Amazon Isn’t The No. 1 Villain In Retail Sector’s Demise
Americans spending their money on smart phones and health care.
By Vitaliy N. Katsenelson
MarketWatch
August 3, 2017
Retail stocks have been annihilated recently, despite the U.S. economy eking out growth. The fundamentals of the retail business look horrible: Sales are stagnating and profitability is getting worse with every passing quarter.
Jeff Bezos and Amazon.com AMZN, -0.03% get most of the blame for this, but the criticism is misplaced. Nowadays online sales represent just 8.5% of total retail sales. Amazon, at $80 billion in sales, accounts for just 1.5%of total U.S. retail sales, which at the end of 2016 were around $5.5 trillion.
Though it is human nature to look for the simplest explanation, in truth, the confluence of a half-dozen unrelated developments is responsible for weak retail sales.
Americans’ consumption needs and preferences have changed significantly. Ten years ago we spent a pittance on mobile phones. Today Apple AAPL, +4.73% sells roughly $100 billion worth of “i-goods” in the U.S., and about two-thirds of those sales are iPhones. Apple’s U.S. market share is about 44%, thus the total smart mobile-phone market in the U.S. is $150 billion a year. Add spending on smartphone accessories (cases, cables, screen protectors, etc.) and we are probably looking at $200 billion total spending annually on smartphones and accessories.
Ten years ago (before the introduction of the iPhone) smartphone sales were close to zero. Nokia was king of the dumb phones, with sales in the U.S. in 2006 of $4 billion. The total dumb cellphone handset market in the U.S. in 2006 was probably around $10 billion.
Consumer income has not changed much since 2006, which means that over the last 10 years $190 billion in consumer spending has been diverted toward mobile phones.
It gets more interesting. In 2006 a cellphone was a luxury only affordable by adults, but today 7-year-olds have iPhones. Not to bore you with too many data points, but Verizon Communications’s VZ, -1.39% wireless-generated revenue in 2006 was $38 billion. Fast-forward 10 years and it is $89 billion — a $51 billion increase. Verizon’s market share is about 30%, making the total spending increase on wireless services alone close to $150 billion.
Retail stocks have been annihilated recently, despite the U.S. economy eking out growth. The fundamentals of the retail business look horrible: Sales are stagnating and profitability is getting worse with every passing quarter.
Jeff Bezos and Amazon.com AMZN, -0.03% get most of the blame for this, but the criticism is misplaced. Nowadays online sales represent just 8.5% of total retail sales. Amazon, at $80 billion in sales, accounts for just 1.5%of total U.S. retail sales, which at the end of 2016 were around $5.5 trillion.
Though it is human nature to look for the simplest explanation, in truth, the confluence of a half-dozen unrelated developments is responsible for weak retail sales.
Americans’ consumption needs and preferences have changed significantly. Ten years ago we spent a pittance on mobile phones. Today Apple AAPL, +4.73% sells roughly $100 billion worth of “i-goods” in the U.S., and about two-thirds of those sales are iPhones. Apple’s U.S. market share is about 44%, thus the total smart mobile-phone market in the U.S. is $150 billion a year. Add spending on smartphone accessories (cases, cables, screen protectors, etc.) and we are probably looking at $200 billion total spending annually on smartphones and accessories.
Ten years ago (before the introduction of the iPhone) smartphone sales were close to zero. Nokia was king of the dumb phones, with sales in the U.S. in 2006 of $4 billion. The total dumb cellphone handset market in the U.S. in 2006 was probably around $10 billion.
Consumer income has not changed much since 2006, which means that over the last 10 years $190 billion in consumer spending has been diverted toward mobile phones.
It gets more interesting. In 2006 a cellphone was a luxury only affordable by adults, but today 7-year-olds have iPhones. Not to bore you with too many data points, but Verizon Communications’s VZ, -1.39% wireless-generated revenue in 2006 was $38 billion. Fast-forward 10 years and it is $89 billion — a $51 billion increase. Verizon’s market share is about 30%, making the total spending increase on wireless services alone close to $150 billion.
Between smartphones and their services, $340 billion will not be spent on T-shirts and shoes.
Between smartphones and their services, $340 billion will not be spent on T-shirts and shoes.
But we are not done. The combination of mid-single-digit health-care inflation and the proliferation of high-deductible plans has increased consumer direct health-care costs and further chipped away at discretionary dollars. Health-care spending in the U.S. is $3.3 trillion, and even a 3% rise in costs would be close to $100 billion.
Then there are soft, hard-to-quantify factors. Millennials and millennial-want-to-be generations don’t really care about clothes as much as we may have 10 years ago. After all, high-tech billionaires wear hoodies and flip-flops to work. Lack of fashion sense did not hinder their success, so why should the rest of us care about the dress code?
In the ‘90s casual Fridays were a big deal — yippee, we could wear jeans to work! Fast-forward 20 years, and every day is casual. Suits? They are worn to job interviews or to impress old-fashioned clients. Consumer habits have slowly changed, and we now put less value on clothes (and thus spend less money on them) and more value on having the latest iThing.
All this brings us to a hard and sad reality: The U.S. is over-retailed. We simply have too many stores. Americans have four- or five times more square-footage per capita than other developed countries. This bloated square footage was created for a different consumer, the one who in in the ‘90s and ‘00s was borrowing money against her house and spending it at her local shopping mall.
Today’s post-Great Recession consumer is deleveraging, paying off debt, spending money on new necessities such as mobile phones, and paying more for the old ones such as health care.
Yes, Amazon and online sales do matter. Ten years ago just 2.5% of retail sales took place online, and today that number is 8.5% — about a $300 billion change. Some of these online sales were captured by brick-and-mortar online sales, some by e-commerce giants like Amazon, and some by brands selling directly to consumers.
But as you can see, online sales are just one piece of a complex retail puzzle. All the aforementioned factors combined explain why, when gasoline prices declined by almost 50% (gifting consumers hundreds of dollars of discretionary spending per month), retailers’ profitability and consumer spending did not flinch — those savings were more than absorbed by other expenses.
Understanding that online sales (meaning Amazon) are not the only culprit responsible for horrible retail numbers is crucial in the analysis of retail stocks. If you are only asking “Who can best fight Amazon?” then you are only solving for one variable in a multivariable problem. These are the facts: consumer habits have changed; the U.S. is over-retailed; and consumer spending is being diverted to different parts of the economy.
Value investors are naturally attracted to hated sectors. But we demand a much greater margin of safety from retail stocks, because estimating their future cash flows (and thus fair value) is becoming increasingly difficult. Warren Buffett has said that you want to own a business that can be run by an idiot, because one day it will be. A successful retail business in today’s world cannot be run by by an idiot. It requires Bezos-like qualities: being totally consumer-focused, taking risks, thinking long term.
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