Amazon Effect

There is the obliteration of retail sector currently happening as a result of Amazon dominance. The proposed acquisition of Whole Foods by Amazon has taken the market totally by a surprise. It only reinforced the reach and dominance of Amazon in the retail landscape. I am a customer of Amazon Prime and like it's convenience very much. If I want to buy something, the first destination I go to is Amazon and not Google or any other search portal. Since I have taken Prime membership, my number of trips to the mall and other retail stores has considerably gone down. I am not only saving gas but also time and energy. There is no question beyond doubt that Amazon Prime value proposition is too good to ignore.

All the major retailers and particularly mall based retailers have experienced this Amazon effect. They have been slowly but steadily losing market-share over the last couple of years. Amazon is now the number one apparel retailer as opposed to Macy's. A lot of mall based retailers have already filed for bankruptcy. It's not over yet and more weak companies will be rooted out of the marketplace over the next few years. That is just nature's law of evolution. Weak hands will perish and strong hands will evolve to survive.

However, in this mass hysteria of everything Amazon, some of the strong players are also getting punished unduly. Companies that have strong balance sheets with an excellent management team in place are also getting punished in this takedown of the whole retail sector. How do we identify such strong retail companies in this current environment,

  • The company should have little to no debt
  • The company should have a good management team in place
  • The company should have a good digital presence or have a strategy in place to bolster their digital presence
  • The company should be willing to shut down non-profitable stores and right-size the company.
Human beings are sensory organisms. We need to touch, sense and feel things. I can't imagine the world where all the stores are extinct and everyone buys everything online. May be it will happen sometime but not in my lifetime for certain. So, a retail company will survive as long as it is run efficiently and is right-sized for the business that it delivers.

One example is Foot Locker. FL is the parent company of about six different retail store fronts. Foot Locker and Champ sports stores are the prominent ones. They have a good international presence as well. The company has been growing fantastically over the last 5 years since implementing a major transformation initiative. The stock has gone down 40% in the last 2 months since reporting earnings for the first quarter in mid-may. The following are the reasons why the stock went down so drastically.
  • They missed the EPS estimates for Q1 by a few cents
  • Whole retail sector take down due to Amazon effect
  • Nike is going to sell few shoes directly on Amazon
Let's take a look to see if the above reasons are justified for a 40% takedown. EPS estimates miss for Q1 is a one-time event because management reiterated the guidance for the full year. Whole retail sector take down unjustly took down FL as well. Other companies like Macy's, JCP, Dillards are primarily mall based retailers and they have seen slowing revenue growth over the past few years. FL is not just a mall based retailer and has stores in small strip joints as well and has been growing revenue consistently. Nike announced the deal with Amazon to sell the shoes directly on the Amazon website. However, Nike clearly said that it is a pilot and very limited. They want to see how it goes in Q4 and then make a decision about it. 65% of the sales in FL is of Nike shoes. Nike has cultivated the partner relationships with FL and Dicks(DKS) over the past many years. Nike is not going to abandon these relationships overnight and switch to Amazon. However, the market is treating as if this is an overnight event. FL is projected to earn $5 per share this fiscal year and grow it at 7% over the next 3 years. The current stock price of $48 gives it a P/E of less than 10. On average, S&P stocks trade at a P/E of 15 for a 3% growth. So, FL is ridiculously cheap. As a value investor, you should be greedy when others are fearful. In my opinion, uncertainty around this stock is giving you an opportunity to own a good company at a reasonable valuation. FL reports earnings on 08/18. I am confident that they will beat estimates. Even if they don't, I am not selling the stock. My timeline is to hold onto it till the Q4 is complete. Traditionally, Q3 and Q4 are their strongest quarters.

Similarly, you can find other companies as well in the retail landscape that are unduly punished due to Amazon effect. As long as you do your research and check all the boxes, I believe there is money to be made in this retail take down.

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