The Future of Retail is With This Company

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The slow contraction of domestic retail has been greatly exaggerated.  Sure, you could be forgiven for thinking that people were simply spending less money. Chipotle (NYSE: CMG  ) and Apple (Nasdaq: AAPL  ) had earnings disappointments , and both of these companies are fair indicators of consumer spending. They represent highly desirable -- but by no means necessary -- purchases for the average consumer.

But, as Amazon (Nasdaq: AMZN  ) showed Thursday night, not all consumer-facing companies are created equal. Take a look at some of the numbers the company released, and you’ll see why I think this is the one stock every investor needs at least a sliver of in his or her portfolio.

Yearly Revenue Growth Gross Margin Expansion North American Sales Growth International Sales Growth
29.5%  200 bps to 26.07% 35.5% 22.2%
Source: SEC filings

The picture gets even rosier if you back out foreign currency exchanges. On a constant-dollar basis, revenue was up an impressive 32% during the second quarter of 2012. The market clearly likes the news, as the stock was up by as much as 7% today.

And yet, the bears will still point to one overriding factor to be bullish on Amazon: it’s currently trading for 245 times (non-GAAP) earnings.

Where’s the disconnect?
How can a company that’s growing revenue by around 30% show a decrease in profit of 60%?  That’s actually pretty simple: it grows expenses faster than it grows revenues. Take a look at how quickly the following spending segments grew, keeping in mind that anything above 30% means expenses grew faster than sales.

  Fulfillment Marketing Technology & Content General & Administrative
Spending Growth 44% 57% 55%  40%
Percent of Operating Expenses 42% 17% 34%  7%
Source: SEC filings, “Other operating expenses” not included

The two categories to focus on here are fulfillment, and technology & content; they combine to account for three-quarters of operating expenses. Each grew by well over the 30% mark Source: SEC filings, “Other operating expenses” not includedlast quarter. Was it money well spent?

In the case of fulfillment centers, I don’t think there’s any other way to put this: without these expenses, I wouldn’t be investing in the company. 

Back when Netflix (Nasdaq: NFLX  ) was just a DVD company, the crucial advantage it had over other competitors was that its fulfillment centers were located strategically throughout the United States -- near post offices. If any company wanted to match Netflix’s scale and customer service, it would have to spend millions on upgrades.

Amazon is building the same type of moat around it that Netflix once had. This year, the company plans to open 18 new fulfillment centers, and more are coming in the future. These centers aren’t cheap -- think billions -- but they are crucial to providing better customer service and faster delivery times. Once completed, competition won’t be able to spend the type of money it takes to match Amazon. 

But, unlike Netflix, the company’s business model won’t be thrown out the window if media starts to be consumed electronically. That’s why Amazon is spending so much on technology and development as well -- if books, movies, and music will be bought virtually instead of being sent to your doorstep, Amazon is still the way to go. 

As things stand right now, sales of physical products (clothes, electronics, gadgets, etc.) account for two-thirds of Amazon’s revenue, while the delivery of movies, music, books, and other media via the Internet accounts for the other third.

What’s the end game?
While technology costs could remain high indefinitely, the costs associated with building out fulfillment centers will eventually subside. When that happens, the network that Amazon has built won’t require as much capital, and earnings should improve significantly.

As things stand, I think there’s only one type of technology on the horizon that could someday usurp Amazon’s advantage: 3-D printing. That’s why you should also look into companies like 3D Systems (NYSE: DDD  ) for your portfolio. If you’d like to find out more about this mind-boggling sector, consider reading our special free report: 3 Stocks To Own For The New Industrial Revolution. You already know the name of one of the companies; get your copy of the report today to get the names of the other two, absolutely free!

Fool contributor Brian Stoffel owns shares of Apple and Amazon. You can follow him on Twitter, where he goes by TMFStoffel. The Motley Fool owns shares of Netflix, Chipotle Mexican Grill, Apple, and Motley Fool newsletter services have recommended buying shares of 3D Systems, Chipotle Mexican Grill, Apple, Netflix, and, and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (4) | Recommend This Article (10)

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  • Report this Comment On July 28, 2012, at 12:32 AM, IlluminatInvest wrote:

    Oh, I think I finally understand their strategy now, once they spend enough on infrastructure they'll be able to raise prices on their products, right? No, still the usual razor thin margins?

    Well then the Kindle will make up the difference. Wait, they lose money on that, too?

    Well at least they'll still have the advantage of being the low cost provider of online retail, until this newfangled 3D printing catches on and we can just print products at home!

  • Report this Comment On July 28, 2012, at 12:04 PM, darnold1956 wrote:

    You have to wonder just how many people scope out a product (especially electronics/computers) at their local store, and then go to to buy.

  • Report this Comment On July 30, 2012, at 6:17 PM, IlluminatInvest wrote:

    Everyone except Costco shoppers. For those that say Amazon has no competition don't you think could cut into Amazon's business just a bit?

    Amazon seems intent to dominate all the low margin businesses like online retail, tablets, and streaming video, where maintaining a competivive advantage requires continuous spending, so at least they're executing their strategy flawlessly.

  • Report this Comment On July 31, 2012, at 2:04 PM, TMFCheesehead wrote:


    The biggest problem a COST would have in matching AMZN's offerings is in it's scale of fulfillment centers. Either way, both are very high quality companies.

    Brian Stoffel

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