The World's Greatest Pairs Trade (Short Amazon, Long Walmart)

Long Walmart, Short Amazon

These two companies have some similarities, they are both major retailers and have market caps around $200 Billion. After that the vast differences between the companies emerge. One trades at a P/E of 14 and the other around 900. One is forecast to make an operating profit of $31 million in Q2 2015, the other $5.8 billion. One has a 3% dividend yield while the other has none.

Why Amazon Has Moved

Amazon is the perfect example of the current market's misunderstanding of income vs capital gains. Income is real wealth that an investor can retain and use elsewhere. Capital gains are not income. Capital gains are only realized by the marginal seller. Therefore it is not true wealth until it is sold. Although many people believe that holding their AMZN stock has made them rich; they will also believe that it caused them to be broke when it finally reverts to its true value.

AMNZ is experiencing a reflexive loop of investors watching the share price rise while misinterpreting this as income and wealth. This misinterpretation drives investors to continue to buy the stock driving the price even higher. Soros, the founder the theory of reflexivity, was heavily invested in AMZN through 2015. This further demonstrates that the move in AMZN is driven by investor emotions and not by fundamentals. The capital gains earned holding AMZN are not real wealth. I reiterate, these gains will only be earned by the marginal seller. Once Soros begins to sell, the market will take notice and the price will move away showing the impact of even his marginal selling destroys much of the "wealth" people believe they hold in AMZN stock.

Walmart

The crash in WMT stock price in October proved to be the perfect entry point for this company. I personally got long just below $58. That fall in share price was completely unjustified. The announcement of a quantified impact of the minimum pay rate to employees should have had minimal impact on the share price. The information about pay raises was public information that was available long before this announcement. Any half decent analyst should have been able to calculate something close to the cost impacts long before WMT announced the quantified number. The share price fall on that announcement was just the lemmings running off the cliff to their timely end.

Macro Drivers

Now I'm sure everyone here can project a DCF and back into the current market price by adjusting the growth and cost drivers in their model. Sadly, I believe this is what most of wall street has reverted to in fear of making bold calls that could be wrong. It is much safer for an analyst just to stick with the crowd and if they do have a view, only express it by being on the outer band of consensus estimates. But regardless of these issues, I would like to provide some ideas on adjustments to the drivers in your models based on future macro changes that could have significant impacts on your resulting valuation calculations.

$$$ USD Bull Market

I personally believe we are still in the beginning of a multi-year dollar bull market. The 9.5 TRILLION USD carry trade short in the FX markets will continue to unwind and strengthen the USD as people continue to buy to hedge their positions. This is the beauty of short gamma market covering.

But how does this benefit WMT? Margin expansion. WMT's primary costs are in terms of foreign currencies while the majority of their sales are in terms of USD. This means that their inventory will be cheaper to purchase in weaker currencies and then their sales will be relatively greater in terms of USD. The net result is higher profit margins.

Lower Oil For Longer

This recent oil boom and bust has paralleled the internet infrastructure boom and bust. In the late 90s an excessive amount of fiber optic cable was laid by highly leveraged companies. In the bust these companies where bought for pennies on the dollar and the crushing weight of the debt was gone. This allowed internet to be cheap for everyone since. I believe the same thing is happening in the energy markets. As these overly leveraged oil firms go bust and massive haircuts are experienced on the debt, you should see oil be cheap for longer. I project that the long end of the oil futures curve is going to flatten and fall off substantially.

Once again this is hugely beneficial to WMT. As one of the most efficient supply chain managers in the world, one must expect that Walmart will capitalize on this opportunity. These lower oil prices will lead to even greater margin expansion as WMT's distribution costs drastically shrink.

In conclusion, I believe that AMZN's growth expectation are very unreasonable and that share prices should reflect this as time progresses. Furthermore, I believe that these two major macro events are going to lead to huge margin expansion opportunities for WMT that AMZN will not experience.

Comments (11)

Jan 28, 2016

http://finance.yahoo.com/q?s=AMZN And the 13% drop after hours helps build my case even more. I shouldn't have taken so much time to finally post this.

When old Mr. Partridge kept saying, “Well, you know this is a bull market!” he really meant to say that the big money wasn’t in the individual fluctuations but in the main movements, not in reading the tape but in sizing up the entire market and its trend
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Best Response
Jan 28, 2016

Not that I'm long AMZN or anything, but I would argue that if you're looking at AMZN from a current earnings perspective then you're missing the point.

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Jan 28, 2016

I understand what you are saying. I'm arguing that the implied revenue growth and cost reductions people are modeling are very unrealistic.

When old Mr. Partridge kept saying, “Well, you know this is a bull market!” he really meant to say that the big money wasn’t in the individual fluctuations but in the main movements, not in reading the tape but in sizing up the entire market and its trend
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Jan 29, 2016

Is that seriously a thesis on Amazon?

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Jan 29, 2016

I agree. I probably posted this without enough fundamental information on AMZN. But here is a quick overview on some problems I see with AMZN.

To believe the current market price you must assume that Amazon is going to grow revenues annually at a rate of 20% while also doubling EBITDA margins by 2025. This seems highly unlikely from a company that has consistently reinvested profits heavily without much concern for margin expansion. I would expect a 20 year old company to be further developed in its life cycle with a focus on stable and sustainable profits. I don't see this trend changing anytime soon.

Currently AMZN is funding its growth through operating leases, capital leases and debt. These figures have increased by 70% since 2010. This is a faster rate of growth than even their revenues. This is totally unsustainable.

Finally I believe that their 16% market share in eCommerce is going to be diminished through competition from other players, specifically Walmart with their increased investment in this space.

When old Mr. Partridge kept saying, “Well, you know this is a bull market!” he really meant to say that the big money wasn’t in the individual fluctuations but in the main movements, not in reading the tape but in sizing up the entire market and its trend
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Mar 19, 2016

You should do some research on AWS.

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Jul 11, 2017

Interesting to look back on this post. Walmart up 15% since early 2016...Amazon up 68%...whoops.

I think it's a mistake to try and be a hero and bet on brick and mortar long term over e-commerce. Short term, sure, but I sure as hell hope the OP covered his shorts!

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Aug 2, 2017

@WallStreetOasis.com
When you size based on volatility, this trade is actually in the money. Even more so when you take into account dividends.

Also it looks like you cherry-picked your starting dates without matching entries for both to make your percents vary so much. Real results are nothing like that. I actually got in this trade at the very start of Nov 2015. So as of that date, with your assumption of equal weighted positions, I'd have lost 55% on the AMZN short and made 42% plus dividends on the WMT long. However, when you take account for the fact that AMZN had a long term implied volatility 50% greater than WMT and weight the positions accordingly, this trade is very far in the money.

I'm not being a hero and this isn't just a short term trade. (Although it could be traded around in a similar fashion to a XLP/XLY pairs trade)

I think this could be one of the best trades in the world to put on and leave for ten years without looking at. (assuming you size to handle the volatility)

A long term equity investment is about CASH FLOW to shareholders. It is not about the number of users or the amount of clicks it gets or the widespread impacts it has on daily life. None of those compensate you for your equity investment.

Keep holding onto your Webvan and Pets.com stock. I'm sure they'll come back.

When old Mr. Partridge kept saying, “Well, you know this is a bull market!” he really meant to say that the big money wasn’t in the individual fluctuations but in the main movements, not in reading the tape but in sizing up the entire market and its trend
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Aug 2, 2017

AMZN's last move into grocery.

Webvan

When old Mr. Partridge kept saying, “Well, you know this is a bull market!” he really meant to say that the big money wasn’t in the individual fluctuations but in the main movements, not in reading the tape but in sizing up the entire market and its trend
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Aug 3, 2017
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