February 5, 2018 Consensus

The Weekly Consensus – February 5, 2018 (Volume 10, Number 6)

The Big Story
Does Amazon Still Not Care About Making Money?
Paul Alexander, CFA

For many years the narrative surrounding Amazon and its attitude toward making money has been that the company doesn’t seek to be profitable. That it values growth opportunity and market share over income. That it has been tirelessly conditioning the investment community to prioritize vision over the bottom line. NYU professor and notable tech pundit Scott Galloway even mused in a speaking engagement last year that every time Amazon reports a profitable quarter, CEO Jeff Bezos probably berates his deputies that they screwed up.

And yet, last week, Amazon reported that it generated $3 billion of net income in 2017. $1.9 billion of that came just in the fourth quarter. According to Galloway’s joke, there must have been a bloodbath in a certain conference room in Seattle.

Or was there? Maybe Amazon is finally warming up to the concept of making money. 2017’s $3 billion profit is up from $2.4 billion in 2016 and $0.6 billion in 2015. In contrast, over the prior three-year period, from 2012 through 2014, Amazon was roughly breakeven. To borrow a famous line by James Bond creator Ian Fleming, one year of profit growth is happenstance, two years is a coincidence, three is a trend. Amazon must have meant to do this, no? Is the company finally allowing itself to reap the rewards of its growth and dominance?

Maybe not. $3 billion seems like a lot, but not when compared to Amazon’s rapidly growing revenue base. Amazon registered revenues of $177.9 billion in 2017, meaning that full year net profit margin was only 1.7%. This is unchanged from 2016, when Amazon also achieved a 1.7% profit margin. So, while total profit dollars continue to rise, profit margins remain steady, and somewhat close to zero. Additionally, nearly $0.8 billion of the company’s Q4 2017 profits came from a tax benefit from the new U.S. Republican tax bill passed in December. Perhaps Amazon is getting to be so big, that a rounding error, a timing shift, or a lumpy tax bill can create a multi-billion-dollar variance from the company’s profit target (of zero). Is it possible that Amazon made $3 billion last year, gulp, by accident?

It doesn’t seem like much of what Amazon does happens by accident. Yes, the company has only been consistently profitable for three years, but drilling down to narrower windows of observation, the recent pattern of consistency seems like less of a coincidence. Amazon has now been profitable in 11 consecutive quarters. One might think that if the company’s profit goal were zero, some unforeseen hiccup or bump in the road would have resulted in at least one negative quarter over that time.

Looking at the numbers and trying to intuit Amazon’s designs on profit is an interesting exercise, but we at Consensus thought we might unlock the truth by conducting some primary research. Actually, an interview. Unfortunately, our contact (and potential informant) only had the same amount of knowledge on the topic as us. The transcript of our interview follows:

Consensus: Alexa, does Amazon try to make a profit?

Alexa: Sorry, I don’t know about that.


Headlines of the Week

Amazon’s profit tops $3 billion as 2017 revenue grows 31%

Suffice to say, 2017 was a busy—and strong—year for Amazon.com Inc., which reported its Q4 and full-year financial results. The e-retailer generated $177.9 billion in revenue in 2017, up 30.8% from $136.0 billion in 2016. Its net income also climbed 27.8% to $3.03 billion from $2.37 billion in 2016.


Keurig, Dr Pepper Snapple Group merge to create new company

In a surprising move, Keurig Green Mountain has announced entering into a definitive agreement to merge with Plano, Texas-based Dr Pepper Snapple. Together the brands will launch a new company, Keurig Dr Pepper, or KDP. The combined company will house Dr Pepper, 7UP, Snapple, A&W, Mott’s, Sunkist, Green Mountain Coffee Roasters, Keurig’s single-serve coffee systems, and more than 75 owned partner brands in Keurig’s system, among others.



Apparel & Footwear

‘People should boycott everything about you’: Athleisure startup CEO rips into rival brand

Athleisure fans across the US are up in arms. This weekend, Bandier, an activewear retailer that stocks multiple brands, launched a private-label collection called “We Over Me” online, in five of its stores, and on Net-A-Porter. But the launch didn’t get quite the fanfare the brand had hoped for as many customers turned to social media to express disdain for the collection, claiming it was far too similar to some of the products sold at Outdoor Voices, an outdoor clothing company based in Austin.

J.Crew Launches Lower-Priced Swinwear Line Aimed at Millennials

J.Crew launched its solid, reliable swimwear range in 1989. It was perhaps never known for this category; rather, swim was just always there, with a little more variety than your typical mid-price retailer. And beginning on Tuesday, it will offer even more variety: It’s launching Playa, a more affordable line of swimwear with prices starting at $22.50 for bottoms and going up to $54.50 for a one-piece. The styles available are perhaps a little more playful and colorful than some of those in its main swimwear line, with lots of stripes, florals, polka dots and pink. They’re available both in stores and online.

Fast Fashion Industry Winners and Strugglers

There is no doubt that clothing remains a big business; Americans spend more than $250 billion on apparel each year. Mar 2014 – Mar 2017 saw exponential growth to fast fashion websites with a 67% increase in visits. However, the last year (Mar 2016 to Mar 2017) revealed a 9.47% decline, as fast fashion brands struggle to maintain production at increasingly low prices. Which fast fashion brands have pulled ahead of the market, while others fall behind? Many retailers, including the once all-powerful Forever 21, have steadily lost market share in the fast fashion industry.



Athletic & Sporting Goods

Nike Gains a Step on Adidas in Competition for Top Soccer Stars

With European soccer’s annual transfer window drawing to a close, and star players from Alexis Sanchez to Virgil van Dijk changing hands at values higher than ever, Nike Inc. has a boots-on-the-ground advantage over rival Adidas AG.  The combined value of the 100 most expensive players in the professional leagues of England, France, Germany, Italy and Spain has hit 8.97 billion euros ($11.2 billion), according to a study by the CIES Football Observatory in Neuchatel, Switzerland. Adding data on individual shoe sponsors reveals that 57 percent of that value comes from players wearing Nike boots — including Sanchez and van Dijk — compared with 33 percent from those wearing Adidas.


Hedge Fund Seeks Spinoff at Company Behind Popular Gym Equipment

Jeff Altman’s Owl Creek Asset Management is pushing Brunswick Corp. to spin out its fitness business after building an activist stake in the company, which also makes boats and billiards tables.  “Brunswick stakeholders would benefit significantly from a spinoff of the fitness equipment business,” the event-driven hedge fund said in a letter addressed to the company’s board. “The marine segment on a stand-alone basis is worth more than the current valuation for all of Brunswick, implying the market assigns negative value to the fitness segment.”  Brunswick’s fitness unit includes brands such as Life Fitness and Hammer Strength and makes up a smaller piece of the company than the company’s marine engine and boat manufacturing business, which bring in the majority of Brunswick’s $4.7 billion in revenue.

Cosmetics & Pharmacy

Riley Rose, Forever 21’s Fun-to-Shop Beauty Store, Finally Launches Online

Riley Rose, the unique and surprisingly engaging chain of beauty stores founded by the family that owns Forever 21, just launched e-commerce. The first Riley Rose store opened near LA last October. Linda and Esther Chang, the daughters of the Forever 21 founders who are running the new endeavor, wanted a freestanding beauty store that would appeal to millennials and Gen Z. The stores are a wonderland of pink and offer a variety of K-beauty, natural skincare, sparkly makeup from both indie and established brands, an impressive assortment of haircare, and — an important point of differentiation from other beauty stores — candy, small accessories, and whimsical home goods. The whole place is happy and will make you want to 1) Instagram it and 2) buy stuff, in that order.


CVS Gets A Boost After Pledging To Stop Altering Its Beauty-Related Marketing Content

After CVS announced plans earlier this month to eventually eradicate the use of manipulated images in its beauty-related marketing materials, both in-store and online, consumer perception of the drugstore chain moved in a positive direction. “The connection between the propagation of unrealistic body images and negative health effects, especially in girls and young women, has been established,” said Helena Foulkes, Executive Vice President of CVS Health and President of CVS Pharmacy, in a statement. “As a purpose-led company, we strive to do our best to assure all of the messages we are sending to our customers reflect our purpose of helping people on their path to better health.” On January 15, the day CVS vowed to phase out airbrushed models used to promote its beauty products, the brand’s Buzz score sat at 16. Ten days later, however, this score, which results from asking consumers if they’ve heard anything positive or negative about a particular brand in the past two weeks, climbed to 19, passing rival Walgreens along the way.


Discounters & Department Stores

Walmart tightens delivery schedule for suppliers

Wal-Mart Stores Inc. plans to ask suppliers to deliver more goods to warehouses exactly on time or face fines, another step in the retailer’s efforts to keep inventory low and shelves stocked as it battles with Amazon.com Inc.  At an annual conference for suppliers, Wal-Mart executives plan to announce that large suppliers need to deliver full orders within a specified one- or two-day window 85% of the time or face a fine of 3% of the cost of delayed goods, said Steve Bratspies, chief merchandising officer for Wal-Mart U.S., in an interview. Previously, suppliers had to hit a 75% threshold to avoid fines. For smaller suppliers the on-time threshold will move to 50%, up from 33%. The change will take effect in April.

Struggling Bon-Ton Stores Inc. details turnaround plans

Struggling retailer Bon-Ton Stores Inc. has put together a turnaround plan focused on closing underperforming stores, providing more sought-after merchandise, improving its marketing and increasing online-related sales by 50% in the next two years. Details

of the turnaround plan were disclosed in connection with a debt restructuring that Bon-Ton is working on with its debt-holders. Bon-Ton, which has dual headquarters in Wisconsin and York, Pa., has been unprofitable for the past six years and recently missed a $14 million debt payment, fueling speculation the company would file for bankruptcy.

Sears lays off 220 employees, mostly at Hoffman Estates headquarters

Sears Holdings Corp. has laid off about 220 corporate employees, effective immediately.

Most of those employees worked at the company’s Hoffman Estates headquarters, and the cuts affected various business units and roles across the organization, Sears spokesman Howard Riefs said Wednesday in an email. The layoffs are part of an ongoing restructuring effort at Sears, and they follow rounds of cuts in March and June, both mostly in Hoffman Estates, totaling more than 500 jobs.


Grocery & Restaurants

Sentinel Capital Partners sells Huddle House

Sentinel Capital Partners has sold Huddle House Inc., the companies said Thursday. Terms of the sale, including the buyer, were not disclosed. The New York City-based private-equity firm acquired Huddle House in 2012.

Home & Road

Tesla to set up mini solar stores inside Home Depot

Tesla is expanding its solar division across Home Depot‘s stores, a source familiar with those plans told CNBC. The expansion would help Tesla test the appeal of its renewable-energy products to a wider audience. It would also help Home Depot use some of its excess floor space to sell new products and gain a competitive edge over its peers.


The circle of Ikea life?

Ikea’s Chief Executive Jesper Brodin made waves at the World Economic Forum in Davos when he said the company is “testing radical solutions” to soften the environmental impact of furniture disposal, including reuse and maybe rental. “There are very different levels of interest depending which city you are in,” Brodin said according to a report by The Telegraph. “So in London, for example, there are a lot of people who commute, and they are not interested, with passion, in building a second home, so rental there is more interesting.”

Jewelry & Luxury

Tourneau Acquired by European Watch Retailer Bucherer

Tourneau, considered the largest watch retailer in America, has been acquired by European watch retailer and jewelry brand Bucherer.  Terms were not disclosed.

The 28-store New York City–based retail chain had previously been owned by Green Equity Investors, an affiliate of Leonard Green & Partners, which purchased it in 2006. Reports that 118-year-old Tourneau was up for sale first surfaced last year.

Rough Market Upbeat at $665M De Beers Sight

Rough-diamond demand was strong at De Beers’ January sight, as manufacturers plan to increase their production in anticipation of post-holiday orders from retailers. The

mining company reported proceeds of $665 million in its first sales cycle of the year, which included last week’s sight in Gaborone, Botswana, as well as its rough auctions. While that figure was 9% lower than the $729 million-worth of rough De Beers sold a year earlier, it represented a 46% jump compared with the miner’s previous sight in December.

Fossil shares tumble after $497M refinance announcement

Struggling watchmaker Fossil Group has bought itself more time — but at a hefty price.

The company said Wednesday it was able to refinance $497 million in debt — but at interest rates well above existing levels. The added financial burden drove down shares of the Richardson, Texas, company 13.3 percent, to $7.96, on Wednesday.  It is the second such refinancing at higher rates within 12 months.

New Guidelines Clarify: ‘Diamond’ Means ‘Natural’

Leading groups in the diamond and jewelry sectors have collaborated to publish a universal standard to use when referring to natural diamonds and synthetics. The Diamond Terminology Guideline is a reference on diamond vocabulary for all sector organizations, traders and retailers to use, nine industry bodies said in a joint statement Tuesday.  The document stipulates that the words “diamond” and “gemstone” imply natural origin. The industry should use “synthetic,” “laboratory-grown” or “laboratory-created,” and should avoid the terms “real,” “genuine” and “authentic,” when describing such man-made products.


Office & Leisure

Staples CEO Leaves Company, To Be Replaced By Coca-Cola Exec.

Sixteen months after being appointed to the position, Shira Goodman is no longer the CEO of Staples. The office supplies retailer announced that Goodman will be replaced by Coca-Cola executive vice president Alexander “Sandy” Douglas on April 2. Goodman joined Staples in 1992 and became interim CEO in May 2016, and the company lifted the interim title the following September. The announcement comes less than a year after Staples agreed to be privately acquired by investment firm Sycamore Partners for $6.9 billion and reports that Staples will split into three entities — U.S. Retail, Canadian Retail and corporate supply — to help attract investors.

Mattel Partners With China’s NetEase to Revive Mobile Gaming

After years of struggling to translate its iconic toys to the online world, Mattel Inc. has created a digital studio with NetEase Inc., a Chinese-based tech giant. Mattel163, a joint venture of the two firms, will concentrate on mobile games. One, focusing on Mattel’s Uno card game, will debut early this year on Facebook Messenger, Android and Apple Inc.’s iOS, the company said. The studio will also work on content for Barbie, Fisher-Price and other franchises. NetEase, China’s second-largest video game publisher, has developed several popular mobile game franchises, including Onmyoji, a 2016 role-playing game with more than 200 million downloads. Over the past year, its online games division has produced about $5.5 billion in sales, which is more than Mattel’s $5.1 billion in total revenue.

Can Power Center Landlords Handle Toys ‘R’ Us’ Retreat?

Few retail real estate insiders were surprised to hear that Toys ‘R’ Us will close 180 stores in the U.S., especially after the retailer weathered a disappointing holiday shopping season, following a bankruptcy filing in September 2017. As power center landlords grapple with how they will fill the closing Toys ‘R’ Us and Babies ‘R’ Us locations, some experts say the number of targeted stores is an encouraging sign, being much smaller than expected. And while store closures remain an industry-wide issue, some experts feel that power center landlords still have options to backfill soon-to-be-vacant locations.

Technology & Internet

Boxed.com rejects Kroger offer

Online retailer Boxed.com has spurned an acquisition bid from The Kroger Co. and is instead sending out feelers to Amazon, according to news reports. Kroger’s bid was believed to be in the neighborhood of $300 million to $400 million

Finance & Economy

Employers added 200,000 jobs in January, topping forecasts

The labor market perked up in January as U.S. employers added a better-than-expected 200,000 jobs and worker wages grew at their fastest pace since the recession, fresh signs that hiring could remain solid this year despite a low unemployment rate that’s creating worker shortages.  The unemployment rate, which is calculated from a different survey, remained steady, as expected, at 4.1%, the Labor Department said. The jobless rate remained at its lowest level since December 2000.  And in good news for workers, average hourly earnings in January rose 2.9% vs. a year ago, up from a 2.5% rate in December and above economist projections of 2.6%.


Consumer confidence jumps as Americans expect 2017 momentum to continue

Consumer optimism pushed higher than anticipated in January, after a surprise decline the previous month.  The Conference Board’s measure of consumer confidence rose to 125.4 in January, higher than the 123.1 anticipated by economists polled by Reuters.  “Expectations improved, though consumers were somewhat ambivalent about their income prospects over the coming months, perhaps the result of some uncertainty regarding the impact of the tax plan,” Lynn Franco, Director of Economic Indicators at The Conference Board, said in a statement.

U.S. consumer spending rises; savings drop to 10-year low

U.S. consumer spending rose solidly in December as demand for goods and services increased, but the gain came at the expense of savings, which dropped to a 10-year low in a troubling sign for future consumption and economic growth.  Rising household wealth due to record gains on the U.S. stock market as well as higher home prices likely made Americans more confident to dip into their savings to fund purchases, economists said. Savings are now at levels last seen in December 2007, when the economy slipped into recession.