Chipotle Valuation Surging to Dizzying Heights, Surpassing Amazon!

It should not be surprising that hiring a veteran restaurant executive to replace an inexperienced founder will have a material impact on the business and its stock. Chipotle Mexican Grill (CMG) is a classic example, as Steve Ells stepping aside for Brian Niccol (formerly of Taco Bell) has launched CMG’s shares into the stratosphere:

CMG’s customer traffic has rebounded (+2% in Q4 2018) after flat lining earlier in the year and material price increases (+4% in Q4 2018), which were sidestepped after the e coli incidents, have same store sales rising 6% and profits surging even faster. The current analyst consensus estimate has CMG earning $12 per share in 2019 on a mid single digit same store sales increase and 5% unit growth. Those figures would place CMG near the top of the sector.

As is often the case, the biggest issue is the magnitude of CMG’s recent stock gains. At more than $600 per share, CMG’s forward price-earnings ratio is a stunning 50x. Why a casual dining chain with 2,500 locations already should trade at such a valuation is hard to understand, unless one believes they are going to steal a lot of market share going forward from here. Many folks believe that will happen, but I am less excited.

To give readers a sense as to how nutty this CMG valuation appears to be, let’s compare it to Amazon (AMZN). I know AMZN is not a dining stock, but I find it to be an interesting comparison because they are both loved consumer brand stocks right now. Not only that, I would venture to guess that an investor poll would conclude that Amazon’s business is better than Chipotle’s and is likely to grow revenue and profits faster over the coming decade. And yet, today we can invest in Amazon at a cheaper valuation:

Looking at 2018 reported financial results, CMG trades at 31x EV/EBITDA, versus 28x for Amazon. I used EV/EBITDA to account for balance sheet items as well, but on a P/E basis the numbers are also similar: 50x for CMG and 59x for AMZN.

For those who are intrigued by Chipotle stock, I would simply point out that Amazon has long been a loved growth stock for which investors are often willing to pay sky-high valuations for. Today an argument can be made that CMG is more expensive and you would have a hard time finding people who expect CMG’s business to outperform AMZN in coming years.

If that’s true, either CMG is overvalued quite a bit, or AMZN is relatively cheap, or both. I would bet that AMZN outperforms from here. For those who like paired trades, being short CMG against an AMZN long looks interesting.

My Recent Target Experience and How The Chase for E-Commerce Market Share is Killing Retailer Margins

There is a Target (TGT) store very close to my house that my family visits frequently. We even keep a shopping list on the fridge labeled “TGT” to simplify our trips.

Given the vast selection of products Target carries, sometimes it is harder to find something in the store than you would think, even if you are very familiar with the layout. To minimize the time we meander up and down various aisles, I have the Target app installed on my phone, which will tell me which aisle each product is located at my local store.

In recent months I have noticed that the prices on the app for many categories are materially cheaper than they are in store. This becomes obvious when you lookup the location of something on the app, see the price, and then 30 seconds later you pick it off the shelf and see a clearly higher price. I would say the discounts average about 10% (just a guesstimate) and are focused on certain categories such as toiletries and cleaning products.



After several trips of noticing the pattern, I became pretty annoyed. If my bill totaled $100 I invariably felt like I was getting ripped off by shopping in-store, even if only to the tune of $10 or so. I looked up Target’s online price matching policy and sure enough, they will match their online pricing for in-store purchases.

The process for collecting the difference is far from helpful, though. Rather than visiting the customer service area and having them scan your receipt or something easy like that, you need to show evidence of the lower price online while the cashier rings up your purchases. So if you have a dozen items that are cheaper online, you need to show the cashier each item on your phone app individually and they will then manually enter the cheaper price for each item. Not only is this time consuming, but it will make the check-out experience awful for the people in line behind me, as they wait for me to bring up each and every item on my phone. As a result, I refuse to do this and am ticked off that I need to in the first place.

The other day I decided that I could have the best of both worlds. Even though the store is right down the street from my house, I can order the items online, have them delivered in 2 days, and save money on top of that by getting the lower online prices. So I fired up the app and began adding items to my cart.

Without a Target Red Card, there is a $35 minimum order to get free 2-day shipping. I was short of that level initially, so I decided to see if they would actually deliver cat litter for free (many retailers have weight limitations for free shipping). I thought it was a long shot since each box of litter weighs over 25 pounds, but sure enough, cat litter is eligible for free shipping. By adding 2 boxes I reached $36 and submitted my order.

Two days later a large flat shipping box was left on my porch by UPS. The box was nearly coming apart, as both boxes of litter had been placed flat/sideways in the shipping box, with some soap and toothpaste tossed in as well without much in the way of padding. I have no idea how much UPS charged Target to deliver this 50 pound box to me in 48 hours, but I would have to say somewhere between $5-10, right? There is no way Target made a profit on this online order and I am not paying them an annual membership fee (like Amazon Prime) to help cover the cost.

Why am I telling this boring retail story? Because when we consider the economics of the decisions Target is making here, it makes no sense. My local Target store has high fixed costs. They should want me to drive to the store, pick my own items off the shelves, go through the self-checkout lane, and drive home. That route will maximize their profit by leveraging their fixed costs and minimizing labor expense, which is only rising (and is now $15 per hour here in Seattle).

Instead, they are offering me higher prices if I visit the store, and that is made obvious to me when the lower online prices are shoved in my face whenever I use the smartphone app (which they encourage me to use in-store to boost the shopping experience). From an economic perspective, they should be trying to coax me into the store by offering perks for doing so. Instead, they are almost begging me to order online, where they will likely barely earn a profit on each order, if at all.

And on the flip side, they are offering cheaper prices online, with free 2-day shipping, and including products such as 25 pounds of cat litter in the free shipping offer. At least make me drive to the store to pick up the cat litter!!!

So, here I am planning to order more of my Target purchases online, which will crush their margins both on the retail side (as store traffic declines) and on the online side (where 2-day shipping via UPS will eat their already reduced margin).

The result is that Target succeeds in their goal of keeping my business and not donating it to Amazon (AMZN) or Wal-Mart/jet.com (WMT). Okay, great, your same store sales will hold up nicely in a very competitive retail world. And your margins will erode quickly, resulting in the same absolute profit dollars earned on higher volumes. Seems like the opposite of what should be happening (keep prices low and make it up on volume).

In fact, there are some items at Costco (COST) that are cheaper in store than they are online, even though this flies in the face of what chains like Target are doing. And that pricing strategy is from a company that chooses volume over per-item margin all the time. In fact, Costco marks up their items (from their cost) the least of any retailer I am aware of. Smartly, they are not getting sucked into this notion that to compete online and keep their stock price up, they need to give away products through the e-commerce channel.

Call me crazy, but some of these hybrid online/in-store business models don’t seem very well thought out, and surely won’t benefit shareholders much in the long run. I love shopping at Target, but it is hard to see how they are going to materially increase per-share profit.

Full Disclosure: No position in Target, long or short, just baffled by the pricing dynamics they currently have in place and believe it reinforces that we are now seeing retailers focus on same store sales and not profits, even at mature, established companies which clearly are not second-comings of Amazon.

Canada Goose: Brings Back Memories Of Other Fashion Stock Heydays

In the spirit of fashion, let me begin this article off with a runway of sorts, even if it is a lineup of stock charts rather than models.

Here is a chart of Michael Kors (KORS)  stock since its late 2011 IPO. Notice the move from $20 to $100 by early 2014:

Here is Coach stock — now called Tapestry (TPR)– since its IPO in 2000. In this case there were two separate astronomical run-ups, neither of which could be maintained.

Abercrombie and Fitch (ANF) was scorching hot when I was in high school in the late 1990s:

And one more: UnderArmour (UAA):
There are many things these companies have in common, and not all bad actually. For instance, notice how all of these brands have survived and built sustainable multi billion dollar businesses?

But on the flip side, the stocks have been duds over long periods of time. While they have been volatile (making for plenty of trading opportunities in both directions), the reason why none of them have been good long-term buy and hold candidates is because fairly early on in their stints as public companies the brands were so popular that the stocks became massively overvalued. So even though the businesses continued to grow, the stocks turned out to be poor investments.

It has been a little while since we have seen a surging fashion brand on Wall Street (UnderArmour likely the most recent), but recent IPO Canada Goose fits the mold. Here is the chart since the 2017 IPO:

GOOS currently is valued at $6 billion USD, versus expected 2018 revenue of $420 million, for an enterprise to sales ratio of ~15x. Even with 20% growth in 2019, to $500 million (the current Wall Street analyst consensus estimate), the multiple is ~12x.

Consider what types of enterprise value-to-revenue multiples the large fashion brands currently trade for:

Tapestry 2.5x
Michael Kors 2.3x
Ralph Lauren 1.5x
Tiffany 3.9x
Nike 3.5x
UnderArmour 1.8x

There is simply no way to justify such a sky high revenue multiple for GOOS. The median revenue multiple from the group of 5 comparables above is 2.5x. So how much does GOOS need to grow over the next decade to simply justify the current stock price? The numbers come out to an 18% compounded annual growth rate from 2018 through 2028, which gets the company to roughly $2.2 billion of annual revenue:

$420M * 1.18^10 = ~$2.2 billion

Put another way, if the business grows from $420 million this year to $2.2 billion in 10 years, and the shares trade at 2.5x EV/revenue at that point in time, the stock price will go nowhere even though sales would have grown by 424%!

The only way these numbers don’t work is if GOOS has somehow figured out  a way to sell clothes for far higher profit margins than the leading fashion companies in the world, which have already amassed multi-billion dollar businesses. Betting on that outcome seems ridiculous to me.

As a result, although it can be tempting to jump on highflying recent IPOs like GOOS, thinking it could be the next big thing in fashion, it is important to realize how lofty the valuations can be. And if stock prices reflect plenty of growth already in future years, the share price will not have to follow suit.

One last example, outside of the fashion space — remember how bonkers investors went for the Shake Shack IPO back in January 2015? Take a look at how the shares have done since hitting $96 in May 2015:

And that is despite SHAK’s revenue surging 137% from $190 million in 2015 to an expected $450 million in 2018.

GOOS buyers beware.

Amazon Shares Pierce $1,430 And Sit Firmly Above 3x 2018 Forecasted Revenue

Valuing shares of Amazon (AMZN) has always been a difficult task since the company does not at all care about short-term profit margins. Investors are left with trying to estimate, based on the company’s various businesses, how large each will get and what type of margins will likely be achieved once each reaches maturity.

Of course, such an approach becomes nearly impossible when you have no sense of which businesses Amazon will choose to enter over time (or maybe the better question is which they will “not” enter). Traditional retail was one thing, but now with cloud services and advertising revenue, margins are going to be all over the map.

I recently trimmed many of my clients’ positions, as I have done once or twice since I made the investments beginning in 2014. My methodology has been inexact, to account for the aforementioned issues regarding Amazon’s various ventures, but it generally involves looking at AMZN on a price-to-sales basis and then seeing what margin/multiple assumptions are baked into such valuations. For instance, if you think they will ultimately earn a 10% profit margin at maturity, you might be willing to pay 20 or 30 times normalized profits, which would equate to 2-3 times annual revenue.

Given the company’s growth, my personal view is that anything up to 3x revenue is at least somewhat reasonable, as I don’t see margins going above 10% given the company’s desire to remain value-based in the eyes of consumers, and anything over 30x profits for a growth company makes me nervous. And if someone argued that they will never reach 10% margins and a 30x multiple is too high, I can totally understand that view. I just think some valuation flexibility is warranted given that Bezos might actually get as close as anyone in business to total world domination.

So below I have posted updated graphs that show Amazon’s stock price over the last two decades or so (not very helpful when trying to evaluate the valuation), as well as their year-end price to trailing 12-month revenue ratio (far more helpful in doing so). Note: the 2018 data points are based on today’s stock price and consensus 2018 sales estimates.

As you can see, AMZN stock hovered around the 2.0x price-to-sales ratio level between 2004 and 2014, with a range of 1.5x-2.5x or so. In recent years, as momentum stocks have led the market higher, that number has surpassed 3x and currently sits around 3.2x.

Given that position sizing in portfolios is always important to me, this graph tells me that now is not a bad time to trim AMZN. Trading above 3x revenue would seem to indicate that investor sentiment is quite high. There may be good reasons for that, of course, but as the company gets bigger and bigger, its growth rate is sure to slow. In fact, in order to grow by the 29% rate that Wall Street analysts are expecting in 2018, total sales need to rise by a stunning $51.5 billion. That very well might happen (and acquisitions like Whole Foods will only help), but when growth slows to only 10 or 15%, investors might not want to pay 3.2x revenue any longer. In my mind, anything above 3.0x tells me to tread carefully.

What do you all think? What kind of profit margins do you think AMZN will earn at maturity (i.e. when its growth rate is in-line with the average company)? What multiple of revenue seems right to you?

Full Disclosure: Long shares of Amazon at the time of writing (even after selling a chunk at $1,400 recently), but positions may change at any time

What A Difference A Strong Holiday Season Makes: Retailing Stocks Back From The Dead

Back in the second quarter of 2017 I wrote a four-part series of posts on the bricks and mortar retailing sector (Part 1: department stores – DDS & KSS | Part 2: mall owners – SKT & SPG | Part 3: balance sheet strength | Part 4: possible LBOs – JWN, DDS, URBN) focused on how Wall Street was pricing many companies as if they were essentially finished as profitable businesses.

Here we are after a strong holiday shopping season where online and bricks and mortar stores shared in the cheer and investor sentiment has shifted dramatically. This is notable because the businesses are the same today as they were back in May and June.

While the mall operators are largely unchanged, aside from above-average dividend payouts, profitable retailers with strong balance sheets have been on a tear. For example, Kohl’s (KSS) is up nearly 100%, hitting $67 today on an analyst upgrade. Similarly, Urban Outfitters (URBN) has doubled from $17 to $34 and Dillards (DDS) has jumped nearly 50% from $48 to $70.

The Kohl’s situation is interesting because the stock is jumping $2 today after a Jefferies analyst raised his price target by a whopping 50% to $100 per share (from $66). If that sounds like a crazy number, it is. While I was positive on the company in the $35-$45 area, after a move into the 60’s it warrants a skeptical eye going forward.

I had been using a $60 fair value estimate, based on 6x EV/EBITDA and 10x free cash flow. After all, this is a department store chain that will report lower revenue in 2017 ($19.0 billion) than it had five years ago in 2012 ($19.3 billion) and I wanted to use conservative estimates. Profitable and stable off-mall retailer? Check. Solid balance sheet with lots of owned properties to offer a margin of safety? Check. Growth company that stands to take market share? Not so much.

Slow/no growth department stores (JCP, DDS, M, KSS) have traditionally traded for 6x EBITDA. Unless you believe KSS can grow their business materially, a $100 stock price seems overly aggressive at 9x EBITDA and 17x free cash flow.

Although retail sales will continue to rise in the low single digits thanks to inflation and population growth, department stores will likely still cede market share slowly over time to online channels, as well as new store concepts. That trend likely explains KSS’s flattish five-year sales performance.

After a huge run, investors now believe that these companies will survive and do decently well, which is a huge shift in sentiment from 6-12 months ago. I consider many of the stocks trading at/near a fair price today, especially considering that revenue growth will still be hard to come by. In addition, the odds are low that media headlines focusing on the Amazon  threat, dead malls across the country, and bricks and mortar bankruptcies are a permanent thing of the past. Like many trends in the financial markets, I suspect we will get another good entry point in traditional retailers down the line when sentiment shifts yet again.

As for riding KSS from $67 to $100, I will leave that bet for Jefferies to make, as the stock is far less attractive today from a risk-reward perspective than it was at $36 last year. Most of these stocks seems like contrarian, sentiment-timed intermediate term trading vehicles more than multi-year, buy-and-hold investments.

Full Disclosure: Long shares of AMZN common, DDS debt, JWN common, KSS common, and SKT common at the time of writing, but positions may change at any time.I have been selling down existing positions in KSS recently, although not every share has been sold yet.

 

AutoZone Three Months Later: Sentiment Shifts Dramatically Again

We are not quite three months from my last piece on AutoZone (AZO), which back in mid September was in the midst of a nasty stock price decline, and now investors seem to feel a lot better about the company’s business. Of course, this is bizarre because AZO is a very large player ($11 billion of annual revenue) in a very stable industry and should therefore be mostly insulated from stock market volatility and immense shifts in short-term investor sentiment.

Below is the five-year stock price chart of AZO I shared back in September when investors were overwhelmed with negativity:

And here is an updated version that shows the last 12 months:

Why exactly a company of this size, with no material change in its business outlook could trade for as low as $497 on August 15th and as high as $763 on December 5th shows just how much the current bull market has lost a sense of rationality. That is a 53% move, for a $20 billion market cap company, in a matter of months.

So how does this happen? My guess is that the markets today are mostly driven by index funds, exchange traded funds, hedge funds, and computerized algorithms. The fundamental bottom-up investors are dwindling in numbers by the day. It is not uncommon for me to meet people who are struck by the notion that I pick individual stocks. The market has been so strong for the last nine years that indexes are now considered to be the only wise investment. It is amazing how much views shift based on where we are in the market cycle. You didn’t have famous investors extolling the virtues of index funds from 2000-2008 (a nine-year period where the market had negative average annual returns), but now that the following nine years have produced +15% average annual returns, all of the sudden they are a “no-brainer” investment.

As someone who strongly believes in the cyclicality of the economy, financial markets, and investor sentiment, the AutoZone example is evidence that picking individual stocks is not silly and the markets are far from efficient. Moves like those in AZO in recent months make my job much more difficult in periods like this, when individual stock moves often make little or no sense based on fundamental research, but as long as opportunities continue to present themselves, I plan to maintain my role as an active manager of client assets. There will always be a place for index investing (for my clients it is mostly through their work retirement plan), but the ease at which it produces stellar returns will continue to ebb and flow with the market cycle.

As for AZO itself, it is hard to argue the shares are anything but fairly valued today. It will be hard for the company to grow their business (in unit terms) given the maturity of the U.S. economy and online competition, and the stock now trades for roughly 18x my estimate of normalized fee cash flow, versus just 12.5x when the shares fetched $500 each. That sounds about right to me.

Full Disclosure: Long shares of AutoZone at the time of writing (holdings have begun to be reduced recently and those trades will continue into 2018), but positions may change at any time

Is The CVS Health/Aetna Proposal Really Just About Amazon?

Financial journalists seem to have a pretty simple playbook these days. Most any retail-related corporate development is a direct result of Amazon (AMZN). Plain and simple. No questions asked.

Last night it was reported that CVS Health (CVS) has made a bid for health insurer Aetna (AET). Immediately the media closed the book on the strategic rationale for the deal; Amazon might soon start offering mail-order prescriptions and CVS needed to make a bold move to counter that attack.

If CVS is really most worried about Amazon stealing away its pharmacy customers, would the best counterattack to be buy the country’s third largest health insurance company? Does that make sense?

It seems to me that the best competitive move to help insulate you from losing prescription share to Amazon would be to buy a last mile delivery company and use it to offer same-day or next-day prescription delivery to the home. After all, it is not like Amazon has any scale in the drug wholesale business, considering that they have yet to even enter the business to start with! And even if they do get into the business, are they really going to be able to get better pricing for drugs than CVS can, with its existing network of 10,000 retail pharmacies?

I would suggest that the CVS bid for Aetna is more about extending their corporate strategy of becoming a vertically integrated healthcare services provider. You have to remember that CVS bought Caremark, a pharmacy benefits manager, or PBM, more than a decade ago. They started Minute Clinic, the largest retail walk-in clinic chain in 2000. They acquired Omnicare, a pharmacy specializing in nursing home services, in 2015. Becoming more than just a retail pharmacy chain has long been the entire idea behind the company. It also explains why reports say that CVS and Aetna have been talking for six months (this idea was not just thrown together quickly because Amazon is applying for pharmacy licenses).

Adding a health insurer to the mix was a logical extension of that. Competitor United Health took the opposite route, as an insurance company that added Optum Health, a PBM, later on. That strategy has been wonderfully successful and I suspect that CVS and United will dominate the integrated healthcare services business for years to come.

Of course, the narrative on Wall Street has nothing to do with any of this. CVS stock is getting crushed today and United Health is up three bucks. The one-year charts make it seem like these businesses have nothing to do with each other:

To me it is simply baffling that UNH trades for 21x 2017 earnings estimates and CVS commands just 12x. If CVS really does build out a UNH-like operation, with a small retail pharmacy division, I can’t fathom how that valuation gap won’t narrow over time. But the investor community right now just can’t get that bricks and mortar component (no matter how small it would be post-Aetna) out of their heads.

What is probably most interesting is that Amazon does not have a history of putting companies out of business when it enters new markets. Amazon started selling books online in 1994. It launched the Kindle e-reader in 2007. If any bricks and mortar retailer should have been gone by now, it would have to be Barnes and Noble. And yet they are still alive and kicking:

A lot of people thought that Best Buy was finished once Amazon started selling a huge selection of consumer electronics. After all, with thousands of reviews, great prices, and fast shipping, why bother going to a store to buy a TV or computer? And yet, here is a five-year chart of Best Buy stock:

All Best Buy had to do was offer price-matching and quick delivery to keep a lot of market share from people who like buying online. And then you will always have a subset of folks who like kicking the tires in-person and asking knowledgeable people questions about the products.

While Amazon’s reach and e-commerce infrastructure will seemingly allow it to always take a certain amount of market share, it does not typically spell death for competitors. This is especially true when Amazon can’t offer anything better than anyone else. Plenty of companies can offer good selection and good prices, and they are finally spending the money to handle the quick delivery too. And with physical stores, in some cases they even have a leg up on Amazon.

Jeff Bezos likes to say “your gross margin is our opportunity.” By that he just means that if you mark up your prices too much, for no good reason, Amazon will undercut you and take your market share. For that to work, margins have to be high in the first place. For books and consumer electronics, gross margins aren’t very high. For other areas like auto parts, where product markups are 100%, do-it-yourselfers will probably shift business away from bricks and mortar retailers and to Amazon for certain items.

In the case of pharmacies, we are not talking about huge markups, from which Amazon can really offer a significantly better deal. Sure drug prices are sky-high in many cases, but there are a lot of middlemen that split the profits. Manufacturers ship product to distributors, who stock the shelves at the pharmacies upon receiving orders, who resell to consumers. Amazon is starting from scratch and has none of those capabilities yet. If their plan is simply to buy drugs from wholesalers and ship them via Prime to their customers, there is not going to be a lot of margin to shave off in the process, nor will they be doing anything different than others.

That becomes even more true because they will not have scale at the outset to get better wholesale pricing from the suppliers. And if Amazon goes directly to the drug makers demands better prices, the drug companies will just say, “sorry, get your supply from the same places everybody else does.” They are not going to voluntarily give up margin when they don’t have to.

And then there is the whole issue of whether Amazon can partner up with the employers, PBMs, and insurers to get access to their customer bases. Is Wal-Mart or Target going to add Amazon to their preferred network for employer-sponsored prescriptions? If CVS buys Aetna, will they let Aetna members get their drugs through Amazon at the same prices they could through CVS retail or mail order? And what is stopping CVS from hiring drivers at $15 an hour to drive around their local neighborhood delivering prescriptions to people’s homes? Does Amazon really have any competitive advantages in this space, assuming they enter it in the future?

I guess they could buy Rite Aid and Express Scripts, to add pharmacies and a PBM, but even after they spend all that money and integrate those businesses, aren’t they just in the same boat as CVS and Walgreens? Sure they are players at that point, but how will they crush the competition?

This is why I am skeptical that Amazon will try to do everything, will succeed at everything, and will kill off legacy providers that have been doing this stuff for decades. When I see a powerhouse like CVS, which will only get stronger if it buys Aetna, trading at 12x earnings, with the rest of the market trading at 20x it just doesn’t make a whole lot of sense. As Warren Buffett would say, “in the short term the market is a voting machine, but in the long term it is a weighing machine.”

Full Disclosure: Long shares of Amazon and CVS Health at the time of writing, but positions may change at any time

 

 

 

AutoZone’s Numbers Don’t Suggest Amazon Will Replace Them Or Their Competitors

After a huge rally over the past five years, shares of auto parts retailer AutoZone (AZO) have taken a beating in recent months as investors fret over Amazon’s ability to become a full service parts supplier.

What is interesting, however, is that auto parts industry observers are far less optimistic about Amazon’s desire and ability to break into a business that often requires super fast delivery (far less than even two hours) and a huge selection of SKUs. Simply put, auto body shops suddenly dumping their relationship with AutoZone seems unlikely. In that case, AZO’s share price slump from $800 to $500 lately is probably unjustified.

There is little doubt that non-time sensitive auto-related purchases have a place in the online world. If you want to stock up on car air fresheners or get a new license plate holder, Amazon is a good place to look. But for more specialized needs, where price is not always the most important factor (getting your car back as soon as possible is), the distribution networks powering the large national auto parts retailers should still provide certainty, comfort, and value.

To see exactly how much AutoZone’s business has been impacted by Amazon, I looked back over the last 15 years to see the trend for the company’s sales per retail square foot. After all, if auto part sales are moving online in a material way, the average AutoZone retail store should be seeing sales declines. This would show up in sales per square foot since a store’s size is constant even if more stores are built.

Here is a graph of AutoZone’s sales per square foot since 2003:

Can you see Amazon’s impact in that graphic? When did they really accelerate their auto parts selection? Does it look like they are having the same chilling effect on AutoZone’s business as they are on, say, JC Penney? I just don’t see it.

For those expecting the impending doom of auto parts retailers like AZO, I think their death may be greatly exaggerated in Wall Street circles lately. In fact, it is notable to point out that over the last five years (when e-commerce growth has really started to disrupt traditional retailers), AutoZone’s revenue has grown from $9 billion to $11 billion, leading to an increase in free cash flow from $27 to $34 per share.

Full Disclosure: Long shares of AZO and AMZN at the time of writing, but positions may change at any time

Dillards Short Squeeze Makes LBO Less Likely Near-Term

It has been a little more than two months since my multi-part series on retailers highlighted the low valuations and negative sentiment on various companies, including department store chain Dillards (DDS).

In recent weeks the stock has soared, in part due to speculation that a massive short squeeze could be imminent. It looks like we are seeing signs of one right now, as the stock has moved from $48 in May to nearly $77 today.

Not only has the recent move narrowed the gap between market prices and intrinsic value, but it also greatly reduces the odds of a management-led buyout in the near-term. When the stock was in the 40’s, a $60 or $65 bid could very well have gotten done. But at current prices, offering a premium would very likely make a transaction less attractive. As a result, I would not be surprised to see the share price retreat after the current spike in short covering comes to a close.

Full Disclosure: Long Dillards debt securities at the time of writing, but positions may change at any time

Amazon and Kenmore: A Mismatch Made in Desperation

For years I have wondered why Sears chose not to sell Craftsman tools on Amazon’s web site. It just seemed like an obvious move to monetize a brand name they owned, given that their own stores are slowly disappearing due to customer disinterest. Earlier this year Sears sold the brand to Stanley Black and Decker to raise much-needed capital, and I suspect it is only a matter of time before the new owner utilizes Amazon to boost market share for the reputable Craftsman brand.

Yesterday the financial markets reacted quite strongly to the news that Sears will now sell Kenmore products on Amazon (the company still owns the Kenmore and Diehard brand names). Sears and Amazon rallied, while shares of competitors like Home Depot, Lowe’s, and Whirlpool fell sharply.

Unlike the Craftsman brand, which I believe resonates with most every demographic, Kenmore seems like an odd fit for Amazon. Clearly, Sears is feeling the pressure to stabilize its business and the country’s largest e-commerce retailer would seem to be a logical place to turn.

The problem is that the Kenmore brand has a loyal customer base, but those people are largely older, whose families have shopped at Sears for appliances for multiple generations and have come to trust the brand. In other words, the only customers Sears has left that shop in their physical stores, and more importantly, the last people who are going to consider buying a washer and dryer on Amazon.

Wall Street’s knee-jerk reaction (granted, most likely from computers, not humans) was to flee from the big box appliance retailers. This appears overdone because appliances only represent a small proportion of revenue at those chains, and they should be more Amazon-proof than many other bricks and mortar companies. The odds of this news materially impacting a Best Buy, Home Depot, or Lowe’s is minuscule, in my view. And the idea that the Kenmore brand is going to be reborn merely due to it being more prominent on Amazon’s site is wishful thinking. As a result, yesterday’s stock moves are likely to be short-lived, and they have provided investors with an opportunity.

Full Disclosure: Long shares of Amazon, Lowe’s, as well as Sears’s corporate bonds that mature in 2018, at the time of writing, but positions may change at any time.