Amazon – Whole Foods

This is a rambling post with thoughts and no coherency.

Amazon and Whole Foods are two companies are at a larger market capitalization than what I normally would research, but I do take interest in the business strategies involved.

Here in Canada, there have been two retail developments in the larger player space over the past decade – the collapse of Target’s entry (despite a few billion in capital invested in the venture), and the merger of Loblaws and Shopper’s Drug Mart. The consolidation of Shopper’s Drug Mart has been more successful for Loblaws than I originally thought it would be. The collapse of Sears Canada was inevitable and I generally do not consider this significant other than another multi-decade titan fading into dust. Walmart Canada and Costco appear to be untouched at present. Amazon’s presence in Canada is still considerably limited and this is likely due to a function of geography and scale (most of the stuff gets shipped out from the Greater Toronto region).

I do notice that Loblaws (via Superstore) is trying to get into the digital presence – they do have parking stalls that are reserved for online ordering pickup and I am fascinated to see how that process works out (I have not used their service).

So I am asking myself what Amazon is trying to do with the Whole Foods merger and I think it is a reasonable gamble on their part. First, the chain itself is profitable and although their margins have compressed like a typical grocery store chain (it is a miserable industry to compete in), they do have excellent mind-share and geographical presence in upper-scale urban areas.

Amazon is trying to expand its retail physical presence and one area where they do not compete in currently is food – the question is whether they are trying to invade this space (i.e. going after Costco directly) or whether they are using it as a shipping hub (which in this case, they paid a lot of money for what are effectively large-scale post office boxes). I also do not believe that remaining in the premium food space is going to continue to be economically viable since the proliferation of other chains (e.g. Market of Choice, Metropolitan Market, to use a couple West Coast analogies, but even a franchise such as Trader Joes should be quivering at Amazon right now) is continuing to cut away at Whole Foods’ dominance. Using this analysis, Whole Foods’ decision to sell out was probably a good one for their shareholders, but the strategic benefits to Amazon still remain at the “reasonable gamble” stage. It must be nice to be able to throw US$13 billion in pocket change (they have $21 billion in cash and equivalents on their balance sheet as of March 31, 2017) at something and see if it sticks.

In terms of how this will impact Canada, it will not be clear until we see what happens in the USA – in Vancouver, there are five Whole Foods stores (and a couple of them were purchased from a company that marketed the stores as “Capers” which started quite some time ago).

So the questions here:

1. Is Amazon trying to augment its food offerings online (which generally have been lacklustre and expensive?)
2. Is Amazon trying to use Whole Foods as a moderate geographical footprint in major urban centres? What is the benefit of having more geographical pick-up locations instead of at-home delivery?
3. Is Amazon just bored and looking to invade another market where they are not dabbling in as one huge experiment? They tried this before with the Amazon Fire phones – RIP (and this also was the final nail in the coffin for Blackberry’s BB10 operating system, which I am still lamenting over since it is soooooo much better than Android).

All things considered, I still don’t think Costco has anything to worry about, but definitely this market space is getting quite cozy.

No positions in any of these stocks. Amazon does look like, however, it will need to raise another 15 billion in debt financing, which they should have no trouble doing.

Amazon and Walmart

Continuing some large-cap cursory scanning, I notice that Amazon is still at its very lofty valuation – I have no idea why they are trading so highly, but then again, that’s been the case for quite some time.

Whenever I look at Amazon I instinctively punch in Walmart. They have been in a trading range for most of last decade, but interestingly enough, they’ve appeared to have broken out of their trading range:

Back in the early 2000′s, Walmart was trading a very healthy P/E (around 20-25) and they had to settle into their valuation by actually earning enough in earnings to warrant the price. A few years ago they were around the 10-11 future-looking P/E range, while now they have crept up to 14 times future earnings. Is this because capital that was otherwise earmarked toward fixed income investments has moved into the equity side? Walmart equity is as close to a GDP-linked bond-like instrument as you could have gotten in the large cap market and I am wondering if others are seeing it this way?

Walmart is pretty much the economic barometer of the US retail economy and the other explanation is that maybe the US economy is recovering or stronger than the media makes it out to be?

I also notice that Target has exhibited a similar boost this year, albeit somewhat less pronounced than Walmart.

Large caps appear cheaper than small caps

Just from my cursory examinations of the markets, it appears that large cap stocks are representing a better value than smaller capitalization issues. I am guessing the market is discounting some form of zero-growth projection in the future for a lot of these firms. One factor to remove from the analysis is government revenues – the theory would be that companies with higher exposure to government business will face pressure as deficits will force spending cutbacks.

Because of the currency differential, US stocks appear to be a better value at the moment – dividend-bearing companies can also be put in the RRSP to avoid withholding tax.

Just as the most basic example, Walmart (NYSE: WMT) is projected to earn about 8.5% of its capitalization this year – much better than sticking it in a 10-year government bond yielding 3.41%. You would think that the company would be able to scale its business appropriately if there was a recession – indeed, by looking at the stock chart you would be hard-pressed to see even a hint of an economic crisis in 2008-2009. You don’t even have to do any research – there is virtually no chance of Walmart not being able to produce profitable retail business in the medium-term future. This is contrasted with Amazon, which has to justify its valuation with huge amounts of growth over the next decade.

You will never see your investment in WMT rise by 30% in a year, but then again, you will not see it sink 30% either. It almost trades like a bond. It is a typical good “grandmother” stock.

There are many better (and smaller) examples of large cap companies that are trading at very attractive valuations, have a “moat”, and unlike Walmart, you could envision scenarios where they will warrant higher valuations.

US Thanksgiving Shopping – Amazon vs. Walmart

The USA celebrated their Thanksgiving weekend last Friday, and one tradition they have is buying new stuff. Reading all the stories about the crowds and such always makes for media amusement in what is otherwise a very slow news day.

Some more sober statistics is that retail sales apparently were up 0.3%, while online sales were up a whopping 16% by comparison with respect to last year’s thanksgiving to this one.

One can easily see why people buy stuff online – it is so much easier to compare prices, shipping costs are now baked into the retail price, and you avoid crowds. I think shopping in crowds is a cultural event for a lot of people, in the quest for finding that elusive “great deal” that you can brag to all your friends about after.

This brings me to the subject of the valuation of Amazon (Nasdaq: AMZN), the largest online retailer. They are trading at $177/share, which gives them a market cap of about $80 billion. Amazon’s sales for the past 12 months were $31 billion, and income was $1.12 billion. So on a past 12 months basis, Amazon is trading at a P/E of 71x, or a yield of 1.4%.

Quite obviously, the market expects Amazon to grow a lot to fit into its present valuation. If the analysts are correct, Amazon priced in 2011 projected earnings will have an earnings yield of 1.96%, or 51 times earnings. You have to assume that Amazon will be able to grow their income considerably within a short period of time to begin to match some other firms with comparative valuations. For example, Walmart (NYSE: WMT)’s 2011 valuation has it at 12.1 times earnings, or an 8.3% earnings yield.

For Amazon to fit into this valuation, they will need to increase their bottom line profits by a factor of 5.9 times from what they have currently made over the past 12 months. This is a huge leap and there is obviously growth in the marketplace that can be better purchased elsewhere.

However, in terms of providing retail customers with a venue to shop in, they do an absolutely fantastic job. This is another classic case of a great company having a stock that you would not want to invest in at current valuations.