Last week, a respected Citi analyst released a report stating that the physical entry of Amazon.com Inc (NASDAQ:AMZN) into the Australian market would put a significant dent in the profits of retailers such as JB Hi-Fi Ltd (AX:JBH) and Harvey Norman Holdings Ltd (AX:HVN). While there is currently no official announcement that Amazon are moving here in the near future, it is believed they are on the hunt for warehousing space in Western Sydney. Australians may not realise that in other countries Amazon has a wide online product offering, much like e-Bay, compared to the Amazon Australia website which offers only books and related products.
The main hurdle for Amazon is the logistical challenge of transporting goods the large distances around Australia which would therefore require several distribution centers. Smaller countries, like England, do not have this problem. Assuming Amazon can overcome this challenge, they will become a direct competitor to the existing Australian retailers and this surely makes them nervous.
In a relatively short space of time, Amazon transformed itself from being purely a book retailer to being a general consumer products retailer and is now the largest online retailer in the world by total sales. The Amazon business model is a relatively low margin model compared to some of the high margin Australian retailers. Amazon’s founder Jeff Bezos once commented ‘your margin is my opportunity’ meaning that wherever a high margin business operates, there is space for a competitor to come in with a smaller margin and take market share from the incumbent. The Citi analyst estimates that entry of Amazon into Australia could reduce JB Hi-Fi’s EBIT by 23% and Harvey Norman’s by 19%.
This situation has been playing out over the past few years in the supermarket space. The business model of the entrenched supermarket chains has been placed under significant pressure from the entry of international low cost supermarkets such as Aldi. The Woolworths Ltd (AX:WOW) share price clearly reflects the effect of this pressure with the supermarket chain struggling to regain its former dominance in the grocery space. This pressure is unlikely to ever relent, as the possible entry of competitors is an ever present threat.
As usual, Australia is late to receive what the rest of the developed world already has. In the case of the full Amazon offering this might change soon if the rumours are to be believed. While this will certainly place pressure on the existing Australian retailers, it will undoubtedly be good for the consumer. Nevertheless, without firm plans to move here JBH and HVN need not get too stressed for the time being.
Aside from being the largest online retailer in the world, Amazon has also had exceptional stock price growth over the past five years. In that time, the share price has gone from $212 to $836, an increase of 3.94 times. The question is, have the underlying business fundamentals increased at a similarly rapid rate?
Looking first at revenue, we find that total revenue has increased from $48bn in 2011 to $107bn in 2015, representing a compound annual growth rate of 22%. Unfortunately, operating expenses have increased at a similarly rapid rate and therefore the net income after tax in 2015 was just $0.6bn. This, then, is clearly a growth story with the bullish case assuming continued strong revenue growth.
In particular, Amazon Web Services (AWS) is a segment of the business that is currently highly profitable and is expected to grow significantly in the future. AWS offer cloud computing services with a wide range of functionality that provides computing power to customers without them having to build their own servers etc. Considering the trajectory of technology, cloud based services appear to be the way of the future. All of this comes with a cost, however, with Amazon’s R&D expenses continuing to grow and investment spending in AWS is likely to be significant in coming periods.
Broker price targets are generally quite bullish at the moment. For example, J.P. Morgan has a target price of $1,000 for December 2017. Another broker, S&P Capital IQ are less bullish but still have a one year price target of $850, a small increase over the current price.
This article was written by William O'Loughlin - Local Investment Analyst, Rivkin Securities Pty Ltd.