On July 31, with Amazon.com (AMZN) having closed at $1,020, Seeking Alpha published my article suggesting that AMZN might be about to crash. The title was Amazon’s Stock Looks Headed For A Waterfall. Since then, the stock has done little but drop.
The main bearish thesis, which I listed as something that short sellers might wish to consider (I’m a long-only investor), was that the company was now missing EPS estimates so badly that, in the face of what I expected would actually be good results from conventional retailers, investors might soon be revaluing AMZN to more normal levels, which could lead to much lower stock prices over time. The article mentioned that AMZN’s pending acquisition of Whole Foods (WFM) at a 30X or greater P/E put a valuation challenge on AMZN. Doesn’t this, and AMZN’s expanding chain of bookstores, suggest that e-commerce can only take AMZN “so far” and no farther? So, why the exalted P/E?
That article was written after AMZN reported its Q2 results.
Now that the retailers that are on a July quarter have weighed in, with enough sales data from Costco (COST), which is on an August quarter to also be able to discuss it, this article makes the case that this new information may show that AMZN stock has more downside risk than upside potential, and that it could be in the process of being valued more normally.
Note, I’m leaving Amazon Web Services (AWS) out of the discussion for now. Value it how you will. I’ll comment on why I cannot value it later in the article. Investors who are bullish enough to own AMZN because of AWS are of course entitled to do that, but for me, that’s a “tail wags dog” story.
Within retail aside from AMZN, there is a huge bifurcation. Some chains have failed, meaning they are restructuring debt and closing a number of stores. Other chains such as Macy’s (M) are profitable but also closing stores and in general struggling to find their way in an omni-channel world of retailing.
However, the evolving data show that the strong retailers are, if anything, outperforming AMZN from either a P&L standpoint and or in e-commerce growth and innovation, and that AMZN may therefore be in the process of going from hunter to hunted.
I’ll discuss several names to show how they are making their way forward in the current retail landscape.
The Big Dog of global retailers commented just a bit on e-commerce in its presentation accompanying Q2 results. On p. 9, it commented that:
Multi-channel sales growth was strong, including online grocery and general merchandise pickup in stores.
Gross margin rate declined 5 basis points as savings from procuring merchandise benefited the margin rate, but were more than offset by the mix effects from our growing e-commerce business, as well as continued investments in price.
Operating expenses increased 3.9%, primarily due to investments in e-commerce and technology.
WMT is focusing heavily on e-commerce and is using its formidable computer-based sourcing and logistics skills to increase its product range and try to leapfrog AMZN in an omni-channel world where order online, deliver to home is expected to shrink as a percentage of total sales initiated online.
Supporting that thesis are just a few of the comments that the CEO and CFO made in what WMT calls its management call, as recorded (no questions taken). First, from the CEO:
In e-commerce, customers are responding favorably to our expanded assortment, which surpassed 67 million SKUs on Walmart.com…
We believe that we’re uniquely positioned to grow and delight customers by providing the seamless shopping experience they desire. Having stores within 10 miles of approximately 90 percent of the U.S. population allows us to serve customers in ways that are most convenient for them. We’ve seen strong results from the rollout of online grocery, which is now in more than 900 U.S. locations, and we’re expanding this service in many of our markets around the world.
Retail is constantly evolving and it’s critical that we move even faster as the customer and competitive landscape continue to change.
All of that represents carefully-chosen summary words; note that before this quote, he presents a number of details about WMT’s e-commerce efforts.
Two points from this quote may be specially worth noting. One is that WMT may be thinking of the AMZN-WFM deal in specifying how WMT’s online grocery business is showing “strong results” and is already in more than twice as many stores as WFM has; with expansion of this initiative occurring globally.
The second point is what the CEO ended with: “it’s critical that we move even faster…” In other words, they are doubling down, as it were, on the competition with AMZN.
Some key details were mentioned later in the same document from Brett Biggs, EVP and CFO of Wal-Mart Stores:
Let’s now move on to eCommerce. As a reminder, eCommerce results include all web-initiated transactions including those through Walmart.com such as ship-to-home, ship-to-store, pick up today and online grocery, as well as transactions through Jet.com and the other sites in our family of brands.
Walmart U.S. eCommerce again performed very well on the topline as GMV [gross merchandise volume] grew 67 percent and sales increased 60 percent, including acquisitions. The majority of this growth was organic through Walmart.com, including Online Grocery, which is growing quickly [just in case you missed the CEO saying the same thing!]. We’re delivering growth through an improved customer value proposition that includes free two-day shipping on millions of items and Easy Reorder, as well as an expanded assortment, now with more than 67 million SKUs – an increase of more than 30 percent from the first quarter. With Easy Reorder, we’re integrating both in-store and online purchases to provide customers with a single spot to view and repurchase the items they buy most frequently.
All these initiatives and all this e-commerce growth at WMT, which was already a large e-commerce player, are going to have, in my view, to have a direct adverse effect on AMZN’s growth and profit margins. Perhaps this will lead to a change in Mr. Market’s perception of downside risk to the growth story at AMZN.
Before moving on, much of what trends in the stock market is driven by news flow, and AMZN may be losing some, perhaps much, of its massive dominance. Witness this Bloomberg News article that I noticed as I was preparing this article:
Wal-Mart Stores Inc. has brought its online grocery delivery service to two more cities, extending a program that could attract new customers as it battles Amazon.com Inc. and brick-and-mortar rivals.
The world’s biggest retailer is expanding the service to Orlando and Dallas in a partnership with Uber Technologies Inc., whose drivers will make the home deliveries. The service already exists in Denver, San Jose, Phoenix and Tampa.
The move is the latest step in Wal-Mart’s broader e-commerce push, which includes curbside grocery pickup in more than 900 locations and two-day free shipping on millions of items. It also comes just a week after German discounter Aldi unveiled grocery home delivery in Dallas and two other U.S. cities…
Not long ago, a headline about retail may well instead have been one reinforcing the idea that AMZN was the innovator. Suddenly, it’s WMT (and in the body of the article, Aldi), and WMT is doing this well before AMZN even owns WFM.
This may show that mindshare is shifting from AMZN to incumbents.
On Target (TGT)
I covered this just last week, in Target Reports Q2: Updating My Bullish Comments From Last Month (and in the prior month’s TGT article). So, there’s not a lot to say that was not said in that piece. From a much smaller sales base than WMT, the TGT news was also good regarding e-commerce. Reporting on a point TGT emphasized, last week’s TGT article said this:
While the absolute numbers remain smallish, a 32% gain on top of a 16% yoy gain in Q2 last year means over a 50% jump in e-commerce sales in two years.
This looks like pretty good progress. Neither WMT nor TGT is lying down before the AMZN juggernaut; rather, they are fighting back and trying to play to their strengths of their large store bases.
I actually liked the TGT story so much relative to its P/E that I took profits on WMT (which were small but positive) and moved the capital to TGT. The main reason is that TGT has an interesting remodel of its stores ongoing and perhaps being improved upon, beginning soon. Its e-commerce progress was another reason to hope for better times at this name.
TGT grew e-commerce sales yoy faster in Q2 than AMZN did.
This is worth mentioning here because COST is booming with regard to monthly yoy total and same store sales. It is not focusing on e-commerce. Yet its yoy sales are tracking up high single digits, with very strong same store comps.
COST has taken what in my very humble opinion is an intelligent view of e-commerce. First, it wants people in its stores, for the “treasure hunt” aspect of shopping. Second, it wants to keep its investment in e-commerce simple. Thus, it wants to focus on low-hanging digital fruit and not compete with AMZN and WMT in offering massive numbers of SKUs, most of which are small sellers.
COST provides an example of a thriving store-based retailer despite the heavy investments in, and growth of, online product purchasing. I like COST shares based on relative value to the high P/E of the S&P 500 (SPY), though on an absolute P/E, or P/E to growth, ratio, it is probably just ‘meh.’ But we live in a relative value world, do we not?
Home Depot (HD)
This large company is doing about 6% of its sales via e-commerce, much of which involves buy online, purchase in the store. More important, HD provides an example of a company that is much larger than WFM, and that is years ahead of the AMZN-WFM combination in meeting the needs of customers with integrated online/store solutions.
When thinking of the next marginal buyer looking at customer-facing stores, i.e. retail, who actually wants some value as well as growth potential, HD, at roughly a 5% forward earnings yield, may offer stiff competition to AMZN, which offers an unpredictable forward earnings yield (but a very low one on a 12-month ahead basis), and a 0.4% TTM historical earnings yield. (Note, earnings yield is the reciprocal of the P/E expressed as a percentage.)
Between HD and COST, and WMT and TGT, investors have many choices from which to choose that offer strong finances, an earnings yield competitive with or superior to bonds, dividend payments, and various ways to potentially continue or resume succeeding despite the alleged AMZN juggernaut.
Now, some comments on two smaller fry.
There are two names that I own and like, which have done very well in the face of the surge of e-commerce. As opposed to the above big box names, these are smaller stores, so I call them small box chains; though TJX (TJX) especially has some larger formats.
TJX reported a modest beat-and-raise quarter last week, and the stock rallied a bit. The company reports growth in e-commerce and is investing in its capabilities. But mostly it wants and is getting customers in its stores to look around (the treasure hunt aspect). It is spending perhaps half of its ad budget on digital media, but it readily admits it is behind the curve on a full e-commerce platform. And, it does not seem to mind. TJX is a global marketer and, overall, is doing fairly well ex-US (and very well in Canada), so even as AMZN moves along internationally, TJX is able to execute ex-US against it.
A smaller but significant player, Ross Stores (ROST), is a deeper discounter than TJX. And, it has no current interest in e-commerce, yet it also reported a nice beat-and-raise quarter last week.
All the above names, plus certain others, represent resilience in the face of the rise of AMZN and the rise of e-commerce. They offer investors alternatives to AMZN for what are in today’s market reasonable valuations, plus dividends, and generally share shrinkage as well.
Before summing up and including some comments on AWS, a few points should be emphasized. These are my opinion, of course.
AMZN’s current version of E-commerce is not so efficient
“Buy online, deliver to home” has structural problems.
The “last mile” is very costly; i.e., getting one or more packages individually to a home. Then, there are issues with all items of what to do if the customer is not home. Will the package be stolen or damaged by weather or an animal if left at the doorstep? There are many other issues. Returns are costly and more frequent if an item is purchased without seeing it up close and personal. The issue of one missing piece of merchandise from a larger order is an issue. Does the retailer send the five items that are in stock and then, separately, send the sixth that it found was out of stock when it took the order (this happens)? Whereas, if a shopper comes to the store and finds 5/6 items desired, that’s not so bad. Often, a substitute will do; or another store will have the item; or, it can wait; or, it can be ordered online; etc.
The last mile problem is so expensive that WMT is already testing home delivery by its employees. It is also spending money to improve its kiosk systems for automated pick-up of orders placed remotely.
Some of my prior AMZN articles have made the analogy between the rise of remote ordering, i.e. from the old Sears, Roebuck and Montgomery Ward. The analogy was that over time, stores were simply better ways to get product to customers than catalog shopping, which was a prior era’s version of Internet-based information presentation. I continue to believe that’s the case today and that AMZN is implying just that by its growing chain of brick-and-mortar bookstores and the WFM purchase. One of several reasons to think this way is that most people, even in “rich” countries, value their free time as having almost no monetary value. Meaning, we are happy to provide the “last mile” delivery via, usually, our cars or trucks, rather than incur the cost of a delivery vehicle and person coming to our residence. Also, in e-commerce, product has to be collected from warehouses, assembled in one or more containers, wrapped in a way that protects the merchandise, and labeled. That’s costly. Whereas in a physical store, either the retailer brings the merchandise to a shelf from a back room, or straight from the truck if it’s a warehouse-type store; or the brand company puts the merchandise on the shelves. Then, the customer walks around the store, picks what’s desired, does in-person comparison shopping if desired, maybe makes an impulse buy or two, and then checks out: no packaging needed other than some cheap bags if that much. Then, after the customer completes the purchase, returns are not usually a problem for many classes of goods. Lots of costs, errors, and other inefficiencies are avoided this way.
For these and other reasons, including that we are social animals and like to get out of the house now and then other than to go to work, I am skeptical that e-commerce is going to devour brick-and-mortar stores. And, I think that AMZN’s strategy is supportive of my views.
What’s AMZN worth?
Well, no one even knows what AWS is worth, much less what AMZN as a whole earn over time. We know the sales and gross margins for AWS. But I think we do not know if internally within AMZN, whether AWS is credited with revenues from AMZN’s retail division, certainly the largest “customer” of AWS. All we have, I believe, are consolidated P&L and margin data – and these are not too impressive.
AMZN also does not break out its R&D expenditures separately. We also know little about the economics of AMZN’s Kindle/Alexa etc. line of proprietary electronics.
Call me unduly cautious, but I give a valuation haircut to companies that tell investors less rather than more. So, when looking at AMZN’s extreme valuations by all measures I use, its sharply declining earnings estimates, and the growing competition both in e-commerce and from traditional discounters, I tend to suspect that tomorrow’s buyers in the stock market may back away. Why not buy a bargain, perhaps TGT, perhaps WMT, perhaps TJX, etc.? Why overweight AMZN’s price to earnings ratio so heavily?
A rebalancing could be underway, just as occurred between tech/telecom and Old Economy stocks beginning in 2000.
Ultimately, perhaps a waterfall decline could be underway. I think that way in this case because: where’s the valuation bottom for AMZN if buyers turn skeptical? 100X P/E? 50X? Etc.
Two additional notes are worth stating. First, I am not an AMZN short in any way, nor do I “work with” anyone (nothing like that at all). I simply write what I think and submit articles to Seeking Alpha for its editorial review and potential publication. Next, I’m not an Amazon.com basher in terms of its success as a company, which is remarkable. I am just criticizing the stock price.
In summary, I hypothesize that the growing examples of resilience and growth, both in e-commerce and in brick-and-mortar retailing, may be putting pressure on AMZN’s stock price and that this pressure may continue much farther in price, given AMZN’s extreme valuation and sharply diminished forward earnings estimates. AMZN is in a short-term downtrend, and since Mr. Market rings no bells when a durable rally is to begin, I think it is possible that a cascading, waterfall-type decline may have started. And, if not now, one could begin at any time. As a long-only investor, I do find the AMZN story and the changes it has catalyzed fascinating and have placed some chips on some of its competitors. I will wish good luck to all investors in all names in this dynamic situation.
Thanks for reading and sharing any views you wish to contribute.
(Submitted Monday at 2:30 PM with AMZN around $950.)
Disclosure: I am/we are long COST, HD, ROST, TGT, TJX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.