growth Scenario Assumptions]: Under this scenario, Amazon’s revenue growth is

assumed to accelerate at nearly double the pace of e-commerce through 2023 before slowing

slightly. This also leads to an acceleration of improvements in operating margin through 2019.

This produces a FCF CAGR of 21.72% over the period, which is nearly double the historical

growth rate.






AMZN Discount Cash Flow--High Growth

27

4. Terminal Growth Rate

We believe that nearly even domestic/international sales mix and the expectation that the

majority of sales will be sourced internationally after 2025. This makes the 50-year global GDP

growth rate of 2% a reasonable baseline for a terminal rate, though we felt it should be modified

to account for management’s strategic vision. We afforded Amazon the benefit of a higher

terminal growth rate due to management’s historical focus on rolling out new, disruptive

technologies and the ability to find synergy across product/service lines. The terminal growth

rate of 4% was used, accordingly.

28

C. Investment Strategy

Covered Call and Straddle Strategy

The covered call and straddle strategies described in the previous sections are based on the

assumption that implied volatility (IV) will decrease by roughly 35% after the subsequent

earnings event. The Profit/Loss charts below exhibit the strategy with option prices as of the

market close of 11/6/15. Under this strategy, a 2% move on earnings would product a break-

even result without the use of the covered call strategy..

Figure: P/L and Option Chain sourced from Fidelity Active Trader Pro as of 4pm EST 11/6/15

29

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amazon.com began as an online book ... - the economist2015, producing a market capitalization of...

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