Amazon recently leaked (WSJ subscription required) their plans to build curbside pickup locations. The company wants small stores that would sell staple grocery products. I understand the appeal of selling these products. I understand the appeal of developing an online system to sell groceries and have them immediately loaded into the customer's car when they drive into the parking area.
This is the strategy I have been arguing for over the last several months at least. However, I have been arguing for Wal-Mart to pursue it. I have been arguing for Target (NYSE:TGT) to pursue it. I have even suggested that Costco (NASDAQ:COST) would be wise to develop the exact same system. In each case, the stores have exceptional economies of scale and have the framework necessary to deliver orders to the customer's cars.
For Amazon, this would require a substantial capital expense in constructing new delivery centers or signing long-term leases. On the other hand, Amazon could lease the facilities. However, most intelligent REITs dealing in commercial properties would prefer to see longer-term contracts. Surely, a company like National Retail Properties (NYSE:NNN) would be an excellent fit.
They excel at acquiring retail properties and designing lease terms that benefit both parties. STORE Capital (NYSE:STOR) is another great REIT for handling retail locations, but they emphasize working with smaller businesses. Regardless, these REITs want long contracts and Amazon might be looking to test this with shorter contracts.
From Amazon's perspective, this is a way to significantly grow sales and develop channels for rapid product delivery. However, for shareholders of Amazon, it represents a significant challenge. Investors can already acquire grocery stores at very cheap multiples. Wal-Mart, Costco, Whole Foods Market (NASDAQ:WFM), and Sprouts (NASDAQ:SFM) all trade at much cheaper multiples than Amazon.
I'll add Target into the mix, though they usually derive under 20% of revenue from groceries. For example, look at this chart of the P/E ratios using the trailing twelve months of earnings. This is an entirely absurd comparison, as I'll explain after the chart:
Since Amazon's presence on the chart requires smashing all the other lines, I put together another one that doesn't include Amazon:
Why I Won't Stick to P/E Ratios
I don't want to stick to the P/E ratios, because they are an inefficient way to value Amazon. Every shareholder in Amazon must know that, or they wouldn't be buying Amazon. Amazon has enormous expenses on research and development each year. Those expenses run through the income statement in the present year, but the benefits from their developments are spread over the next several years. Therefore, it would be inappropriate to strictly look at the price to earnings ratio.
Let us shift to the P/S (price to sales) ratio. Amazon's story has been their rapid growth in sales, but it looks like the story needs to continue for years to justify the valuation. As a frequent customer, I believe that Amazon's growth in sales will continue. However, I don't like this strategy for Amazon. Here is the P/S ratio:
The space Amazon wants to go into trades at cheap multiples of earnings and sales. The margins are weak, so Amazon would need a massive growth in sales from this venture for it to be worthwhile.
Now for the sake of margins, it helps to use EBITDA rather than earnings. The depreciation on physical properties provides a great tax shield, but I love property values generally move higher rather than lower. By stripping out the interest impacts and including the value of debt in the analysis, we get a better feel for the total value of the business. This still isn't perfect because I can find no metrics to provide EBITDA + Research/Development as one half of the equation. Therefore, I'll stick to EV to EBITDA.
In this manner, Amazon still trades at exceptionally higher valuations. If you're thinking, "Amazon will grow faster," then I agree completely. Amazon will likely grow earnings, sales, and EBITDA faster than any of the grocery stores. Why is that? Is it simply because Amazon is a vastly better company? That is an unlikely explanation.
A much better explanation is that Amazon can grow revenues and earnings faster than grocery stores because they are not a grocery store. They operate in a more desirable sector with great leverage on their costs. If Amazon decides to open grocery stores, I see no reason for that sector of their business to deserve the same multiples as the rest of the business.
Why I Own Wal-Mart and Target
Even though the retail giants don't have the same rapid growth potential as Amazon, they trade at vastly lower multiples. They create solid earnings and free cash flows that can be used to pay dividends and buy back shares. At the right price, I would happily own Amazon. I'm not saying Amazon is overpriced. I just don't see room for a boring value investor at these multiples.
For the sake of shareholders across each company, I hope Amazon doesn't come into this sector. The grocery market already carries enough competition to keep margins weak. The arrival of another company would be a clear negative sign for the sector, but it would also be negative for shareholders in Amazon. If they wanted to own a grocery store, there are plenty trading at dramatically lower multiples.
I'm not fool enough to publish a bearish view on Amazon. That is how analysts ruin the average accuracy of their forecasts. However, I would be disappointed to see Amazon jump into a low-margin business when shareholders have valued them based on growth in more attractive businesses.
On the other hand, I remain bullish and long on both WMT and TGT. The valuations there are very compelling, even if their future plan is operating low-margin retail businesses. Unlike Amazon, the valuations on WMT and TGT already reflect the difficulty of operating those businesses.
Note on Numbers
This article relied on charts built by Yahoo Finance. I've found some of the figures provided by Yahoo and Google Finance over the last few weeks have been lacking in accuracy. The valuation metrics, to the best of my knowledge, are still roughly accurate.
Disclosure: I am/we are long TGT, WMT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Tipranks: No ratings from this article. My bullish views on WMT and TGT are captured in other pieces that flesh those companies out.