Amazon Taking the Fight to Walmart

“But while media products still account for a majority of Amazon’s sales, the company’s added dozens of new products. It’s become the online Walmart, not the online Borders… Amazingly, it is much lower than Walmart, which allows it to undercut Walmart’s prices. That’s unheard of until now. Periodically, you’ll hear Walmart slicing prices…With a retailer like Target or Walmart we can look at the number of stores they have and figure out how many more they have before they reach saturation and can’t grow anymore…” — CNBC’s Mad Money 11/23/2009

There is no doubt that Amazon’s (AMZN) stock has enjoyed an outstanding run over the last year rocketing nearly $100 from $38 to $134 in that time. The stock’s performance has led to skepticism over valuation from many analysts and investors. The company is an attractive growth candidate but with the P/E ratio of greater than 70x obviously there are concerns that it is just too hot. Even when factoring the growth of the company the PEG ratio looks pretty rich at 2.73x, so it is understandable that there is a significant portion of float that are short AMZN.

On Monday’s Mad Money, Cramer looked at the case of Amazon which he described as a misunderstood and underestimated stock. He thinks that many of the doubters conceive Amazon to be an online version of Borders (BGP) that mainly sells books, music and movies. Instead, as anyone who uses Amazon knows, it is more like an online Walmart (WMT) where the product selection is diverse and the prices are tough to match anywhere.

Amazon is not limited by the same constraints as a bricks and mortar retailer like Walmart, and they can sell to anyone, anywhere as long as they have an Internet connection. That is one reason that Cramer likes the sustainability of Amazon’s growth rate because they need not worry about saturation of actual store front. Furthermore, e-commerce has continued to boom in the last year growing 21% in the last year, or four times the pace of traditional bricks and mortar retail.

We cannot disagree with the recent success of Amazon and the stock’s climb seems justified. However, from a value investor’s standpoint we maintain our position that Walmart is more Undervalued than is Amazon. Amazon receives our neutral or Fairly Valued stance because the growth, while impressive, has largely been priced in and the upside from here may be limited. Whereas Walmart, a stock that has been range bound for years, has slowly and steadily grown in sales and cash earnings. Earnings growth for the next two years will come in at the mid to high single digits. This progression has made the stock by comparison more attractive from a fundamental perspective.

In the past, the market has been willing to pay about .68x to .87x revenue per share, whereas the market is currently only giving WMT .52x price-to-sales. Similarly, the historically normal price-to-cash earnings ratio has been 13.6x to 17.7x, but it is currently only 10.2x. This is a classic case of the tortoise and the hare; long term investors could do worse than to stick with the tortoise until the market comes around on its fundamental strength.

Amazon Taking the Fight to Walmart

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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