Ernest Hemingway once stated “there is no friend as loyal as a book”. In considering its unfathomable rise from humble online bookseller to global retail sector dominance, there is clearly no-one as loyal as an Amazon (AMZN) customer.
Having celebrated the 20th anniversary of its IPO earlier this year, it seems hard to believe that Amazon’s flotation in 1997 established a market valuation of ‘only’ $438 million (£336 million). As the online behemoth prepares to deliver its quarterly results this week, it can now boast of a market capitalisation approaching $500 billion.
As it seems increasingly hard to remember a past before Amazon, it becomes difficult to envisage a future without it. The “Amazon Effect” is rapidly casting its shadow across the entire retail sector.
Place your bets
With Amazon’s shares accounting for a third of the S&P 500 retail index, the company’s domestic market is feeling the full force of its seemingly unstoppable ascent.
US hedge fund managers are suggesting that the retail sector may be the next “big short” and this cannot simply be dismissed as hyperbole.
The markets will be quick to accommodate the bears predicting the death of traditional retail space as we know it. ProShares is one of the first major US exchange traded fund (ETF) players to join the party.
The ETF manager filed prospectuses with the US Securities and Exchange Commission this month as it plans to launch three funds betting against the traditional bricks-and-mortar retailers.
The fall of the malls
Malls are being hit hardest by this rise of e-commerce. A research note issued by Credit Suisse in May tried to quantify the potential extent of the fall out, predicting that up to a quarter of all US malls will shut down by 2022.
The retail apocalypse has reached a crescendo this year as store closure announcements and bankruptcies gather pace.
Michael Kors (KORS) confirmed in the second quarter that it will close up to 125 of its stores, with J C Penney (JCP), Sears (SHLD), Abercrombie & Fitch (ANF) and Macy’s (M) all currently downsizing.
Credit Suisse estimates that approximately 8,640 US stores will close by the end of 2017. This retail sector decimation will exceed the peak closure levels endured during the financial crisis.
Retail space or retail wasteland?
While Amazon may sound the death knell for hundreds of malls and retailers over the next decade, it is important to put the US retail sector into context.
The Amazon Effect is more pronounced in the US because there is a comparative abundance of retail space. Simply put, the sector has been far too aggressive in growing retail space over the last couple of decades.
This level of expansion has far exceeded organic demand which is typically equated with population growth. The following 2017 infographic compares square feet of retail space per 1,000 people on a country-by-country basis.
The figures speak for themselves. In terms of the countries analysed, the US has over double the retail space of its nearest rival, Norway. The chasm widens further when considering other developed nations, with multiples of approximately nine and 11 applying to Italy and Germany respectively.
Emerging markets are characterised by growing levels of disposable income, investment in infrastructure and an increasingly visible middle class. However, the world’s largest economy has 51 times the retail space of China, with India subject to an incredible multiple of 400.
The undeniable fact that people are now happy to eschew the traditional shopping experience altogether has enhanced the overcapacity problem, thus leading to the Amazon effect.
The Morrisons story
It may be worth embracing the enemy rather than engaging in any ill-conceived notions of competition. Morrisons (MRW) is a notable success story in this regard, having joined forces with Amazon in 2016.
After agreeing to supply the online giant with fresh produce for its Amazon Fresh service, profits in Morrisons rose by 13.5% in the first six months of 2016. This was the first increase in profits since 2012 for the beleaguered supermarket chain.
Despite Q2 Financial Conduct Authority data identifying Morrisons as currently being one of the most shorted stocks in the UK, its share price has risen 8% in 2017.
TK Maxx and the impact of deep value
In a June research note from US firm Cowen, senior equity research specialist Oliver Chen identified seven retail companies as being “un-Amazon-able”. He noted that “…deep value companies or luxury goods companies are… less vulnerable to share losses vs. Amazon”.
These “super-value” retailers included The TJX (TJX) Companies, a corporation which has a very familiar UK presence in the form of TK Maxx. David Bucolo, senior securities analyst at Aviva Investors, considers its uniquely evolving product line as a key component in ensuring ongoing profitability.
He noted in November last year that “every week the merchandise will be different. That generates customer loyalty, because customers will keep returning to see what’s new”.
In conclusion, the Amazon Effect may have been most destructive in the US but the global retail sector is undoubtedly standing up and paying attention.
While it may be too late for many traditional US retailers and malls, the retail sector in other markets may still have some breathing space. Perhaps the sector can look towards some UK companies for inspiration.
Whether it is a case of collaboration (Morrisons) or establishing unique selling points (TK Maxx), the need to evolve is becoming increasingly prevalent in the Amazon era.
Customer wishing to gain exposure to Amazon, Morrisons or The TJX Companies can trade the stocks directly on-line or over the telephone.
Other companies mentioned in the Cowen research note, for example Ross (ROST) and Costco (COST), are also tradable via our international dealing service. ETFs may present the best way of investing in an index such as the S&P 500.
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