Why I Hold Wal-Mart and Sold Amazon

Includes: AMZN, WMT
by: Andrew Corn

It can be challenging to part with a stock that has performed so well and to hold another that has lagged all year. Yet I have sold Amazon.com (NasdaqGS: AMZN) and am holding Wal-Mart (NYSE: WMT).

Sure one stock is a Consumer Discretionary and the other a Consumer Staple so the two firms are not truly a direct comparison. Looking carefully; they are both low price retailers known for efficient back ends used to deliver products on the cheap. Yet they compete on different fields; Wal-Mart by car and Amazon by click. The world is changing as I observe these companies seeping into each other’s territories, tactics, and markets. This may accelerate direct competition.

Amazon has been the poster child for the Internet age. No bricks and mortar, no pricy real estate and consistently aiming for lower overhead in every phase of its value chain. This theoretically should allow Amazon to be the low cost and high profit provider. Its margins have always come under analyst scrutiny and continue to hold back earnings growth. Additionally, by use of the web and partnerships on the web, it can offer every product imaginable assuming it can procure it, or have it dropped shipped based on client/vendor contracts. The firm through its expansive web presence and technology has embraced cloud computing enabling other firms to use Amazon’s back end to manage their on-line presence. Now a maturing company with over 20,000 employees and massive state-of-the-art warehouses, the firm posted 2008 revenue over $19 billion. My investors benefited nicely holding the stock this year far out pacing the Consumer Discretionary Index as well as the S&P 500.

Wal-Mart is the world’s largest retailer by revenue with over two million employees and north of $400 billion in revenues. The firm is the poster child for bricks and mortar. WMT is the grizzly bear in the room and cannot be ignored. Without many acquisitions, it has grown organically in an exponential fashion. WMT’s stock is actually down year-to-date. This means the market thinks that WMT is worth materially less today, than it was worth on 12/31/08. I believe the market is wrong.

So what has changed my perspective after the spectacular run we have experienced with AMZN and the yawn-fest of WMT? It is a small announcement by WMT that could have dramatic impact.

In Amazon’s June filing, the firm announced that it obtained only 53% of its revenue from within the United States, an impressive global expansion statistic. Gaining revenue outside the US in markets potentially growing more quickly than domestically attractively positions AMZN to our investment process. With approximately 7,873 stores and only 24% of its revenue obtained outside the United States, Wal-Mart has built a strong and powerful brand in the United States, and has enormous room to grow internationally. The firm is not shy about its global expansion plans. It is grounded with its stores and now is moving on-line.

Wal-Mart dipped its toe into the world of online retailing a few years ago and has recently decided to raise its game. By adding one million SKU’s to its online offerings from other sellers as part of its online mall, Wal-Mart is directly threatening Amazon’s revenue. Similar to the structure of Amazon’s business, Wal-Mart will receive a portion of the revenue of all products sold from its website; however its partners will ship products directly and be responsible for exchanges and returns. Simply by entering the game, Wal-Mart’s presence will melt away some of the future growth and earnings potential of Amazon.

Back on September 19th the NY Times published a piece Can Amazon Be the Wal-Mart of the Web? What is missing from this article is the pricing, negotiating and sourcing power that provide WMT with what many people call an unfair advantage, and that it is applying these skill sets and its size to the web.

The online retailing space itself may be growing; however, Wal-Mart has the media, financial strength, customer touch and its own cloud to potentially take significant current share, or future market share growth away from Amazon. Wal-Mart is the big, ugly monster of retail, making and breaking suppliers and as stodgy of a firm as it is viewed by the Street, it has changed retailing forever and will continue to lead store innovation. Now WMT is serious about on-line.

Amazon is moving forward and borrowing a page from Wal-Mart’s playbook by expanding its private label business offering hundreds of private label kitchen products and outdoor furniture, and using its relationships with manufacturers to undercut prices from the competition. Additionally Amazon who is no slouch has made impressive moves like the acquisition of top niche player Zappos.com. With a battle looming, any distraction due to merger integration versus Wal-Mart going it alone can also add vulnerability.

On the other side of this trade is the attitude and publicly stated goal of WMT. According to Kerry Cooper, Wal-Mart’s chief marketing officer, “Our vision is to make Walmart.com the most visited and valued online site.” This is not good news for on-line retailers of general merchandise.

Some analyst will predict an online world big enough for the two competitors. Some straight facts: AMZN has an operating margin of 3.78% compared to 5.73% for WMT. This data point has held AMZN stock back with much debate about free shipping, revenue grabs, customer loyalty, and additional volume—which to date has not closed the profitability gap, an albatross for AMZN. Traders will look at time frames and want to ride the momentum of AMZN. As a long-term investor, WMT is poised to revert to mean performance (that of the Consumer Staple Index) which would translate to shorter term out-performance to catch up and perhaps out-perform longer-term as the firm moves on-line in a more meaningful way.

This opens up more channels to generate incremental revenue both here and abroad. The wake a firm the size of WMT creates will certainly rock many boats and capsize small ones. With an undervalued P/E of 14 compared to a P/E of 59 for AMZN, I am in the retail space, remaining long WMT.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Through various equity strategies under his supervision he is currently long WMT.