Amazon.com and the State of the Retail Industry

Increasing uncertainty in the U.S. economy and retail sector points to continued struggles for companies like Wal-Mart, Amazon.com, and Target.

Feb 7, 2014 at 4:26PM

A cursory glance may make it appear that the recent underperformance in the retail sector in the United States largely occurred because consumer dollars shifted to Internet retail giant Amazon.com (NASDAQ:AMZN). That assumption would be a mistake, as Amazon missed on the key metrics of revenue and earnings, which suggests that the company and other retailers face some strong headwinds in 2014 and beyond.

 Amazon's revenue in the fourth quarter came in at $25.6 billion, missing the consensus estimate of $26.08 billion. Amazon's earnings were much worse as it ended the quarter at $0.51 per share, below the $0.69 per share analysts wanted to see.

The company said its retail business was strong for the quarter, but when asked about margins it wouldn't talk about the specific numbers
. So assuming there are no margin surprises, the earnings issue seems to center on Amazon's Amazon Prime business. Amazon Prime came under pressure because of alleged increases in the cost of fuel, which were said to raise shipping prices. The problem there is that the cost of fuel hasn't risen much over the last couple of years, which points to the probability of a different issue.

 Shipping costs were said to have climbed 19% for the company in the fourth quarter, which offset increased sales from its Amazon Prime service. The company responded by throwing out the idea of increasing the cost of the service by $20-$40 in 2014.

Other possibility
So with fuel costs cited as the reason for Amazon's lower-than-expected earnings while fuel prices have been level for a couple of years, what else could have caused Amazon to miss on earnings by so much?

 The one other major element could be the huge number of people Amazon has hired over the last four years. During that period of time the company has increased the size of its workforce by 108,000, which on average would be 27,000 new hires a year. That's a huge expense, and it actually makes more sense than the fuel price assertion.

Whatever the reason, Amazon does face a challenge with its wildly popular Amazon Prime service, which has become a big hit for the company. Amazon will have to tread carefully if it does raise the price of the service.

Wal-Mart's performance

Pointing to another concern for the retail sector, as well as the overall U.S. economy, is the ongoing weak performance of retail behemoth Wal-Mart (NYSE:WMT).

Wal-Mart recently lowered its adjusted earnings and earnings expectations. It narrowed its adjusted earnings guidance to $5.11-$5.21 from the $5.10-$5.30 per share that it previously estimated. Wal-Mart's earnings expectations have also been cut back to $5.10-$5.30 per share, down from the $5.20-$5.40 per share prior guidance. The company has cut its outlook for 2014 three times already.

For the fourth quarter, Wal-Mart is looking at adjusted earnings to be at the low end, or possibly a little below, the $1.60-$1.70 range it is looking for.

The bottom line is I don't believe that all of this can be attributed solely to Amazon.com.

Target's unenviable challenge
Target (NYSE:TGT) has had a nice run over the last five years, more than doubling since March 2009. That performance is under pressure now as the ongoing news about the data breach has brought Target much of the type of attention that no company wants. Since Nov. 20, 2013, Target has dropped by over $9.00 per share to trade at a little over $55.00 per share as I write.

In early December Target discovered that up to 70 million customers had their names, phone numbers, mailing addresses, and email addresses stolen by hackers. The actual breach started to happen in the latter part of November. Those who see the costs of the breach in the hundreds of millions see the valuation of the company as compelling. Analysts who see the breach possibly costing Target upwards of a billion dollars see the share price of the company continuing to fall.

Where Target could surprise is its limited exposure to overseas challenges. If Target can continue to perform well, even with the crisis it's facing, this could be a good time to take a position in the company.

Outlook
The retail sector in the United States appears to be under pressure, which would point to a weakening economy. Even though Amazon.com enjoyed a solid quarter, that can't be the reason why 33 major retailers lowered their outlooks for the fourth quarter and the year ahead.

There needs to be more clarity on margins from Amazon in order to see whether or not the company played a part in the fall in earnings. Amazon's hiring definitely made up part of that earnings disappointment, although that points to a growing demand for the products offered by the company.

The point is that consumers appear to be cutting back on spending, which means that they have less cash to spend or they are concerned about the health of the economy. Coupled with downward earnings performances from Wal-Mart and Amazon.com, it looks like the retail sector is going to struggle through 2014 at least.

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Gary Bourgeault has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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