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Amazon fever, the death of retail

Amazon is causing the death of retail! Remember when they used to sell books? Now they are the causing the death of retail and the stock price has gone parabolic, making Amazon Inc stock market darling.

Where do Amazon make money?

Amazon make money on their traditional e-commerce platform, the third party marketplace which enabled every day folk to make money online ( in a similar way to Ebay), Amazon Prime subscriptions, Web Services, and hardware.

Less and less people are shopping in bricks and mortar shops either in city centres or out of town shopping centres because they are buying their stuff online. Amazon started as a book retailer and has grown into some much different affecting competitors in every market they enter. They are the largest internet based retailer in the world by total sales and market capitalisation.

How has Amazon done this?

Amazon’s CEO Jeff Bezos has harnessed technology to make Amazon a very lean company. Using technology they have evaporated most of the costs of traditional retail. First by using the power of the internet and riding the digital revolution, then by bringing supply chains into the 21st centuary, reducing the cost of deliveries and now by eliminating human staff from bricks and mortar stores (they are doing this in the USA).

Cutting costs allowed Amazon to compete on price and undercut everyone else. Great for growing revenues. Profit however, have been more elusive. Amazon has a astronomically high share price with a multiple of earnings of 200x as of August 2017.

Automation has been key to Amazon’s business plans. Check out Amazon fulfillment warehouses;

Amazon Go;

and

Amazon Prime Air.

Wow, pretty cool if you ask me, but, are they getting ahead of themselves. Economists say one of the missing ingredients of modern western economies is productivity growth. Simply put, the amount of output per unit of input into the economy. Automation is the future of which Amazon has been a driving force, and it could trigger a productivity miracle. This is not without some serious side affects;

Causing unemployment, where people give up looking for another job, leaving them reliant on the welfare state.

Causing deflation in wages, when wage inflation is needed in a healthy economy.

Amazon has built a brand and grasped market share at the expense of making reliable profits that justify the valuation. Amazon e-commerce operates on very tight margins, as does it’s hardware division.

To be valued the same as any other retailer they are going to need to grow their earnings 16 times by using widely used valuation metrics. So why are they valued so high? Innovation and ingenuity is pushing them forward and the stock market loves it. Increasing the social good by relieving people from doing boring cashier jobs, working in a warehouse, or driving delivery vans. Increasing productivity and making a lot of stuff a lot cheaper than it was before.

Add up all their profits since 1994 they still made less than Microsoft made in the fist 6 months of 2016. Amazon web services is the division that makes makes most money (with the highest margins) and subsidises the expansion and growth of Amazon retail. Amazon has never paid a dividend because most of it’s earnings go into growing the revenues.

Is there a cure for Amazon fever, we think so

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A bet on geopolitics and history in the making

Historical events don’t always have to come out of a book, or be taught in colleges and universities. People around the world enjoy reliving history.  Dressing and acting like people did from times long past no doubt make historical events come alive.  Events from the past have provided copious inspiration for film, music and books based on true stories, and using historical fact to weave stories around.  Two examples, before we enter this post.  Jaws the film was an incredible success for director Stephen Spielberg.  Jaws the book by Peter Benchley, was based on the Jersey Shore shark attacks of 1916.  A panic stricken beach town caused by one shark attacking multiple people inspired one of the best known film stories of all time.  I bet you didn’t know the book about Norman Bates called Psycho was later made into a film, but, the book was actually based on a real murderer called Ed Gein.

Historical events happen all the time, but, there as some monumental events happening right now. Not just Brexit, Donald Trump insulting another journalist, Vladamir Putin playing grand piano as he waits for the Chinese Premier Xi Jinping at the “One Belt, One Road summit”.  Rather events that your children’s, children may study in the future but not from a school curriculum.  This post will review big things happening in geopolitics, economics and how it’s going to affect financial markets.

In the lifetime of most people the United States of America has been a leading global superpower. Affecting our culture from everything from Breakfast cereals to Televisions shows, sorry television programmes, and children’s toys.  Not to mention the functioning of politics, pensions plans and other financial institutions.  The Hollywood film industry is (or rather the industry as a whole) is arguably one of the most powerful industries in the world, with the power to inspire and influence peoples ideas, lifestyle choices and emotional biases.

Could this be the beginning of the end of America being the worlds leading superpower?

American has provided security and stability to a lot of countries by providing intellectual and financial capital for financial systems, institutions and contributions to countless technological breakthroughs.  Any big change to this will have big consequences for anyone thinking about where to place their bets for growing their wealth.  Let’s take a look at the bigger picture.

Since the Bretton Woods Agreement after World War Two the United States Dollar has been the worlds dominant reserve currency. US Dollars where lent to countries damaged by war to build infrastructure again so that society would function properly. A good idea, which especially helped the United States, because it developed the world economy and promoted North Amercian economic and political values. Values which they gained originally from Europe (and the rest of the world before that). Great news for the World Economy as it developed a stable system allowing countries and individuals to trade and prosper. Part of the agreement stipulated oil had to be traded in Dollars. So if you need oil for industry or whatever you have to buy dollars to trade it. The reserve currency status also meant dollars where the preferred currency to trade goods and services in the global economy.

Soviet representatives attended the conference. They declined to sign off on the final details of the plan. Labeling the institutions created by the agreement to be branches of Wall Street. Which of course they are / where. Institutions created by the USA and United Kingdom where the International Monetary Fund and the World Bank.

The IMF’s Articles of Agreement state: the IMF is ” to promote international monetary co-operation, international trade, high employment, exchange-rate stability, sustainable economic growth, and making resources available to member countries in financial difficulty. ” All good things right? They hold a fund made up of Special Drawing Rights which consist of a basket of other currencies that can be used to help stabilise member nations using liquidity (cash injections).

Other things that came from the Bretton Woods Conference where the instigation of freely floating currencies and the idea that it’s better to reduce trade tariffs to promote trade. Relative to before Bretton Woods the world economy is almost a completely free trade system now with low tariffs being standard practice.

Agreements ratified at Bretton Woods encouraged many countries around the world to use dollars for trade. This financial model has worked well and allowed a lot of people to benefit who would not have if a plan had been signed off based on the principles of the Soviet era. Many advances in technology, medical sciences, welfare systems would not have happened had it not been for this system. For normal people, this means no more having a toilet in the shed in the back garden, hot water, a General Practitioner to help with your ailments, a pension, money if your your boss cuts you loose from your job as well as other welfare benefits and many more things like, iPhones, GPS so you don’t get lost,  free online software, shops with almost anything you could want, and doctors with almost any drug required to help you live longer. Let’s not forget the option to travel almost anywhere in the world for a holiday or vacation.  Of course the list goes on.

Betting on Geopolitics

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The letter is dead long live Royal Mail

Royal Mail’s bread and butter business is in structural decline.  As sure as video killed the radio star email has killed the letter.  Following the accession of a new monarch in various countries on lookers would proclaim ” the king is dead, long live the king “.  As one monarch dies they salute the new monarch.  Royal Mail’s letter business is dying but they are saluting new avenues of growth from Parcel Deliveries in the UK and around the world through the wholly owned dutch subsidiary General Logistics Systems (GLS).

Let’s take a look at why Royal Mail could be a good investment.  Royal Mail was fully privatised for the first time in 500 years in October 2013.   During is life as a state run monopoly Royal Mail built up a massive asset base and had no pressures regarding operating efficiency (like modern publicly listed companies do).  It employees are well treated with generous pensions and sorting offices use aging technology.  For the new management of Royal Mail cost saving opportunities will be around every corner.  From making better use of technology to bringing the employee pension scheme up to modern standards.

Modern technologies are being employed to create productivity gains, the work force has been reduced and the number of mail centres and delivery offices have been reduced.   Rivals like Deutsche Post (DP) where privatised years ago and it has had a marked positive affect on their business (possibly not for employers but for the business).  DP sports operating margins of close to 8%.  Royal Mail’s operating margins are just over half of that figures so they’ve got some catching up to do.  Catching up is what they are currently doing.

What has an investment in Royal Mail share got going for it?

  • Lots of low hanging fruit for saving costs, costing savings plan increased to £600M by 2018.
  • Can bid for contracts outside of the UK allowing Royal Mail to benefit from Globalisation. GLS operating in 42 European Countries and all over the world and is the 3rd largest parcel delivery provider in Europe. Revenues from this part of the business are growing at nearly 10% per year.  Stimulation of Eurozone economies by the European central bank are feeding through to GLS’ main markets including Germany, Italy and France.
  • Operating profit margins and operating profits should rebound as transformation costs reduce and investments in acquisitions start to enhance earnings. Geographic expansion has been made having purchased ASM in Spain and GSO in California, USA.
  • More control over pricing in the UK and in the other countries they operate in.
  • Online shopping is growing at 10% per year.  Parcel Deliveries are becoming a larger part of the delivery Market help offset the decline in letter deliveries.  Royal Mail should continue to win a significant part of this business despite competition from TNT, DP and Yodel.
  • Offering customers a better service.  Personally having bough myself a new watch recently with Royal Mail’s 24/7 tracked service I new where it was each step of the way.
  • Royal Mail owns lots of property.  As property prices have inflated the value of not or under used Royal Mail property has soared.  Sale of these assets to property developers desperate for quality plots in prime London locations will help fund Royal Mail future expansion plans and pay it’s dividend. Owning property is also a good hedge against inflation.
  • Royal Mail debt is relatively low.  Interest payments are covered by operating earning easily and net debt is a comfortable amount.
  • Dividend growth was over 5% last year and is expected to be over 4% this year.  The dividend yield is currently higher than average.
  • As far as the share is concerned it is in a range bound market and currently sits at the bottom of the range.  Making a increase to the upper end of the range a good bet.

What are the negative aspect of investing in Royal Mail

  • Higher transformation costs and investment spend has hit operating profits and reduced profit margins
  • The dividend is barely met by free cash flow after capital expenditure, financing and acquisition costs. Albeit higher due to the current transformation and acquisitions to lay down geographical expansion.
  • Amazon are delivering their own parcels.
  • Increased competition from Rivals, espcially in the UK market.  For instance Deutsche post has moved into the UK market by buying UK Mail.
  • Regulatory burdens reducing competitiveness, such as having to provide the universal service
  • Slightly overvalued compared to the transportation industry average (not taking into account dividend growth)

Big questions remain

Can the growth in Global operations and high performance of UK Parcel deliveries offset the reduction in revenue from UK letter deliveries?

Can acquisitions add to growth after financing costs?

Will the cost reduction programme go to plan without spiraling transformation costs?

Will dividend increases continue at the current rate?

Opinion of the author; Royal Mail is a good bet based on dividend yield, dividend growth rate, manageable debt levels, transformation plan of decreased costs, technological enhancement and productivity drive going to plan, and the global expansion.  A reduction in operating costs will see it’s share price move up and reduce it’s PE ratio to be inline with that of Deutsche Post, which has a 5 year average PE of around 15 and a lower dividend yield.

 

Disclosure; the author owns share in Royal Mail. 

 

 

 

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