Retailers: Follow the Growth Online

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Retailers: Follow the Growth Online

There’s an old saying on Wall Street that investors should never bet against the US consumer. For decades, that was good advice as bounce-backs in consumer spending helped power the US economy out of most post-war downturns.

However, that truism was upended in the wake of the housing bust and financial crisis of 2007-2009. A toxic mix of weak economic growth, paltry gains in personal income and reduced access to credit prompted consumers to save more and focus on paying down debts rather than spending.

The good news is that this era of consumer austerity isn’t hitting all retailers and Americans are increasingly in a buying mood (see the chart, “Americans Open Their Wallets”).

Sales momentum at some of the largest US retailers was positive through the late summer “Back to School” season. The average North American retailer tracked by Bloomberg reported that same-store sales increased more than 6.2 percent in August, the fastest pace so far this year. The resurgence was broad-based, with solid gains in apparel, home goods, discount chains and department stores. These trends bode well for the all-important holiday spending season.

And while overall retail sales have been weak, e-commerce remains a growth market with online sales growing from under 1 percent of total US retail sales in late 1999 to more than 5 percent by the middle of 2012 (see the chart, “The Online Sales Boom”). Here’s a look at three stocks exposed to markets enjoying particularly strong consumer spending.

Amazon.com (NSDQ: AMZN) is best known as an online retailer of books, a business it pioneered in 1995. The company is now the world’s largest online retailer, selling digital and print media, electronics, apparel and myriad other categories of goods.

Amazon has been a disruptive force in the retailing industry and it’s now riding the growing popularity of ecommerce. The 2011 bankruptcy of Borders Books, once one of the largest and most respected booksellers in the US, largely stemmed from the fact that no bricks-and-mortar store can rival Amazon’s inventory of titles.

Amazon’s growing selection of electronics goods offered at discounted prices has represented a serious competitive threat for once-dominant electronics retailer Best Buy (NYSE: BBY) over the past few years. Best Buy has been forced to match Amazon’s prices to propel sales and the result has been weakening profitability and margins.

Increasingly, Amazon is becoming the dominant e-commerce destination site on the web. The share of Amazon’s sales driven by search engines such as Google has actually declined in recent quarters, a sign that consumers are searching for items directly on Amazon’s site and a testament to the power of its brand.

Buyers feel their online payments on the website are secure whether the goods they’re buying are sold directly by Amazon or by third-party sellers who simply use the company’s website and payments system to market their products.

The company’s low-cost distribution platform, which includes advanced inventory management systems and a network of warehouses, conveys a major cost advantage over traditional retailers. As the share of retail sales conducted online continues to jump in coming years, look for Amazon to be a major beneficiary.

Perhaps the most important near-term growth driver for Amazon is its digital media business and the Kindle Fire tablet computer. The company recently introduced four new versions of the tablet that will be available in time for the 2012 holiday season, including a 7-inch Fire priced at $159 and three high-definition (HD) Fire models priced at $199 to $499.

While Amazon is tight-lipped about the manufacturing cost of the Fire, most believe the company prices the units at close to cost and makes its profits by selling to consumers digital media delivered to the tablet.

Amazon has been particularly aggressive in expanding the video content it conveys to Amazon Prime subscribers via the Kindle. Most recently, the online giant inked a deal with pay television station Epix to offer the latter’s titles, including content produced by Viacom (NYSE: VIA) and its subsidiary Paramount Pictures, as well as Lions Gate Entertainment (NYSE: LGF) and Metro-Goldwyn- Mayer. That deal brings Amazon’s library of video titles to over 25,000.

Trading at 2.2 times sales and 65 times 2013 earnings estimates, Amazon.com is not a cheap stock but that valuation is justified by its growing dominance of the online retailing industry.

Ebay’s (NSDQ: EBAY) eponymous auction website allows users to buy and sell goods over the Internet either through a competitive auction process or for a pre-set price. In addition, the company also owns ticket re-seller StubHub.com, Half.com and a number of other online properties. These websites combined have over 100 million users and account for about two-thirds of operating income.

However, while eBay’s e-tailing websites will benefit from the continuing shift in favor of online sales, a stronger growth prospect for eBay is its PayPal payments division. Pay- Pal allows retailers to set up an account and process credit and debit card charges often in a matter of minutes. The system also handles sensitive customer credit card data on customers’ behalf.

In addition, PayPal allows users to set up an account to pay merchants providing only their e-mail address and a password rather than typing in their credit card details online.

Favoring online sales is the accelerating move towards a cashless society— consumers are increasingly paying for goods with credit and debit cards rather than with cash and checks. PayPal is a major beneficiary of this revolution in retailing. Meanwhile, operating income from eBay’s payments segment is up more than 60 percent year-over-year.

eBay has partnered with Discover Financial Services (NYSE: DFS) on a deal to facilitate offline transactions. Once the partnership is completed, PayPal users will be able to use their account at any merchant that accepts the Discover card.

Payments can be made either using a traditional plastic PayPal issued card or via a PIN-based mobile transaction on a smartphone linked to their account. The service is scheduled to start with 1,500 large merchants in the second quarter of 2013 and will be rolled out across the Discover network.

While the rise of online retailers has hit profitability for some types of brick-and-mortar retailers, there’s still plenty of value in the offline world. One example is Home Depot (NYSE: HD), the world’s largest home improvement retailer.

Spending on new home sales has been weak over the past three years, but consumers have continued to spend on remodeling their existing properties, pushing up demand for the kitchen equipment, paint, flooring and hardware that are the core of Home Depot’s business mix. With home sales and prices finally showing modest signs of firming up this year, Home Depot should benefit.

Home Depot’s second-quarter 2012 results beat consensus expectations. The company reported $1.01 in earnings per share (EPS), compared to the estimate of $0.98 in EPS, and revenue of $20.57 billion, compared to the estimate of $17.81 billion. EPS rose 17.4 percent, while revenue climbed 1.7 percent, compared to the same year-ago period. Learn to spot your own superstar stocks, with our free report, The 4 Secrets of Great Value Invetors.