Online Retail Stocks Priced Like a Major Growth Industry in the Weird New-Normal
If you somehow weren’t convinced a market bubble is taking place, read on. Online retail stocks are fetching valuations that would make biotech blush, even though earnings growth prospects are slow and predictable. It’s a real head-scratcher, even for market bulls.
Owing to “new” retail’s valuation of 65-times earnings (17-times for traditional brick-and-mortar retail stocks), the S&P retail sector is collectively valued at 26-times earnings. That’s over double the historical premium retail usually trades at to the S&P 500. (Source: “The Difference Between “Old” And “New” Retail? A Record 50x PE Turns,” Zero Hedge, July 20, 2017.)
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The puzzling thing for investors is that retail stocks are being priced like growth stocks. This is made possible by the likes of Amazon.com, Inc. (NASDAQ:AMZN), whom investors can’t seem to get enough of. But it’s not like online retail is anything new. Many of the leaders have been around since the Tech Bubble collapse, and have taken many years to generate any profit. They may be stealing market share, but retail will never be a “growth” industry. After all, the National Retail Federation (NRF) only expects combined retail sales to grow 3.7%-4.2% in 2017. (Source: National Retail Federation estimates 8-12% US e-commerce growth in 2017,” Business Insider, February 10, 2017.)
To be fair, the NRF does expect online retail market share to grow between 8%-12% until 2020. This is about three times more than the rate of brick-and-mortar retailers (2.8%). But still, at the end of the day, everybody is fighting for the same pool of consumer dollars. Growth will always be what it is because consumer spending is largely inelastic.
Valuation by Industry within Retail Sector |
|||||
| P/E | Price / Sales | Price / Cash Flow | Price / Book | ||
| Industry | Quarter | (TTM) | (TTM) | (TTM) | |
| Pharmacy Services & Retail Drugstore | 1 Q | 13.77 | 0.29 | 10.65 | 2.85 |
| Grocery Stores | 2 Q | 18.74 | 0.23 | 5.12 | 3.3 |
| Home Improvement | 2 Q | 23.7 | 3.01 | 26.92 | 6.37 |
| Specialty Retail | 2 Q | 6.58 | 0.34 | 4.93 | 1.59 |
| Technology Retail | 2 Q | 226.28 | 8.04 | – | 28.04 |
| Automotive Aftermarket | 2 Q | 18.14 | 0.74 | – | 3.9 |
Data courtesy of CSIMarket, Inc.
In the meantime, evidence of a consumer spending slowdown keeps growing.
In the first quarter ending March 2017, GDP slowed to a 0.7% annualized rate, the slowest pace in three years. The biggest culprit? A slowdown in consumer spending. Big-ticket consumer durables took the biggest hit. Sales of things like automobiles and household appliances slowed to levels not seen since 2009. (Source: “U.S. GDP Growth Slowed on Tepid Consumer Spending,” FOX Business, April 28, 2017.)
Not coincidentally, the 10-year benchmark bond yield rose from 1.83% before Donald Trump was elected, to a high of 2.63% in March 2017. While this wasn’t a huge nominal gain, it was huge on a percentage basis and was probably responsible for the slowdown in GDP growth experienced in the first quarter. In other words, consumers are so cost-sensitive that a small 80-basis-point gain in the 10-year bond (in which lending rates are influenced) caused a demand slowdown. Do retail stocks seem like the place to be given this?
We’re at the point of the business cycle where investors should be running away from retail stocks. Growth has peaked, interest rates are moving higher, and consumer spending has never really taken off since the U.S. Housing Bubble.
Possible Trouble Ahead from Online Retail Stocks?
When we talk about online retail stocks, we’re really talking about one company: Amazon. It’s responsible for about half of all online sales, and that share is growing. But the incredible valuations ascribed to them may not last forever. Trouble is rising on a couple flanks.
For one, there’s growing talk in D.C. circles that Amazon is getting too big. While Amazon’s top dog Jeff Bezos has never testified before Congress, the rumblings are getting louder. The top Democrat on the House antitrust subcommittee, David Cicilline, has voiced concerns about Amazon’s $13.7 billion acquisition of Whole Foods Market, Inc. (NASDAQ:WFM). He’s even requested a hearing to flesh out the potential impact on consumers. Cicilline said “Congress has a responsibility to fully scrutinize this merger before it goes ahead.” (Source: “Congress Begins To Ask If Amazon Is Getting Too Big, Antitrust Hearing Called,” Zero Hedge, July 14, 2017.)
Regardless of the action or inaction Congress takes, other players have Amazon squarely in their sights.
Wal-Mart Stores Inc (NYSE:WMT) has taken aggressive measures to re-steal market share back to their camp. Since August 2016, Wal-Mart has acquired e-retail sites Jet.com, ShoeBuy.com, and Moosejaw.com. If the deep-pocketed corporation is able to harness its online properties, it could result in a price war between the two retail titans. That’s great news for consumers, not so great for profits where margins are already razor-thin. After all, it took Amazon almost twenty years to figure out how to make money.
Ultimately, online retail stocks are just the tip of the spear. Their valuations are little rooted in reality. But then again, the same could be said for much of the market.
