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  • Brett Schafer

Underdog Target will Outperform Amazon Over the Next Five Years

Last decade, and especially the last few years, Amazon has dominated the e-commerce space. They now do an insane 49% of all e-commerce in the United States, equivalent to 5% of all retail. When you add in AWS, prime video, Alexa, and the myriad of other services this company offers you can see why they hit a $1 trillion dollar market cap earlier this year. Traditional retailers like Sears, Macy’s, and JC Penny are headed for bankruptcy while the whole retail industry seems to be in panic mode. If you don’t believe me, look at the stock charts of the biggest grocery chains after Amazon announced its acquisition of Whole-Foods last year. The utter dominance from the big bad bully in Seattle has a lot of investors scared to invest in other retail. 

Two stocks have come out of the onslaught relatively unscathed: Target and Wal-Mart. Both have under-performed the broad market over the last five years, with Target up 32% and Wal-Mart up 38%. Those aren’t eye-popping numbers, but hey, at least they’re not Sear’s. Target’s valuation is disrespectfully low, with a price-to-earnings ratio (P/E) of 11.84 compared to the S&P 500’s 25.84. Even with the big sell-off over the last few weeks Amazon is one of the priciest stocks on the market with a P/E over 90. 

Target stock has been hit with a recent sell-off.

Now that you have some of the background, you shouldn’t be shocked from what I am going to say next. Target stock is going to outperform Amazon over the next five years. For reasons outlined below I believe Amazon has hit its peak market share, and retailers like Target are going to benefit because of it.

Target’s Outlook

If you look at Target’s third quarter earnings report, nothing really pops out at you. Sales were up 5.7% Y/Y while earnings per share were up 35%. Don’t expect EPS to continue to grow at these rates, as the trailing 9-month Y/Y growth rate was 20%. The only reason the stock dropped 10% or so was a decrease in operating margin, which management addressed on the conference call as a one-time inventory blip. With meh earnings like this you might be asking, why am I so bullish on this stock? It’s simple. With a stock price as cheap as this you don’t need  blowout sales reports, consistent growth is all that matters. Don’t forget the dividend either. Right now the yield is at 3.5%, with plans to raise the payout annually (for reference, Amazon doesn’t pay a dividend).

What has me really excited about Target is they are finally innovating on their point-of-sale, delivery, and e-commerce platforms. Last quarter digital sales were up a whopping 49%, prompting Merrill Lynch analysts to tell their clients to buy the stock. On the conference call executives reiterated that Target’s transition is just getting started and that earnings should continue to improve as they move into digital offerings. This company is in the very early stages of changing their business model to compete in the modern era, and investors will be rewarded handsomely once they finish.

Free store pickup on online orders is one of Target’s many new offerings. 

In summary, I like Target’s prospects as a competitor to Amazon, but I absolutely love their valuation and dividend. To me it looks like a classic value stock; a hidden gem in a beaten-down industry. 

Losing My Bullishness on Amazon

If you look at the facts I laid out above, it looks probable that barring any unforeseen circumstances Target’s stock price will improve and most likely beat the market over the next few years. However, I said Target’s stock was not just going to go up but outperform Amazon for the next five years.

Amazon has great products, great innovation, and a great executive team. The problem is their business model. They claim to be the most “customer-focused” company on the planet, which on its face seems fine and dandy. Problems occur though when your warehouse workers (i.e. the backbone of the company) are treated like dog shit. It has been documented numerous times how horrendous the conditions are inside Amazon’s fulfillment centers, a truly miserable experience for all the workers. And you’d be kidding yourself if you think they are going to stop there. The company just filed a patent for a device that can track a worker’s whereabouts in real-time. Amazon has gotten away with these POS tactics in the past, but their is no way anyone can survive treating their workings this poorly (well, I guess unless they are robots).

The second thing I would be nervous about if I was an Amazon investor is its data harvesting tactics. Just like Facebook and Google, Amazon is in the business of data, specifically every single one of its customers. As we have seen with Facebook, when you have a business model centered around getting as much user data as possible things can get a little messy. Now, unlike Facebook, Amazon’s whole business is not built on user data. Ask yourself this question though: how likely is it Alexa is going to start playing ads at some point? I’d say damn likely. 

Don’t think Amazon is immune from consumer backlash either. People are starting to smarten-up about this “customer-focused” facade and the lasting effects of contributing to Amazon’s growing power. Brands are smartening up as well. Tons of companies have been mercilessly destroyed after Amazon undercuts them by selling competing products on the platform themselves. Amazon is a virus to any company that it works with, sharing a product’s body and then killing it from the inside out.

Putting all this together, it should come as no surprise that the “boycott Amazon” pitch forks have started to form. If any of these revolts start gaining momentum (as an American citizen I hope they do) it is inevitable Amazon will slowly loosen its stranglehold on the retail industry. 

Amazon’s Loss is Target’s Gain

In the long-run Amazon’s loss is Target’s (and Wal-Mart’s, and America’s) gain. I am looking for Target to gain market share in e-commerce that hopefully can bring them on a level playing field with the monopoly up north. As they continue remodeling stores and improving their user experience same-store sales should increase which in turn will drive steady growth in EPS. Mark it down, from late November, 2018 onward Target’s stock will outperform Amazon. 

Disclosure: The author may have interest in the stocks talked about. 

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Listen On: Spotify Apple Podcasts Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capita

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