Ecommerce, i.e. the fastest-growing part of the retail industry, doesn’t operate exactly like its brick-and-mortar counterpart. While goods and services do change hands, there’s a completely different infrastructure involved, whether it’s the marketplace, or logistics, or payments system, or ancillary services. That’s because each of these things is necessarily driven by technology.
The recent past has, however, seen traditional retailers like Wal-Mart investing increasing amounts in building this technological infrastructure even as Amazon takes an increasing interest in brick-and-mortar operations to drive efficiencies in its delivery system.
Retail ecommerce is also unique because a single company (Amazon) accounts for most of it, is the major trend-setter and the greatest influencer on the entire industry, at least in the U.S. While new players are emerging, it won’t be easy to unseat Amazon simply because of its size, experience, prices and loyalty program. So it’s only a company like Wal-Mart, which has similar resources and huge experience that can hope to truly challenge the ecommerce leader. And that’s still a work in progress because Wal-Mart, while reporting strong ecommerce growth and offering attractive growth projections, still isn’t statutorily required to say how much the business contributes.
The other major point of difference is the fact that unlike traditional retail it’s relatively easy for an advertiser or other Internet service provider to also get involved in the retail process and thereby siphon off some of the profits.
The holiday season will soon be kicking off, and since it’s the busiest season for retailers, this might be a good time to take a look at what industry watchers are projecting. Market research firms agree that overall retail will strengthen from last year, that traditional retail will also strengthen, that ecommerce will continue to grow much stronger than traditional retail and that the rate of ecommerce growth will come down slightly.
eMarketer expects US retail ecommerce sales to grow 15.8% this holiday season, slower than the 17.8% posted last year, thus increasing its share of total retail from 10.6% to 12.0%. The main drivers named were U.S. consumer confidence (at its highest level in 15 years) and tax cuts that could boost spending, but border taxes that could raise prices and general political instability were stated reasons for caution. For full year 2017, eMarketer expects retail ecommerce sales to grow 16.0%, down slightly from 16.2% growth last year with its share of total retail sales going from 8.2% to in 2016 to 9.2% this year.
Deloitte expects overall retail holiday sales to grow a healthy 4-4.5% over last year’s shopping season with ecommerce growing a much stronger 18-21% to reach $111-$114 billion during the 2017 holiday season. Last year, ecommerce holiday sales grew 14.3% year over year to $93.8 billion, according to Deloitte. Deloitte sees 2017 drivers in the rising disposable personal income (2% last year compared with 3.8-4.2% this year), high consumer confidence, a strong labor market and expectations for stability in the personal savings rate at its current low level.
NetElixir expects holiday sales growth of 10% this year compared to 11% in 2016. The research firm sees mobile devices as a major driver and projects that 35% of all online purchases will happen on smart phones. The research firm estimates that Amazon’s share of online sales was 30% in the last holiday season while Slice Intelligence estimated that its share was closer to 38%.
The difference is attributable to the way they measure market share: while NetElixir uses data from their customer base of online retailers Slice Intelligence uses a panel of more than five million online shoppers. Whatever the methodology, it’s clear that Amazon is the dominant online retailer.
Industry at a Glance
The following diagrams seek to define the broad spectrum of companies primarily dependent on the Internet for the distribution of their goods and services, as well as companies that enable these exchanges:
Zacks also breaks down each large sector such as Retail/Wholesale and Computer & Technology into groups of companies such that there are a total of 256 such sub-sectors or industries.
These “X” industries are then grouped in two: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (Click here to know more: About Zacks Industry Rank)
Therefore the Zacks Industry Rank is a good indicator of investment opportunities within an industry at any given time. Moreover, because stocks in the same X industry have certain common positive or negative factors affecting them, it has been observed that there is some positive correlation between them.
As depicted above, the Internet-supported buying and selling process includes four Zacks categorized segments, i.e. Internet - Commerce, Internet - Services and Internet Services - Delivery and Internet – Software/Services.
In the last six months, the Internet - Commerce segment outperformed the S&P 500 by a wide margin. The market appreciated 23.1% during the period, compared to the S&P 500’s 8.8%. It also appreciated 51.7% year to date compared to just 14.2% for the S&P 500.
Revenue growth over the past year (ending June 2017 when results were last reported) was 34.9%. EPS before non-recurring items was up 6.3% on a more or less consistent share count. Forward earnings estimates are showing little appreciation, however, indicating that the industry is currently in investment mode.
The Internet - Services segment hasn’t done quite as well, having grown 19.7% in the last six months and 27.8% year to date.
The business has a stronger margin profile, with revenue growth of 22.0% over the past year, EPS decline of around 11.8% on a share count that dropped 3.9%. Forward earnings estimates for the December quarter and fiscal years 2017 and 2018 are all trending down. It is apparent that the industry is seeing significant investment, which is why the high revenue growth is not dropping to the bottom line.
The Internet Services - Delivery segment has been the most sluggish, growing 19.6% in the last six months and just 2.1% year to date.
Revenue growth of 32.9% brought the industry back to profits despite a modest increase in the share count. Op-ex and interest expense remain high, impacting the EPS before non-recurring items. The debt level has shot up with no positive impact on the cash position. On the other hand, rising intangibles could indicate industry consolidation but increase risk. The debt-to-total capitalization ratio remains manageable in the 43-44% range with the current ratio being maintained above unity.
The Internet Software/Services segment is up 7.5% in the last six months and 29.7% year to date.
Revenue grew 16.5% off a much smaller base with EPS before non-recurring items growing 11.8% on a slightly lower share count. Still, there are opportunities here that can be exploited.
The ecommerce marketplace is influenced by both buyers and sellers. Moreover there are multiple trends, both big and small, and old and emerging, that are always in play. So it helps to take a quick look at what’s going on-
Buyer Trends & Preferences
- Mobile, Wearables: These remain as important as ever as users are increasingly accustomed to anytime anywhere shopping. The online store never closes, nor does the online payments machinery. Even brick-and-mortar sales are supported by mobile apps that increase awareness of products and push promos at opportune moments. Payments tech from Apple AAPL, Alphabet (GOOGL - Free Report) , Samsung, Alibaba, Paypal and others help the electronic transfer of funds to stores. eMarketer estimates that smartphones will remain a huge driver, growing to 50% of mobile commerce in 2017 and 53.5% by 2020. Larger mobile screen sizes, new categories (cars, grocery, luxury that were earlier restricted to offline purchase) and greater comfort in using online payment systems are the main drivers.
- Social Networking: The traditional buying experience often involves friends or family getting together to look through merchandise and select after much discussion. The online experience has been more restrictive in this respect. Despite the fact that personal recommendations and comparison shopping have been around for a while, these are helpful in making a selection, but don’t make buying a collaborative exercise. So the shopping experience has been more of a chore than fun. Once the novelty of doing things online wears off or for those who have been doing it online from the get-go, there will be a natural tendency to start looking for more, so this is where social networks like Facebook FB and Twitter (TWTR - Free Report) for example will start playing a bigger role. Others like Pinterest are already travelling this path.
- Voice Search: Merkle’s Digital Marketing Report for the first quarter indicates that Google AdWords increased 19% sequentially and 21% year over year in the first quarter of 2017 with product listing ads being one of the hottest trends. Product listing ads (PLAs) accounted for more than half of retail search ad clicks, growing 48% sequentially. Spending on Google Shopping increased 32% year over year. The continued popularity of mobile search helped Google. Google has said that 20% of searches through its mobile app and Android devices are voice searches. Therefore, it’s clear that voice search is no longer a novelty but an emerging trend for shoppers.
- Geography Isn’t A Barrier Any More: These days, if people want to buy something they don’t get at the retail store, the first thing they do is check online (or they might check online first and decide their point of pickup accordingly). So the world is getting ever smaller as shoppers see local, state, national and international barriers melt away. Satisfaction of course leads to higher expectations.
According to Frost & Sullivan, Southeast Asia (only Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam) is poised to become one of the world's fastest-growing regions for e-commerce revenues, growing from around $11 billion in 2015 to more than $25 billion by 2020.
According to Forrester research, the five key Asia/Pacific markets of China, Japan, South Korea, India and Australia will almost double from $733 billion last year to $1.4 trillion in 2020. Size and population density in China and India make them very important markets. So let’s just touch upon prospects in the Chinese and Indian markets since they are on a very strong growth trajectory.
According to Forrester, China will remain the biggest ecommerce market in the next few years generating 9X the size of the Japanese market and 17X the size of the South Korean market by 2020. eMarketer estimates that ecommerce will be 23.1% of total retail sales in China, growing to 40.8% of total sales by 2021. More than 75% of these sales will be through mobile devices by 2021.
With the digital revolution in China, many Chinese have multiple devices they use to research a product or shop on. Devices will take a new turn this year as virtual reality (VR) starts playing a bigger role taking consumers from the “VR café” experience they enjoyed in 2016 to devices enabling the experience. eMarketer quotes a GfK forecast that retail sales through virtual reality (VR) devices in China will grow from RMB 650 million in 2016 to RMB 1.6 billion in 2017. Moreover, all the big ecommerce companies like Alibaba, Tencent and LeEco will continue to invest heavily in VR this year.
Cross-border trade is another driver, as Chinese youngsters are extremely brand conscious and like to buy foreign goods, especially if they’re from the U.S., South Korea or Japan and especially in categories like food, dairy, personal care and beauty. But local brands are increasingly capturing mind share, especially in electronics and mobile phones. The Chinese Ministry of Commerce says that cross-border transaction value will make up 20% of total Chinese foreign business and continue to grow at over 30% a year.
The Ministry also sees a growing number of Tier 2 and Tier 3 cities coming online with only 10.6 million of the estimated 159.9 million new users between 2015 and 2018 coming from Tier 1 cities.
According to the ASSOCHAM-Resurgent India study, the number of people shopping online will grow from an estimated 69 million in 2016 to 100 million in 2017 driven by a growing number of digital natives (including people in their early teens and from tier two and tier three cities), better logistics, broadband and Internet-enabled devices.
Mobile commerce will be 45-50% of total retail sales this year compared to 30-35% in 2016. Popular categories in 2016 were apparel, which grew 85%, mobile phones 68% cosmetics 25%, watches 75% and artificial jewelry 65%.
Seller Trends and Strategies
- Focus Shifts from Device to Consumer: This is a direct offshoot to the phenomenon that many people currently use multiple devices so that the device on which a product is researched is not necessarily the one where the purchase is completed. Also, the purchase may finally even be completed in the physical store, leading to what is being called the online to offline (O2O) trend. Therefore, it has become important to follow the customer on the various devices rather than follow the device. This understanding is still relatively nascent, but it’s a trend that is catching on.
- App versus Mobile Web: As the ecommerce market matures, it’s becoming very clear that smaller players can’t compete with what companies like Amazon offer. Also, their customers don’t already know them, which means that they aren’t eager to download their apps. These players need a platform to be able to display their wares and promote their brands. This is where Google plays an extremely useful role as the search engine can now pick out and display relevant information not just from across the web but also from individual apps that have been indexed. As smaller players are more dependent on the mobile web, its importance versus apps is increasing by the day.
- Omnichannel Approach: Logistics is one of the most important considerations for ecommerce retailers. Whether building their own warehouses like Amazon does or relying on specialists like Alibaba does, ecommerce companies are required to act nimbly because customers want quick delivery and quick return options. For smaller etailers, it doesn’t make sense to go it alone as customers are hard to serve and the business is hard to scale. So they usually prefer to join an online marketplace to leverage their capabilities.
- The challenge is more complex for the big players because the number of buyers and sellers is growing as is the volume of transactions. Amazon deals with this through its warehouses and encourages sellers to store with it through the Fulfillment by Amazon (FBA) initiative. FBA requires sellers to store inventory in Amazon warehouses with Amazon taking care of sales and support. This helps to cover cost of the warehouses that Amazon needs to invest in anyway. In some cases, Amazon ties with retailers to use their brick-and-mortar locations as pickup points for customers with those requirements.
- Amazon has also leased 21 aircraft to support its logistics operations. It is has also taken the lead with respect to drone deliveries, having secured necessary patents and having tested the technology in countries where drones aren’t effectively banned. So just about as soon as the FAA approves the concept, Amazon drones will take to the skies.
- For big traditional retailers, omnichannel is a stepping stone to the online world. They already have the logistics and physical stores in place though of course they are adjusting locations in line with expansion plans. So while they continue to invest in the physical store experience they are supplementing this with online channels to expand their reach. Book online and pick up at store is a popular model for them.
- Technology Investment: Traditional retailers like Wal-Mart (WMT - Free Report) and Target (TGT - Free Report) want to build their online apps/websites/storefronts in a way that they can preserve their brand value while expanding their reach. Therefore, they are in competition with the big online players rather than in partnership with them. Online players are faster to adopt new technologies that help them improve navigation and customer experience, which in turn improve reviews and thus draw more traffic to them. But traditional players are pulling up their socks too. For instance beacon technology that enables retailers to track customers in the store and push promos and offers to them is expected to increase in importance. New payment technologies such as near field communication (NFC), quick response (QR) code, Soundwave and Bluetooth low energy (BLE) are facilitating the process. Innovative new technology is influencing every aspect of the buying experience spanning gadgets like TVs and game consoles that are increasingly getting connected to digital versions of books, music, video and games that are becoming available for online purchase and consumption.
- Advent of Chatbots: Social networking platforms like Facebook Messenger, Twitter, WhatsApp and Google Allo are warming up to the idea of chatbots. Businesses are increasingly operating globally, across time zones and catering to customers that expect everything to be immediately available. But it’s not always possible to have customer service people on the job at all hours because of a dearth of resources and other constraints. But with chatbots, people can get personal queries answered as and when they require. Some platforms like Facebook Messenger already have a large number of chatbots on them, so users are getting used to the idea. And companies that can’t get people to download and/or use their apps (though Google is making this easier by crawling apps for indexing and Android Instant Apps), have the option of getting their chatbots on a social networking platform to interact with consumers.
- Discounting Remains Important: The market is more competitive than ever before, so retailers compete very hard on the number and percentage of discounts. One format that Groupon (GRPN - Free Report) pioneered didn’t do so well however because of the low barriers to entry and the company has since launched a marketplace to increase scale.
Emerging New Format
Alphabet has launched “Purchases on Google,” which is a variation of its usual product listing ads (PLAs) for Android and iOS devices. The objective is to speed up the purchasing process for customers. There are no additional charges/CPCs for these ads. The Google carousel displays the products in the usual way, but if they qualify, a “Buy on Google” message appears that leads the user to a seller-branded page. Either fresh payment information or the details stored with Google allows immediate checkout from this page. Google only processes the sale but order fulfillment, customer interaction and customer data remains available to the retailer.
The broader Retail sector, of which Internet Commerce is a part, is doing better than the S&P 500 so far this quarter. Around 13.2% of retail companies have reported results so far. Revenue growth of 14.1% bettered the S&P 500 average of 6.9% although earnings growth of 11.6% fell short of the S&P 500 average of 13.3%. The beat ratios were, however, higher than the S&P 500, meaning that the sector is doing better than expected.
So 100.0% of retail companies that reported earnings beat revenue estimates with 80.0% also beating on earnings. This compares favorably with S&P revenue and earnings beats of 79.1% and 76.9%, respectively. At the end of this quarter, the sector is expected to report revenue and earnings growth of 5.8% and -2.3%, respectively. For comparison purposes, the S&P 500 will grow 4.9% on revenue and 3.0% on earnings.
The other companies we are discussing in the e-commerce outlook fall under the broader Computer & Technology sector. The sector hasn’t done as well as retail so far in the third quarter, posting revenue and earnings growth of 13.8% and 52.8%, respectively. The revenue and earnings beat ratios are 100% and 83.3%. At the end of this quarter, it’s expected that revenue and earnings growth will average at 6.9% and 9.9%, respectively.
Take Your Pick
While we generally prefer stocks operating in strong industries at any point of time, a negative sector outlook doesn’t mean that there aren’t any good picks at all.
Zacks methodology helps us find the stocks that have upside potential despite the hiccups.
The Internet - Services industry is the most attractive for investment right now, with stocks like Autohome ATHM, Baidu BIDU, Bridgeline Digital BLIN and Facebook FB, all of which carry a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. Zacks Rank #2 (Buy) stocks like Etsy ETSY, Gree Inc (GREZF - Free Report) , Interxion Holding NV (INXN - Free Report) , Limelight Networks (LLNW - Free Report) and Match Group (MTCH - Free Report) are also recommended.
The stocks in the Internet Commerce and Internet - Delivery Services industries aren’t recommended at this time.
The Internet - Software/Services industry also offers opportunities: 58.com (WUBA - Free Report) and Bazaarvoice BV are ranked #1 while Boingo Wireless (WIFI - Free Report) and Okta Inc (OKTA - Free Report) are ranked #2.
Retail ecommerce remains a fairly small part of total retail right now, but because it is a fast-growing part, it is increasingly accounting for a larger share. Just a year ago, we were looking at a mid-single digit share, but this year, eMarketer thinks that share will be a tenth of global retail sales.
Ecommerce sales in Asia will account for 14.7% of total retail sales, with China contributing more than half the sales, followed by Japan with slowing growth rates and then India, which will be the fastest growing. Volumes will double by 2021. This year, ecommerce will account for only 8.8% of total retail sales in Western Europe, but grow to 11.4% by 2021. Germany is the top retail market but UK the leading ecommerce region.
Government data indicates that retail ecommerce has outpaced total retail sales growth in recent times even in bad quarters for the sector. Some of this is on account of the continued shift from offline to online retail, as customers (baby boomers) move to online channels. But it’s also because new consumers (millenials) often start out on online channels. These consumers spend more time in a connected, social environment and take for granted many of the online tools previous generations struggled to understand, appreciate and adopt. Therefore, ecommerce will likely continue to outpace total retail sales in the foreseeable future.
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