Using DuPont Analysis: Is Amazon Really That Great?

Feb.10.12 | About:, Inc. (AMZN)

Until the internet boom, retailing was an asset intensive business relying upon bricks-and-mortar stores. However, the rise of (NASDAQ:AMZN) changed that, as it leveraged the internet and economies of scale with a new approach to retailing. However, in an ironic twist, there are rumors that AMZN will begin experimenting with bricks-and-mortar stores.

AMZN's financials are driven by its core retailing business. With its potential foray into retail stores, AMZN will have something in kind with the ubiquitous Wal-Mart, Inc. (WMT) and its substantially smaller, but trendier, counterpart, Target Corp. (TGT). This article will compare AMZN to WMT and TGT.

Select Retailers

Ticker Name Market Capitalization ($B) Enterprise Value ($B) Forward P/E
AMZN, Inc. 84.2 76.4 68.8
WMT Wal-Mart Inc. 212.2 263.3 12.6
TGT Target Corp. 35.4 53.5 12.3
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Source: Yahoo!Finance

DuPont Analysis is one way to dig a little further into the companies to see what similarities (or differences) there might be. DuPont Analysis is a view of breaking down Return on Equity (ROE) into factors that can be further analyzed. These factors are commonly a profitability measure, a turnover measure, and a leverage measure. DuPont Analysis was created by E.I. du Pont de Nemours and Company (NYSE:DD) in the 1920s. For this analysis, I looked at a five-factor analysis:

DuPont Analysis

DuPont Analysis Factors Factor Calculation
Asset Turnover Revenue/ Average Assets
Profitability EBIT / Revenue
Interest Burden (EBIT - Interest Expense)/EBIT
Tax Efficiency* 1 - "Tax Expense"/(EBIT - Interest Expense)
Leverage Average Assets/Average Equity
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*For simplification, I've included minority interest in tax expense and ignored the impact of some minor discontinued operations.

More simplified versions of the DuPont Analysis will treat the middle three factors as a single profitability factor that looks at Net Income to Revenue. However, companies have become more focused on tax reporting, and this increases the overall complexity. While leverage is calculated in the Asset to Equity ratio, the cost of the leverage is lost in the profitability margin. Possibly, one company has obtained lower cost debt than another, and that financial engineering is different from how it runs its day-to-day operations. It should also be noted that the values for tax expense are book accounting values, and not the same as the ones reported to the IRS, which are tax accounting values.

The first step of completing the analysis is to pull some basic quarterly financial data for the companies as listed below. One slight difference is that AMZN reports on calendar year quarters, while WMT and TGT use a slight offset with their financial year ending in January. All figures are in $ billion:

AMZN Financial Data ($B)

Financial metric Quarter ending March 2011 Quarter ending June 2011 Quarter ending Sep 2011
Revenue 9.9 9.9 10.9
EBIT 0.3 0.2 0.1
Interest Expense 0.0 0.0 0.0
Tax Expense 0.1 0.0 0.1
Net Income 0.2 0.2 0.1
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Source: Yahoo!Finance. Note some values appear to be 0 or small due to rounding. Actual calculations use numbers before rounding.

WMT Financial Data ($B)

Financial metric Quarter ending April 2011 Quarter ending July 2011 Quarter ending Oct 2011
Revenue 104.2 109.4 110.2
EBIT 5.9 6.4 5.9
Interest Expense 0.6 0.6 0.6
Tax Expense 2.0 2.0 2.0
Net Income 3.4 3.8 3.3
Assets 186.1 193.7 195.0
Equity 65.0 67.9 67.2
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Source: Yahoo!Finance

TGT Financial Data ($B)

Financial metric Quarter ending April 2011 Quarter ending July 2011 Quarter ending Oct 2011
Revenue 15.9 16.2 16.4
EBIT 1.2 1.3 1.1
Interest Expense 0.2 0.2 0.2
Tax Expense 0.4 0.4 0.3
Net Income 0.7 0.7 0.6
Assets 43.0 45.5 48.4
Equity 15.2 15.1 15.3
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Source: Yahoo!Finance

The next step is to use the basic financial data and calculate the ROE decomposition for each company. I looked at the "pre-holiday" quarter for all three companies for comparison.

DuPont Comparisons "Q3" 2011

DuPont Analysis Factors Factor AMZN TGT WMT
Asset Turnover 0.59x 0.35x 0.57x
Profitability 1.4% 6.5% 5.4%
Interest Burden 0.88 0.81 0.90
Tax Efficiency 0.48 0.65 0.62
Leverage 2.38x 3.09x 2.88x
ROE (quarterly) 0.8% 3.7% 4.9%
ROE (annualized) 3.2% 14.6% 19.8%
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Source: Author calculation - Q3 is the quarter ending Oct for WMT and TGT and Sep for AMZN.

The first observation is that AMZN is not really that impressive. It has a similar turnover to WMT, and both are better than TGT; it trails both in terms of profitability. AMZN does have lower overall leverage than either company. Furthermore, AMZN does not appear to be that tax efficient; however, this is book accounting and not tax accounting, so I would discount that consideration. However, there are a couple key differences. AMZN and TGT also sell groceries and many every day items that smooth out their quarterly results. Despite recent disappointment, AMZN does much more revenue in the holiday quarter, which should help improve its overall performance. The next key distinction is that AMZN has a very different asset structure from TGT and WMT. AMZN has almost $10 billion of cash and short-term investments on its balance sheet, which represents approximately 40% of its total assets. These differences show that while DuPont Analysis might be a starting point, there are additional considerations. The one consistency is that ROEs declined from the second quarter to the third quarter for all companies, largely due to a decline in EBIT margins.

I had hoped to see the DuPont analysis show AMZN with higher profits, ROE and asset turnover than its competitors. To me, this suggests that AMZN does not deserve its rich valuation, since it is not better than its competitors. However, it would be important to more carefully examine the issues that I raised. DuPont analysis was developed a long time ago when companies were bricks-and-mortar, heavy industry led the way, and the computer had not even been invented. Enormous technological change has taken place since then, and impacts the operations of companies and how they should be valued.

Furthermore, DuPont analysis is more around company operations than valuation, which is critical for an investor looking to buy or sell a company. When this article refers to equity, it is book equity and not market value equity. Leverage also refers to a comparison of book assets to book equity, which is very different from comparing enterprise values to equity market values.

As for WMT and TGT, which are more closely aligned and have very similar forward P/Es, I would have to pick WMT based on this analysis. It offers a superior ROE driven by its asset turnover ratio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.