SolStock
SolStock
U.S. retail sales in October rose by the most in eight months, underscoring robust demand still despite mounting macro uncertainties. As nice as this might sound for retailers ahead of the busiest shopping season of the year, a deeper dive would reveal this is only the beginning for more pain in the coming months.
Consumer purchasing power has actually taken a turn for the worse. The bulk of the latest retail sales growth was driven by stubbornly high inflationary pressure on basic necessities like food and energy, while spending on discretionary goods like consumer electronics and apparel declined. The results have also proven earlier market optimism on the slower-than-expected pace of consumer and producer price increases observed in October as premature, with the latest round of commentary from Fed officials still hard-pressed on a hawkish policy stance.
This spells a double-whammy for big tech consumer-based retailers like Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) ahead of the coming holiday season and beyond. Apple continues to trade at a lofty valuation premium relative to peers, putting the stock’s resilience and general outperformance against this year’s broader market selloff at risk of faltering. Meanwhile, Amazon is on a gradual decline towards losses in market share of close to 50% this year, with the rout accelerating as the outlook on its more-resilient cloud-computing unit sours alongside the macro overhang on its e-commerce moat.
Both remain significantly susceptible to looming macroeconomic headwinds that are poised to dull the retail sector’s luster and hopes for a post-pandemic recovery. Yet, the impending downturn also represents a reasonable long-term investment opportunity for a sustained trajectory of longer-term upside potential buoyed by both companies’ respective moats and market leaderships in their areas of specialties.
U.S. retail sales (not adjusted for inflation) rose 1.3% y/y in October, or 0.9% y/y excluding gasoline and autos. Both figures exceeded consensus estimates, marking the “biggest increase in eight months”. Driving segments of sales growth included grocery stores, gas stations, and restaurants, underscoring the weight of soaring inflation on necessities, with the brunt of the impact borne by lower-income consumers who are more sensitive to price changes.
Meanwhile, retailers of discretionary goods such as apparel, consumer electronics, and sporting goods saw a sales decline of more than 2% over the same period. The results imply continued weakening in consumer purchasing power as inflationary pressures persist, while retailers of discretionary goods are looking to lure buyers ahead of the holiday shopping season with price cuts and steep discounts in an attempt to clear inventories.
The tough operating outlook for retailers is further corroborated by the gradual decline in household savings in recent months, alongside a steady increase in credit card debt towards the pre-pandemic peak of more than $900 billion in September:
Payment processing giant Visa (V) had recently noted that while aggregate consumer spending has remained resilient and consistent throughout the year, buying behavior has rapidly evolved as a result of deteriorating financial conditions and surging inflation, with data showing a decrease in purchasing power. Average U.S. household savings have also declined from an average of 3.5% in the second calendar quarter to 3.1% in the third calendar quarter, which is a significant downward adjustment from the “five-year pre-COVID average of [approximately] 7.7%”. Credit card debt is also racking up, “approaching the pre-pandemic peak of $916 billion in September”.
Source: “Can Apple Dodge a Holiday Quarter Disaster?“
The upcoming holiday shopping season is expected to be relatively muted when compared to prior years as consumers’ budgets for discretionary goods get squeezed by the rising cost of necessities like food and energy as discussed in the earlier section, as well as soaring interest rates that are ramping up the payment size on home mortgages and car loans. Holiday season retail sales this year are expected to increase between 6% to 8% y/y (or 2.5% y/y for online sales), representing a substantial deceleration from the whopping 13.5% y/y growth (or 8.6% y/y growth for online sales) observed in the fourth quarter of 2021. The shift in discretionary spending away from goods and towards services like tourism and dining out in the post-pandemic era has also compounded pains for the retail sector’s near-term outlook.
Consumers’ increasing sensitivity to price changes has also pulled forward this year’s holiday shopping season as many look to spread out purchases and take advantage of sales and discounts to alleviate stress on diminishing budgets for discretionary spending. Recent industry research showed that more than three-quarters of Americans have been “searching the web for the best deals and discounts to maximize their spending power”, while “nearly half of U.S. consumers plan to spend less this holiday season than they did last year” due to the pinch of inflation and the looming economic downturn. This makes another headache for retailers looking to capitalize on holiday season demand in coming months to prevent more costly inventory write-downs later on, as luring purchases would mean substantial discounts, and inadvertently, pressure on the bottom line. This spells a bleak near-term outlook for the sector, especially as investors’ preferences engage in a rapid shift away from prioritizing growth and towards profitability in the risk-off environment.
Citing a challenging global macroeconomic environment and “broad-scale inflation” that has impacted consumer purchasing power worldwide, Amazon is expecting its “slowest holiday quarter growth” on record. The company guided fourth quarter sales growth in the range of 2% to 8%, inclusive of a 460 bps FX headwind. This implies continued deceleration across its cloud-computing cash cow, while its core e-commerce business across North America and International geographies anticipate a return to declines, which is consistent with the company’s observation of slowing demand due to the “tougher recessionary environment” ahead.
Anticipated softness in Amazon’s e-commerce sales over coming months is further corroborated by cautious sentiment across aggregators – or owners of multiple online vendors – on the platform. Based on a recent panel conducted by RBC Capital Markets with Amazon Aggregators, the majority has cited “foggy” visibility over near- to medium-term demand due to looming macro headwinds, and “expects softness in Q1” despite broad-based bullishness on longer-term e-commerce growth.
To better capture the shift in consumer purchasing behavior (e.g., pulled forward holiday shopping season; increased sensitivity to price changes) amid a weakening demand environment, Amazon has prudently frontloaded its holiday season discounts by kicking off the fourth quarter with its “first-ever Prime Early Access sales event” that took place on October 11th and 12th. However, the relatively lackluster results from the October Prime Day sales event compared to the one in July already provides a preview on what to expect ahead of a mediocre demand environment leading up to the coming gifting season.
The first eight hours of Amazon’s October Prime Early Access sale held similar transaction volumes to the “previous 30-day average”, which was a far cry from the 13% lead observed during July’s Prime Day event. The majority of items purchased during the October sale event were under $20, with the “average household outlay (at) about $75” on the first day. And by the end of the October Prime Early Access shopping frenzy, the average order size was down to under $50, a 23% shortfall from July. The results point to weaker demand for more profitable and higher ticket price items, which is consistent with persistent softness in shipments of pricey consumer electronics like PCs and smartphones this year.
The e-retailer has also sought an early introduction of Black Friday sales this year, with related discounts being promoted on the platform since early November. As mentioned in the earlier section, the continuation of discounted offerings is expected to weigh on Amazon’s e-commerce margins further, and management expects no less given the compounded weight of an enduring surge in global fuel and freight costs:
I think the biggest issue quarter-over-quarter, the increase in losses versus Q2 was tied to some additional operating costs in Europe. We’ve seen higher fuel costs there, even more certainly in the United States. And Prime Day always has lesser profitability because there’s just a lot of deals. And it’s a bit of margin from Prime Day in both North America and international. So a big part of that is device sales. And again, we sell a lot of devices during our Prime Day events. We don’t make money on the device. We make money on the use of the device. So that always can end up hurting profitability in the quarter.
Source: Amazon 3Q22 Earnings Call Transcript
However, we see the slight, though weaker-than-expected, pickup in holiday season/discount driven demand as a welcomed sight, as it would help improve and offset some of the underutilization costs racked up from Amazon’s overly aggressive expansion efforts on its e-commerce fulfilment capacity last year. But investors’ sentiment is likely to unravel further over the coming months as the e-commerce business faces an imminent slowdown alongside profitability risks. Continued rate hikes will also weigh on valuation multiples across the board, sending further headwinds to retail-centric stocks like Amazon over the course of the Fed’s policy tightening trajectory.
However, the looming downturn could create a reasonable investment opportunity for longer-term upside potential in Amazon, buoyed by expectations that its core e-commerce business will continue to “grow in-line or outgrow the long-tail of e-commerce”, as well as its market leadership in cloud-computing and emerging prowess in digital ads. Specific to e-commerce, Amazon’s diligence in growing its Prime subscription base is expected to be a “net positive that should provide longer-term benefits, particularly internationally” by anchoring its reputation as the reliable and accessible one-stop-online-shop for global consumers. Amazon’s robust appeal to third-party (“3P”) vendors via its “Fulfilment by Amazon” (“FBA”) program also safeguards its leading market share in global e-commerce as well.
Based on recent commentary from Amazon aggregators, FBA remains the “best platform in terms of margins and operational efficiency despite increasing fees and a more challenging operating environment”, with many seeing the platform as key to brand building. While many of the vendor aggregators have acknowledged that the deteriorating macroeconomic outlook is weighing on the inventory situation, they expect said headwinds to start alleviating by mid-2023. And despite growing competition within the online marketplace sector against newer platforms like Walmart (WMT) and Target’s (TGT) expanding e-commerce reach, Amazon is expected to remain the primary beneficiary of longer-term secular growth trends in e-commerce, given the attractive margin profile enabled by FBA still. This points to sustained e-commerce tailwinds for Amazon, as 3P vendors currently account for more than half of all merchandise sold on the platform, with related sales generating higher margins for the e-retailer.
Specifically, related revenues generated from fees charged on third-party vendor sales, as well as fulfilment via FBA (i.e., storage and delivery) currently drive higher margins compared to Amazon’s 1P sales. According to data disclosed by Forum Brands, an aggregator of Amazon’s 3P FBA vendors, Amazon’s fee charged on 3P sales range from 8% to 15%, with fulfilment taking another 8% to 23%. The segment’s acceleration in sequential growth observed in the second quarter also showcases increasing recognition by 3P sellers of value in Amazon’s fast and free shipping capabilities, which bodes well with the company’s continued efforts in optimizing utilization of fulfilment capacity. Increased 3P sales have also helped Amazon diversify its product selection, and accordingly diversify its consumer-base, reducing concentration within specific demographics like lower-income households to offset recession risks.
Source: “Everything We Like And Dislike About Amazon’s Q2 2022 Earnings“
Amazon_-_Forecasted_Financial_Information.pdf
Acknowledging the mounting macroeconomic uncertainties ahead, Apple has also sought to temper investors’ expectations about its upcoming holiday quarter sales. Specifically, its iPhone and Mac product categories are expected to take a prominent hit, with management guiding deceleration on demand for its handsets and a decline for Mac laptops.
We view management’s expectations for a decline in Mac demand ahead of the holiday shopping season as reasonable given consumer weakness. Global PC shipments are on track towards a 12% to 13% y/y decline this year, with the 19% y/y decrease in demand observed in the third quarter representing the steepest drop since the mid-1990s. And similar weakness is anticipated across both Apple’s peers and the broader smartphone supply chain, with Dell (DELL) being the latest to call out the spread of economic uncertainty impacts from retail consumers to enterprise IT spending that were previously considered more resilient over the coming months.
The company also faces challenges of a tougher PY comp due to the release of the M1-powered MacBook Pro around this time last year, alongside marked FX headwinds. Paired with management’s guide for decelerating iPhone demand that now looks to be worsening due to China’s COVID lockdowns and the related impact on its supply chain, this is likely to create more jitters in already-fragile investors’ sentiment.
But the anticipation for weaker-than-expected near-term fundamentals aside, we view Apple’s lofty valuation premium over peers with a similar growth profile and capital structure as the main overhang over its shares’ performance in the coming months. The stock has merely lost 17% of its value this year, while peers like Amazon are nearing losses of 50%. Investors have largely remained confident in the stock given Apple’s robust cash flows generated from its sprawling ecosystem of profitable offerings, as well as its near-term demand resilience demonstrated to date and longer-term growth prospects across key technology trends. But with the impending wave of consumer weakness hitting its books over coming months, alongside aggressive Fed rate hikes through early- to mid-2023, Apple’s lofty valuation premium faces greater risks of toppling over in the near term.
But in a similar case as Amazon, any near-term pullback in the price of Apple shares would make a compelling investment opportunity for longer-term upside potential. As discussed in our previous coverage on the stock, we view the $110- to $149-level as a reasonable entry range. Specifically, the lower range, which represents our bear case PT on the stock, is becoming an increasingly probable outcome ahead of prominent challenges to Apple’s sales and margins over coming months, while broader market valuation multiples continue to adjust downward for rising borrowing costs and a looming recession.
Apple_-_Forecast_Financial_Information.pdf
The bottom line is that bottom line matters under the currently dire macro outlook. Investors are fixed on profitability and margin expansion in addition to growth, which are difficult to achieve for any constituent in retail – even e-commerce leader Amazon and tech giant Apple. While stronger-than-expected retail sales in October make a punchy headline with a pinch of an optimistic connotation for the consumer-centric sector amid mounting macroeconomic uncertainties, it actually implies more challenges ahead. For Amazon and Apple, this suggests an inevitable near-term bump in performance, but for investors, the impending pullback could represent a reasonably profitable longer-term investment opportunity to keep on the watchlist.
Thank you for reading my analysis. If you are interested in interacting with me directly in chat, more research content and tools designed for growth investing, and joining a community of like-minded investors, please take a moment to review my Marketplace service Livy Investment Research. Our service’s key offerings include:
Feel free to check it out risk-free through the two-week free trial. I hope to see you there!
This article was written by
Boutique investment research shop providing professional coverage on disruptive thematic equities. Our analysis provides a deep dive on growth drivers present in the secular market to identify outperforming investments.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
