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;
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.
Will the authorities decide to tame the beast? People love Amazon because they have made stuff cheap, but, have they become to diversified?
Amazon took on the book industry by taking it digital, practically destroying Barnes and Noble.
Supply chains have been automated.
Bricks and mortar stores are getting automated.
Amazon is taking on the grocery market (viz the purchase of Wholefoods in the USA) and the existing grocery service for Amazon Prime users.
Amazon does TV shows and music streaming.
They do restaurant delivery.
And the most profitable part of Amazon is the web services division.
What else do they do? Credit lending, payment services, booking publishing, and fashion design. There has been talk of Amazon getting into the pharmacy business.
As the list of Amazons victims grows when will this become a political issue? Profits from Amazon Web Services and Amazon Prime funds the expansion of a low margin and a low cost attack on all retailing, flying in the face of conventional capitalism, where profit if king.
Amazon’s predatory pricing business model may put them in the cross hairs of the US Government at the pointy end of an antitrust case, which could be catalyst for major price declines in Amazon Inc stock price. Investors will surely grow tired of the pursuit of growth over profits. It’s already got political with President Trump stating publicly on Twitter of Amazon’s anti trust issues.
Trump has previous will Jeff Bezos and the Washington Post for ‘fake news’ and their unflattering reporting of President of the Trump campaign. Bezos owns the Washington Post and has used them to attack Trump after his anti trust comments. Could the president be talking down the share price of Amazon, in a similar way as he has done with the generics drugs industry?
Something this scenario lacks compared to many other high profile anti trust cases in America is that the accused is not making an obscene amount of profits from their business activities. When the social costs start outweighing the benefits maybe this won’t matter any longer, but, who’s going to pay all the lawyer fees. We bet it’s not coming from Mr Bezos personal fortune. E-commerce accounted for less than 12% of USA retail sales in 2016. Amazon has the lions share of this but it’s still probably not going to be a good enough foundation for a Trump vendetta on Bezos.
What angle can be used to benefit from Amazon fever?
People commenting on financial markets have called it an everything bubble. Asset prices have all risen together. Retail stock valuations where ripe for a fall, at the end of a period of expansion in retail floor space, allowing retailers to increase profits. Now some very good retailers are trading at much more reasonable valuations and represent a good buying opportunity as a result of the Amazon threat. What’s more competing companies will be forced to embrace more technology to bring their operation into the 21st Centuary.
Here are some opportunities;
Target Inc is on the clearance rack. One of the kings of bricks and mortar retail has seen earnings declines and a reduction in share price. This has caused Targets dividend yield to increase substantially. Known as a dividend champion Target has raised their dividend for 50 straight years. Chances to buy dividend champions with above average dividends don’t come round very often.
Gap Inc. Gap has some good brands (trading under various names) and operates mainly in the USA but with a international footprint. Critically Gap Inc has a strong balance sheet with cash in the bank which covers long term debt commitments. What’s more they have a high dividend yield currently covered comfortably by profits. Gap is expanding in Asian which would undoubtedly spur the next round of earnings growth when it comes. Inventory levels have been kept under control and accounts receivable are also below 5 year averages indicating that they are not having to offer more credit to customers. However, net income has fallen as their operating expenses have increased (we don’t have any explanation for this but it’s most likely a cost of expansion, and advertising etc). Earnings per share are expected to have a modest drop in 2018 of less than 2% before increasing afterwards.
American Eagle Outfitters. Are in a similar position to Gap with a strong balance sheet. Unlike Gap they have less cash on the balance but they have no long term debt and a high dividend comfortably covered by earnings. Expansion into Europe may be a bright spot for earnings as well as expanding ecommerce operations internationally. Both inventories and accounts receivable have been growing indicating that some stock is going unsold requiring credit promotions to sell stock. Despite this 2017 net income is at a similar level to 2016. Earnings are expected to fall in 2018 by 12.27% which has driven the share price down, but expected to increase after that.
Leasehold commitments should also be taken into account when analysing retailers like Gap Inc and American Eagle Outfitters. Both Gap and American Eagle Outfitters are established retailers, so that changes in profits will come from store closures and improvements to costs control.
A couple of other stocks to be added to a watch-list include Deluith and Five Below who are both expanding their store count, which will help them grow earnings, and therefore their share prices.
To my mind fashion and retailing to younger shoppers works well on the high street in brick and mortar shops because young hip 13 to 30 somethings want to be seen, looking fashionable and cool, strutting the streets of the USA, Europe and Asia.
Both American Eagle Outfitters and Gap Inc are trading at the bottom of their trading ranges making them look attractive on a technical analysis (chart analysis) view point. Risks include the fact that the USA is in the late phase of a business cycle that is getting very long in the tooth. Current share prices reflect current earnings estimates. If estimates prove to be too negative and earnings surprise on the upside share prices will rise, and vice versa if they come in lower than expected.
Due to the uncertainty about the affects of the current business cycle and possible recession in 2018, including how severe it will be, investors should make any decision to invest based on relation to their overall portfolio. Visualise how much money you initially where going to invest and cut it by 50%. Leaving cash available to invest later if the share price drops further when valuation are even better. Consumer discretionary stocks are very cyclical meaning that what goes down will go back up as a new business cycle kicks off.
Who would have thought that Amazon’s predatory pricing could have such a beneficial affect for investors as well as cash strapped consumers.
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