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The early take on Amazon’s (AMZN) January announcement that it was considering an increase in the $79 annual fee for Amazon Prime was that it might lose some members, but its bottom line would be fattened. Suppose – in the wake of the actual announcement of a new $99 fee for the service, revealed Thursday – it works in the opposite way: spurring yet more sales growth but not doing much for actual profits as the online retailer continues to discount heavily.
That’s one possible takeaway from the lesson of Costco (COST), the membership warehouse merchant, and its occasional fee increases over the years, and some analysis added by William Blair & Co. analyst Mark Miller in the days leading up to the Amazon Prime price hike.
After a meeting with an Amazon investor relations official, Miller came away with these thoughts, among others:
Staples (SPLS) reports fourth-quarter results later this week – 39 cents vs. a year-ago 46 cents, excluding extraordinary items, is what’s expected – and value investors may sniff a bargain.
After all, Staples has a lovely dividend yield of 3.6%, it has often raised its payout, it’s trading at a forward PE ratio of just 11, and it has a big restructuring underway aimed at restarting sales growth, cutting costs, broadening the products its sells and better competing with the likes of Amazon (AMZN) and Wal-Mart (WMT).
Staples through the first three quarters, ended November 2, 2013, bought back 18.2 million of its shares for $269 million. Not a large gesture, to be sure, but the message seems to be: it’s cheap, so we’ll buy some, and maybe you should, too.
If you’re among those convinced that profits at Amazon (AMZN) will matter at some point, how and specifically where the company invests now will be especially crucial. While users have the joy of considering Amazon an Internet retailer, the company itself has the dreary tasks of running more than 80 million square feet of warehouse space, overseeing some 117,300 workers and constantly trying to reduce shipping times to satisfy consumer preferences the company helped create in the first place.
Even Amazon has limits to how much it can invest. Capital expenditures were $3.4 billion last year. We think the fastest way to sustained profits for the company, which has been famously unprofitable during long stretches in recent years, is to concentrate its resources as much as possible, particularly in North America where its business is already more mature and produces stronger margins.
The slide in Amazon (AMZN) stock was set off by a disappointing report on fourth-quarter sales and earnings per share, but also spooking investors was a suggestion by the online retailer’s executives that they will be raising the fee for Amazon Prime members from its current $79 to something between $99 and $119.
Won’t that scare off Prime members, and thus lead to even slower sales growth, some wondered? Perhaps. But Mark Miller, a retail analyst at William Blair in Chicago, looked at Costco’s (COST) experience in jacking up its membership fee in recent years, and found that the increases resulted in very little churn. Costco enjoys membership renewal rates above 80% and fee increases in 2000, 2006 and 2011 – 13%, 12%, 10%, respectively – didn’t change that, Miller reported.
A lot of retailers blamed weak consumer spending for their lousy holiday earnings reports, and at least some shareholders bought the excuse. But accepting that rationale now looks particularly naïve. Investors who haven’t already dumped the weaklings in their retail sector holdings might want to get right on that task. From the trend in the SPDR S&P Retail ETF (XRT), it looks like many investors have already started.
The whiners vs. the doers seems to be an early earnings season theme. Culling retail investments seems particularly wise following last week’s business news. Turns out that consumer spending has been healthy enough lately. It’s certain individual retailers that should worry investors.
Consider the report from the U.S. Commerce Department on Thursday. Consumer spending was up 3.3% in the fourth quarter, which was the best performance in three years. Moreover, the pace of spending seems to be picking up. December spending was up twice as much as analysts had predicted, and November’s numbers were revised upward.
While Morningstar’s (MORN) 2013 asset allocation fund manager of the year, FPA Crescent, is currently devoting significant assets to the stocks of challenged old-techs such as Microsoft (MSFT) and Oracle (ORCL) where it sees the problems already more than baked into the price, Morningstar’s Domestic Stock fund of the year is trafficking in newer generation tech-centric leaders on the growth side of the investing spectrum.
Among the top 10 holdings in Morgan Stanley (MS) Focus Growth, run by lead manager Dennis Lynch and his team of co-managers cited by Morningstar as the top stock jocks in 2013, are Facebook (FB), Amazon (AMZN), Google (GOOG), Priceline (PCLN) and Salesforce (CRM). Facebook, which the team owned pre-IPO and has added to, accounted for 10% of assets based on portfolio holdings reported for the end of September (the latest available).
Value stocks they aren’t; the average PE ratio for the portfolio is above 25. And growth was rewarded last year. Morgan Stanley Focus gained nearly 50%, nearly 20 percentage points ahead of the market overall (the S&P 500). The fund’s 10-year annualized return of close to 10% is more than two percentage points better than the S&P 500. But as befits a growth-oriented approach, the feasts are often interrupted by stomach churning famine. In five of the past 10 calendar years the fund ranked in the top 10% of similar large-cap growth funds, and in three of the years it was in the bottom 10%.
By most accounts, the U.S. economy is heating up, but Ulta Salon Cosmetics (ULTA) is slowing down its growth and that’s cause for investors to take a harder look at the retailer’s business model and on how well management executes its plan. Ulta stock plunged a month ago after it missed a quarterly earnings expectation and cut back on new store openings planned for 2014, a growth-limiting step.
With just 664 stores at the end of the third quarter, ended November 2, Ulta would seem to have plenty of open space to keep expanding in the U.S. And the company has been a reliable performer in recent years, along the way winning a lofty valuation for the stock, as measured by PE ratio. Shouldn’t this pullback be a buying opportunity?
A tiny worker unit at Amazon (AMZN) – 30 maintenance and repair techs at the online retailer’s warehouse in Middletown, Del. -- will vote on union representation next month, and if they vote to join the machinists union you can expect apocalyptic predictions of how a unionized Amazon couldn’t stay in business.
Amazon may be regarded as a tech company by investors and by consumers, but the employee headcount and asset base – 109,800 workers as of the end of the third quarter and an increasing network of warehouses around the country – scream logistics. Bloomberg Businessweek reports that pickers at those warehouses make $12 an hour. With the above profit margin, it hardly seems that Amazon could stand the costs of a unionized workforce.
If T-Mobile (TMUS) is half as disruptive to Verizon (VZ) and AT&T (T) in the mobile phone business as recent articles in the New York Times and Bloomberg Businessweek suggest, those larger carriers could be screwed. T-Mobile’s self-promoting CEO John Legere is delighting in introducing consumer-friendly policies that could gain his company considerable market share, or at least force his larger rivals to match his terms to keep their customers.
Remember, however, trashing the other guy’s profits doesn’t assure you of any profits. Sometimes, the price cutter in an industry simply screws it up for everyone, himself included. Ask Jeff Bezos at Amazon (AMZN), a company we refer to at YCharts as the Suicide Bomber of Retail. Yes, Amazon ran Borders out of business and is trashing the results of Barnes & Noble (BKS) and Best Buy (BBY), but the online retailer has little in the way of profits to show for its accomplishments.
Society’s growing insistence on instant gratification has been the saving grace of bricks and mortar retailers this last decade, because even Amazon.com (AMZN) can’t hand over Bluetooth speakers or a warm sweater minutes after you decide to buy it. But with online sellers getting serious about same-day delivery programs, Target (TGT), Wal-Mart Stores (WMT) and other real stores will find themselves fighting to keep even this key advantage. For shareholders in those massive, slow-growth companies, it might be an expensive war.
eBay (EBAY) upped the ante in this battle a couple of weeks ago by announcing plans for same-day delivery in 25 cities by next year. It also announced the acquisition of a U.K. courier company, Shutl, to facilitate the expansion. EBay, along with Amazon and Google (GOOG), already offered same-day delivery on a very limited basis. The roll-out with Shutl, which already delivers in several U.S. cities, ramps up the program quickly. Amazon and Google also are expanding their same-day delivery programs.
eBay’s sole goal in this venture is to raise revenue. Although EBay will charge $5 for the service, CEO John Donahoe explains that delivery itself doesn’t need to make money for the company. He’s happy if it breaks even. Similarly, Amazon CEO Jeff Bezos is unconcerned with the cost of the service. Amazon already spends billions of dollars annually on free and subsidized shipping.
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