Wal-Mart Vs. Amazon: Which Should You Buy?

Toiling in the shadows of Google (Nasdaq: GOOG), Apple (Nasdaq: AAPL) and many other tech stars in California’s Silicon Valley, a team of 1,500 technologists are hard at work on behalf of an unlikely employer: Wal-Mart (NYSE: WMT).

#-ad_banner-#The retail giant has belatedly understood that simply having website for e-commerce won’t cut it in the era of social media and mobile surfing. In response, the company is now committing serious resources to its digital efforts.

Will those 1,500 Wal-Mart staffers help turn the company into a leading-edge tech firm? Probably not. But they can identify hundreds of small ways to improve the online shopping experience. After all, consumers now carry the Internet in their pocket, thanks to the proliferation of smartphones.

As Gibu Thomas, Wal-Mart’s senior vice president of mobile and digital, recently told The Atlantic magazine, “IBM published some data about what retail traffic comes from mobile devices, as a kind of benchmark, and Wal-Mart’s numbers are a lot higher than the industry norm.” He adding that with the use of technology, “we can combine the breadth of online and the immediacy of offline to create an experience that means we can be a one-stop shop for you.”

   
  Flickr/JeepersMedia  
  As more shoppers start to use the Wal-Mart’s technology both online and offline through the expanding capabilities of its apps, the distinction between these two firms starts to blur.  

To be sure, nobody has married technology and retail as well as Amazon.com (Nasdaq: AMZN), which should cross the $100 billion sales threshold next year.  Not bad for a company that didn’t even have $10 billion in sales back in 2005. While Amazon’s annual revenue growth has never slipped below 20%, Wal-Mart’s sales grew just 1.6% last year (to $476 billion). The sharp line between online and offline retail can be summed up with these two companies’ divergent growth rates.

Yet Wal-Mart’s belated embrace of technology signals a desire to encroach on Amazon’s turf. As more shoppers start to use the company’s technology both online (at Walmart.com) and offline through the expanding capabilities of its apps, the distinction between these two firms starts to blur. After all, at maturity — and Amazon will one day be mature — both of these firms will have to contend with the same rules of retailing, from inventory and distribution management to pricing strategies that rely on wafer-thin margins.

With that in mind, let’s take a look at the financial performance of each of these firms in 2013 and the current market valuation assigned to those results.

Wal-Mart carries an enterprise value that is roughly 75% higher, even though its sales base is more than 400% larger. These firms generate similar gross margins, despite Amazon’s vaunted efficiency. And though Amazon’s lack of a retail footprint should translate into much better operating margins, the reverse is actually true. (To be fair, Amazon is willingly losing money on various new initiatives such as media streaming, and its core operating profit margin is likely at least as high as Wal-Mart’s.)

You might notice that this analysis ignores the fact that Amazon is poised to grow at a very fast pace, with plans to eventually “make it up on volume.” Will 20% revenue growth in 2014 and again in 2015 push Amazon’s margins up to respectable levels? Merrill Lynch analyst Justin Post thinks “the Street is applying a ~7-8% margin potential to 2015 revenue, which would result in ~$11.50 in 2015 EPS, and a 32x 2015 P/E.” Post actually sees operating margins reaching just 4% in 2015, with EPS of around $6.

Analysts at Goldman Sachs have recently developed earnings forecasts for 2016 for both of these firms, so we can do an apples-to-apples comparison on that year’s results.

Note that Wal-Mart has hit a ceiling in terms of margin expansion, and those metrics won’t likely be any better in 2016 than they were in 2013. And by 2016, analysts broadly assume that Amazon’s gross margins will finally move above 30% as the company looks to reap efficiency gains.

Amazon is likely to grow at a better pace in 2017 and 2018 than Wal-Mart, but by then, the days of 20% top-line growth will likely have passed, unless Amazon enters some massive new niche such as broadband access or wireless phone service. Simply based on the core business of e-tailing hard goods, there are limits to Amazon’s potential size.

At the start of 2014, few have questioned what Amazon will look like at maturity. CEO Jeff Bezos continues to launch new initiatives that forsake near-term profits for long-term growth, leading analysts and investors to once again take it on faith that the company will one day be a profit powerhouse.

Yet a look at the rest of 2014 shows a looming hurdle. Amazon is expected to earn around $0.45 a share in the first six months of 2013, but a more robust $1.45 a share in the last six months of the year. In other words, analysts are expecting an imminent inflection point, which sets the stage for 120% EPS growth next year and perhaps another 100% jump in 2016.

How will investors respond if Amazon yet again explains that near-term profits will need to be sacrificed for the sake of market share? Though this stock is up more than 450% over the past five years, the path to further gains is likely to become very challenging as the company learns how to generate real profit margins.

Risks to Consider: As an upside risk, Amazon may make several bold splashes into new segments this year that keep investors focused on the future and not on the present.  

Action to Take –> This isn’t an argument to buy shares of Wal-Mart. The retailer, despite its technology forays, will be hard-pressed to grow at a fast pace. Its prodigious free cash flow production does mean that it is a great long-term holding. But the stark disparity in these two firms’ valuations, based on 2016 forecasts, highlights that shares of Amazon embed a great deal of risk. Shares endured a growth scare in late January, and we may see more of those over the rest of 2014.

P.S. StreetAuthority’s research team recently named Amazon one of its Top 10 blue-chip stocks. You can get this report absolutely free, just by signing up for our premium advisory Top 10 Stocks. You’ll also receive our exclusive report on the absolute best stocks on the market to own in 2014. This annual list of stocks has beaten the market time and time again, including individual returns of more than 900%. To learn more, click here.