Amazon (NASDAQ:AMZN) and the Coming Onslaught

Robert Weinstein - The Street  SEP 25, 2012 2:40 PM

With its razor-thin margins, the online retailer will have a harder time with Apple, eBay, and others in the mix.

 


You may not guess it by looking at the chart, but Amazon (NASDAQ:AMZN) is in a tough spot.

Its disciples are fully convinced the company is able to continue growing as other stronger players in retail sit idly by and watch it happen.

Even with the incredible growth Amazon has enjoyed, the truth of the matter is that its operate on razor-thin margins, and a large portion of sales come from other smaller retailers that use Amazon as a marketing platform.

Many small companies believe as a result of Amazon collecting sales tax in more states, including just recently in California, its businesses will grow or, at a minimum, will not continue falling apart because of an uneven playing field against online merchants.

I wish these smaller companies luck because it's not enough.

People buy products online for many reasons, and sales tax is only a small part. People don't care if they pay sales tax and/or shipping charges. People are smart enough to compare the total cost of a product from a website to its cost at a retail store. For most products, adding in sales tax is not going to level the playing field and put pricing from bricks on par with pricing from clicks.

That said, some items are best-suited for sales in the online world, and some products are best-suited for retail stores. The differences can be seen with a couple of recent purchases my family made. My son Brenton needed a new bike. I looked online and quickly discounted buying online due to the assembly required. Sometimes assembly is worth it, such as when I bought an air-hockey table from Sears (NASDAQ:SHLD). (I posted hourly updates on Facebook (NASDAQ:FB) while I assembled the table at 4 a.m. on Christmas evening.)

Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) offer bikes for sale and they assemble them. You can't beat the deal for a $200 kid's bike. Even if Amazon moves to the point of same-day delivery, its offering of items requiring a great deal of time to assemble -- also sold inexpensively at retailers -- isn't an edge.

I believe it makes better financial sense for those seeking exposure in retail to look again at stocks like Wal-Mart, Target, Google (NASDAQ:GOOG), eBay (NASDAQ:EBAY), and Apple (NASDAQ:AAPL) rather than Amazon.

For example, too much media attention has been made about Amazon's move into next-day and even same-day delivery plans. This is something that is already offered by others with a much lower earnings multiple.

Wal-Mart offers online ordering and pickup at the store; Wal-Mart's sister store, Sam' Club, even offers this service for bulk wholesale purchases. Wal-Mart also has almost ten times the sales revenue as Amazon. It is virtually impossible to imagine Amazon ever having the ability to out-negotiate vendors for product pricing over Wal-Mart. If Amazon doesn't have a product price advantage, what do they really have over Wal-Mart? Demonstrating another advantage over Amazon is Target, which allows customers to return online purchases to their local Target store. Target is also much larger than Amazon by total revenue. In the physical product marketplace, both Wal-Mart and Target sell more than Amazon. Wal-Mart and Target also sell at higher gross margins than Amazon.

In the digital world, Amazon is under a total assault by Google, eBay, and Apple. Investors should anticipate other entrants not currently in the space. For example, Facebook may ascertain an opportunity in "renting" virtual mall space, not unlike Amazon's merchant program.

Anything sold in the virtual world is no further than two mouse clicks away from another site selling the same product. Google is actively working to promote shopping comparisons and has a payment system in place.

Additionally, the book/eBook market Amazon has so successfully dominated is already showing signs of cracks. Apple is selling greater quantities of eBooks and undercuts Amazon in pricing for many of them. eBooks now outsell physical copies and anyone with a website can sell an eBook.

With such a low barrier to entry, it's just a matter of time before selling eBooks at the retail level is a loss leader to bring customers to the site. This is not unlike how gas stations operate, except when you only offer digital products, you have no pricing power. Can Amazon continue to grow and, more importantly, is Amazon a buy with its current 300+ PE ratio? Of course not: As Amazon's sales and revenue grow, it will increasingly run into Apple, Google, Target, Wal-Mart and others who will push back. If Amazon is able to grow its razor- thin margins, you can bet others that are much bigger and have the capability to dominate will emulate the model. Playing the game of ignoring the landscape where competitors include Wal-Mart, eBay, Target, and many others is full of peril.

It's a no-win situation for Amazon's shareholders, and if they refuse to acknowledge the gravity of the situation, at least protect yourself from a catastrophic loss. You can do so in several ways. A common method is through "portfolio insurance" or buying put options.

The Amazon November $200 strike puts can be bought for about $1.15 each. For about the price of a dollar menu item plus tax, you can ensure that you will cap your potential downside, and anything under $200 doesn't result in further losses.

A January $190 put will cost you about two dollar menu items including tax. If you think Amazon trading $190 can't happen, keep in mind that at $190, Amazon will still be more expensive than Google, Wal-Mart, Target, or Apple on an earnings basis.

I use a proprietary blend of technical analysis, financial crowd behavior and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner.

At the time of publication the author had no holdings in any stock mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.