A Convergence Of Amazon And Staples

| About: Staples, Inc. (SPLS)

I tend to favor value stocks when it comes to investing my clients' money as well as my own. Not surprisingly, my portfolios do not currently include shares of Amazon.com (NASDAQ:AMZN). Amazon is what I would call a great company, but an overvalued stock. Of course, as I've learned many times in the past, overvalued stocks can become more overvalued while undervalued stocks get even cheaper. Still, I'm not one to dive into a stock that sells for 90 times projected 2015 earnings.

Staples (NASDAQ:SPLS) is at the opposite extreme. Staples is not a great company - at least not anymore. Many analysts would also argue that despite the favorable valuation, Staples is not a great stock either. Interestingly, in some ways, Amazon and Staples are similar. First, they are both large retailers. At $74.5 billion in trailing 12-month sales, Amazon is larger than Staples; but Staples's 12-month trailing sales of $23.1 billion isn't too shabby.

Second, both companies have a big internet footprint. Everyone knows that Amazon is the world's largest internet retailer. In fact, all of company's sales are generated online. However, people are often surprised to learn that Staples is the world's second-largest internet retailer. Nearly half of the company's total sales are currently generated online.

There are differences, too. Of course, the most obvious difference is expected growth. Investors are fully aware that Amazon is a rapidly-growing company. That's precisely why they are willing to pay such high multiples for the stock. Amazon's revenues were up 50% in 2013. Growth like that can generate lots of goodwill in the investment community.

Staples, on the other hand, is not growing. On the contrary, it is shrinking. It recently announced plans to close 225 stores by 2015. Revenues fell 5.2% during the most recent fiscal year. Investors definitely do not like shrinking companies. Yet despite the contraction, trailing GAAP net income of $620 million was about two-and-a-quarter times larger than Amazon's trailing net income of $274 million. Another difference is that Staples pays a very generous dividend. The stock is currently yielding well over 4%. Yet during the most recent quarter, the payout ratio was just over a third, so the company should be able to sustain the dividend at current levels.

In one important way, Staples and Amazon are actually converging. Staples is a traditional bricks-and-mortar retailer that is becoming more of an internet retailer by closing stores and moving a greater proportion of its sales online. Amazon is an internet retailer that is investing in bricks and mortar. No, Amazon is not planning to open retail outlets. It is, however, investing heavily in expanding its distribution and data centers. In just the past two years, the company doubled the square footage of its distribution and data centers in international markets and almost doubled the square footage in North America. This expansion is a real investment in bricks and mortar.

Amazon does have one significant advantage that Staples may not be able to mimic. Amazon has convinced an estimated 10 million shoppers to become "prime" members. This means these shoppers have been paying $79 per year primarily to avoid shipping charges. In other words, the company has been generating $790 million per year in membership fees even before it sells anything. Amazon recently announced plans to increase the annual membership fee to $99. So if shipping costs remain constant and there is no attrition, an additional $200 million should flow straight to the bottom line. While some attrition is likely, most analysts believe that the increase in the fee is not enough to cause a meaningful drop in membership. Furthermore, any current members Amazon loses are likely to be replaced by new members.

The bottom line is that Amazon is an outstanding company that enjoys tremendous advantages over other retailers - bricks and mortar or online. Yet that does not mean the stock is worth any price. Still, as I said before, an overvalued stock can easily become even more overvalued. But that isn't my preferred way to invest. I would rather collect the dividends while I wait for Staples to get its house in order.

Disclosure: Staples is included in the portfolios that Vahan Janjigian manages.

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