Will Amazon Grow Up to Be Wal-Mart?

Wal-Mart (WMT) got its start almost 50 years ago with its first store in Rogers, Arkansas (1962). Since then, the company has expanded to create a global franchise generating more than $400 billion in revenues with a market capitalization valued at about $190 billion. Amazon.com Inc. (AMZN) is a relative toddler (founded in 1995 by CEO Jeff Bezos) generating about $20 billion in revenue with a market cap about 1/5^th that of Wal-Mart.

Mr. Bezos graduated summa cum laude, Phi Beta Kappa in electrical engineering and computer science from Princeton University in 1986, and we know he has no problem in thinking big. The evidence can be found in his space travel company, Blue Origin, which is expected to initiate human travel in the upcoming years. Beyond space, Mr. Bezos is presented with a multitude of growth opportunities that have the potential of elevating Amazon from a young toddler into a mature adult like its cousin Wal-Mart.

So how does Mr. Bezos get the company through puberty to adulthood? Well actually, all I believe it will take is just more of the same. The company has created an incredible franchise with huge barriers to entry, if you consider the billions spent on the technology, infrastructure, and its distribution dominance as compared to its e-commerce brethren. Bolting on new categories (whether its jewelry, sporting goods, groceries, private label or digital downloads) can be extremely profitable since unlike Wal-Mart, Amazon doesn’t need to build or reconfigure thousands of stores to expand into new categories.

For example, Wal-Mart has opened over 600 Sam’s stores nationally in order to target the wholesale club market. Once a new category is added, the blue-print is rolled out nationally and then eventually internationally. And just like Wal-Mart, as economies of scale are achieved, the cost savings are rolled back into lower prices, which then brings more customers, and even more scale advantages. This virtuous cycle then creates deeper and deeper moats separating itself from competitors.

GROWTH OPPORTUNITIES

Besides just the natural expansion of users purchasing more online and Amazon adding to existing categories, here are some other fertile areas for future growth:

• Amazon Prime (Free shipping membership is driving incremental revenue and usage).
• Kindle (This digital reader is already estimated to account for 35% of Amazon’s book sales and some analysts see $2 billion in Kindle revenues by 2012).
• Zappos.com (This acquisition provides instant dominance in shoes and adjacent product lines).
• International Expansion (Joyco.com acquisition in China is an example of how Amazon is expanding into emerging markets).
• New Categories (There are virtually limitless potential categories, but the migration to digital will be key).
• Cloud Computing, Storage & Other Services (EC2 cloud computing, S3 storage, and other outsourced technology services offer promising opportunities)

TREND IS AMAZON’S FRIEND

Source: U.S. Department of Commerce

E-Commerce sales account for only about 3.6% of total retail sales ($32.4 billion in Q2’09), but as you can see from the chart, the upward sloping trend is the friend of Amazon. With the proliferation of broadband and the natural aging of our next generation of computer-savvy internet users, not only is the number of online shoppers increasing, but the amount of time spent online is escalating as well. If you consider catalog sales (e.g. Land’s End, L.L. Bean, Eddie Bauer, etc.) have represented about 7-8% of total retail sales, there is a lot of head-room left for online sales to catch-up or replace these sales. Mr. Bezos believes online industry sales can ultimately reach 15% of total retail sales (double catalog sales). Top-rate online franchises like Amazon will be natural beneficiaries of these trends and funnel shoppers through their internet aisles, as a function of these demographic and behavioral tailwinds.

CAPITAL ADVANTAGE

Even when you account for the significantly higher revenue growth rates and growth initiatives (e.g., Kindle, E3, digital, etc) for Amazon relative to Wal-Mart, the capital intensity (as measured by CAPEX/Sales) is still about 70% higher for Wal-Mart as compared to Amazon. For one thing, Amazon does not need to support the some 8,100 stores in 15 countries that Wal-Mart is saddled with, and in turn Amazon can redeploy that capital into areas such as new products, services, and lower delivery costs. Surviving the dot-com bubble bursting, along with paying down billions of debt has afforded Amazon even more capital flexibility.

VALUATION

Valuation can be tricky, especially when you’re talking about a high growth company like Amazon. The exercise becomes a little easier once you realize Amazon is generating about $1.5 billion in free cash flow per year, with $4.3 billion in cash/investments on the balance sheet with virtually no debt in the middle of one of the worst recessions in a generation. At roughly $90 per share, AMZN is trading at over 53x’s Wall Street analysts’ projected earnings of $1.68 for 2009.

Jeff Bezos and the rest of the management make it very clear the company is managing their business to one key goal – maximize free cash flow per share (music to my ears – see my article on cash flow). On that basis, AMZN trades at about 25x’s trailing free cash flow and closer to 22x’s if you strip out the $4 billion+ in cash on the balance sheet. If AMZN can grow 15% for the next 5 years (not a given), the valuations just mentioned above could be chopped in half, if price levels and share count remained constant.

With the large run-up in 2009, I have locked in some gains this year, but tactically I will be doing what “Deep Throat” advised in the movie All the President’s Men, and that is to follow the money (cash). If Bezos and Amazon can continue on its current growth trajectory in the coming years, this toddler will mature into a company more closely resembling its cousin Wal-Mart.

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management and client accounts do have direct long positions in AMZN and WMT at the time article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Comments

[rrtzmd:]

...I agree...it seems like Bezos and Amazon just keep making all the right moves...the recently announced "frustration free packaging program" is just another example...I don't think anyone yet quite appreciates the revenue generating potential of such a program...

Oct 05 08:27 AM

[Jeff B.:]

I hope that Amazon never "becomes Wal-Mart". First, the two retailers have totally different approaches to business. Wal-Mart is all about getting the cheapest possible consumer goods to people in the lower & middle socioeconomic spectrum -- with the expected BIG product quality problems. Just try to buy anything in Wal-Mart that isn't made in China. They want minimal customer touch. It's all about pushing lots of cheap stuff out the door as fast as possible, and maybe you'll stop on the way out for some lousy fast food. Amazon is ALL about the customer exsperience, and always has been. Find me a seminar on eTailing that doesn't use Aamzon as THE benchmark for user experience. Their recommendation engine is the best in the business (far better than Netflix, for example), and it's easy to return something, check customer reviews, etc. Also, it's prett easy to imagine that Aamzon's typical customer probably makes twice as much or more in a year than Wal-Mart's. I hope to God that AMZN never becomes Wal-Mart.

Oct 05 10:13 AM

[2contango:]

One big caveat is that Amazon's main competitive advantage is no sales tax.

Cash-starved states will eventually find a way to capture the sales taxes they are losing to online transactions. And when they do, look out below.

Oct 05 10:59 AM

[borisb:]

2contango, Amazon's main competitive advantage isn't sales tax. The company has
spent $billions since 1995 to develope the franchise.

Amazon has grown the electronics and general merchandise category >30% per year and it will
be interesting to see how this does in the next few years. The breakout depends on this. Kindle/Kindle Store are small revenue contributors but the gross profit opportunity might be seriously better if the e-reader holds on to some of the first-ish mover advange.

Oct 05 12:48 PM

[poortorich:]

It is easier for walmart to replicate what amazon is doing rather than the other way around. In fact, that is what walmart is trying to do right now. However, i cannot imagine amazon trying to set up a retail store.

Oct 05 01:31 PM

[2contango:]

borisb: Amazon is a strong retailer, but the bottom line is that it is about the same as other big retailers like Walmart and Best Buy when it comes to efficiency and customer service.

What differentiates Amazon is that the total cost to its consumers is often cheaper than its rivals because it doesn't charge sales tax. Once Amazon loses that differentiation, then it has to stand on the strength of its brand.

The brand is strong, but online customers are notoriously fickle, shifting loyalties as retailers race to the bottom. Amazon might succeed where others have failed. But the risk of holding Amazon will increase.

Oct 05 02:53 PM

[rrtzmd:]

...wrong...I live in a Kentucky and have to pay sales tax on all my Amazon purchases...I live only a couple of miles from Walmart but shop there only occasionally...Amazon gets practically all of my shopping dollars...in the comfort of my home, I shop when I want...Amazon provides a wide selection and easy comparison of products...I get other purchasers reviews...I get links to competing dealers...if I chose to buy from Amazon, I usually get two day delivery free of charge...and, so far, Amazon's customer service has been great...the point is that Amazon does everything I want, quickly, simply and at reasonable prices...and so far no one else has given me any reason to shop elsewhere...


On Oct 05 02:53 PM 2contango wrote:

> borisb: Amazon is a strong retailer, but the bottom line is that
> it is about the same as other big retailers like Walmart and Best
> Buy when it comes to efficiency and customer service.
>
> What differentiates Amazon is that the total cost to its consumers
> is often cheaper than its rivals because it doesn't charge sales
> tax. Once Amazon loses that differentiation, then it has to stand
> on the strength of its brand.
>
> The brand is strong, but online customers are notoriously fickle,
> shifting loyalties as retailers race to the bottom. Amazon might
> succeed where others have failed. But the risk of holding Amazon
> will increase.

Oct 05 04:40 PM

[iggyDalrymple:]

<JeffB wrote, " Amazon is ALL about the customer exsperience">

I deal with both Amazon and WalMart for the same reason...to buy stuff, not for the experience.


<"I hope to God that AMZN never becomes Wal-Mart.">

I doubt God is very concerned about that.

Iggy

Oct 05 08:56 PM

[Snitzer:]

If Amazon gets the Kindle down to a sensible price (sub 100) then I can see the stampeding hordes headed thataway, and I'm doing my best to hold out until they do. The Kindle yearning is strong, but the yankee skinflint is strong within me, even after living in the South all these years. The only problem I've ever had with Amazon is they will bump up the price of items left in the shopping cart for a day or two. If course, the fix is to empty the cart, and it won't be long before the prices are back to where they were before.

Oct 05 09:51 PM