Our last Stock Exchange looked at consumer discretionary spending. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – Amazon Apocalypse in Retail?

Amazon (AMZN) made waves again last week with its announcement that it would partner with Sears (SHLD) to sell Kenmore branded appliances. The announcement sent shares of competing appliance sellers like Best Buy, Home Depot, Lowe’s, and Whirlpool tumbling (BBY, HD, LOW, WHR) while bolstering Sears. Best Buy and Home Depot have acquired a reputation with some as being relatively ‘Amazon-Proof’, and for investors with such opinions these moves may represent a opportunity. It’s worth noting that Whirlpool is one of the main manufacturers of parts for a variety of Kenmore products, although it remains to be seen if it’s 30+ year partnership with Sears will survive.

Between its purchase of Whole Foods Market (WFM), filing a trademark for a prepared meals service (bludgeoning Blue Apron (APRN)), and freshly announced partnership with Sears, Amazon is attracting a lot of attention from the punditry and even some from regulators. Barron’s cites Reuters’ report that The FTC recently opened an investigation, as part of its review of the company’s purchase of Whole Foods, into claims by Consumer Watchdog that Amazon uses deceptive discounting practices.  The word ‘antitrust’ continues to be whispered with increasing volume, and more and more with a bone to pick are finding this to be the moment to pile on with. The same day the FTC announced its investigation, David Kahan, CEO of Birkenstock Americas fired off a letter to the company’s retail partners accusing Amazon of “Modern Day Piracy” and attacking “All Brands”. The letter accuses Amazon of running Birkenstock’s blockade of sales to it by buying from resellers instead, and warns retail partners to steer clear or risk ending their relationship with the German shoe company.

Rupert Hargreaves’ piece published earlier this week on ValueWalk, does an excellent job examining some of the concurrent dynamics affecting brick and mortar retail. It isn’t pretty.  He covers the precipitous drop in retail traffic over the summer, how consumer behavior with private-label credit cards and store closures exacerbate each other’s effects, and the major disadvantage brick and mortar stores face in having to deal with issues like shoplifting and robberies. For more, you’ll have to check out his article. While retail stores are closing and laying off workers, Amazon is hiring, listing 50,000 full time positions across its fulfillment network nationwide.

Expert Picks from the Models

We’re joined again by one of our favorite guest experts on the stock exchange: Blue Harbinger (also known as Mark Hines) who we were lucky enough to have for last week’s edition of The Stock Exchange as well. Blue Harbinger specializes in independent investment research, and we’re glad to have his thoughts again this week.This week’s picks happen to center around retail, similar to last week’s focus on related discretionary spending and luxury goods.

Holmes: This week I like L Brands (LB), the fashion retailer. This stock’s dip since January is the sort of set up I like to see when sniffing out a good deal. From the chart below you can see LB is below both its 50 and 200-day moving averages, and has received support at the $43-level. The price moving above the 50-day average at $49.81 would be encouraging. With limited downside and plenty of upside potential, I hope I’ve brought the humans a solid pick.
 

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BH: L Brands is a profitable business but it has a lot of debt, and retail will be challenged going forward. In particular, L Brands has exposure to “B and C” brick and mortar retail stores, and these spaces will be challenged as the proliferation of online retail continues.

H: What are B and C stores? I have to admit I’m not familiar with these terms, or the details of L Brands’ capitalization structure. I do know what works for me, however, and this is it! Plus, I’ve read that Victoria’s Secret and Bed Bath & Beyond customers, L Brands’ flagships, are some of the most loyal in retail. That’s good, right? Loyalty has to count for something…

BH: I do believe the company’s brands give it some competitive advantage and allow for premium pricing (Victoria’s Secret and Bath & Body Works account for over 90% of total L Brands sales). However, sales fell 6% in June, below consensus estimates, and this feeds into the narrative that all “brick and mortar” stores are going to get “Amazoned.” I don’t necessarily believe this narrative is true (plenty of prime location stores will continue to do just fine), but the company’s plans to increase exposure (including “less-than-prime” retails spaces) is concerning. L Brands spends a lot of money maintaining its stores and training its employees in order to provide an exceptional customer experience, but brand preferences change over time and less foot traffic to some of its expensive locations doesn’t bode well.

Some investors may be lured in by L Brands low price-to-earnings ratio, but I suspect it’s low for a reason (i.e. business is facing challenges).

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BH: Given the choice between L Brands and RH, L Brands seems much healthier, but realistically I am not interested in investing in either one.

H: Take RH up with  RoadRunner, it’s his pick this week, and was Athena’s a few weeks ago. While I can’t speak for the bird or our resident goddess, I’m comfortable sticking to my pick, and my method works for me.

Felix: Broadcom (AVGO) is my pick for the week. While it may be hard to see the value of a stock that looks like it’s already on a tear, I’ve done my homework on this one. Put plainly, I think it has a long, long way to go. Take a look at its 12 month chart and you’ll see what I mean. Although I’m focused on the chart, I still know there’s long term growth in semiconductors to beat the band, and the company has excellent cash flow. Broadcom is showing me it can keep this up.

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BH: I like the amazing long-term growth potential of the semiconductor industry, and in one way or another Broadcom is going to be a part of that (Broadcom differentiates itself as a leader in the design of new capabilities and products where high margins are believed to be attainable). However, I have a variety of near-term concerns ranging from the fiercely competitive semiconductor industry, to the company’s high valuation multiples, the delay of the big Brocade (BRCD) deal, and the fact that Broadcom almost has more cash flow than it knows what to do with right now considering its target 50% free cash flow payout ratio (i.e. dividends and share buybacks) which isn’t necessarily all that bad of a problem to have.

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F: It doesn’t sound like all that bad of a problem to have at all… It’s not usually the sort of thing I focus on, but you’re making me think this is an even better pick than it seemed at first glance. It has its hands in so many industries in the technology sector! I like the diversification.

BH: It also has some concentration risk with Apple/Foxconn (more than 10% of revenue in 2016). Further, it’s a high beta stock thereby subjecting investors to market price volatility, and the technology sector to which it belongs probably cannot keep rallying forever.

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In a nutshell, this might be a good Rip Van Winkle stock to sleep on for the next 10 years because if you can avoid stressing out over the volatility then your future self will probably thank you for owning it.

F: It’s precisely long term holding that I’m interested in, although a little shorter than 10 years. While you might think the volatility would bother a fussier investor like me, I take solace in my method and don’t let it bother me.

Road Runner: My pick of the week is Restoration Hardware (RH). Regular readers probably remember that Athena picked RH a few weeks ago. It’s nice to think I came across the same pick as a wisdom goddess, but by a completely different method! Unlike Athena, I look for stocks that are at the bottom of a rising trading channel, and if you look at the chart below you can see why I like RH. It’s been in a steady rising channel since early March, and is at the bottom of the channel again at 71.60. I expect the price of RH to continue to rise back above $75, but will only hold the position so long.

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BH: I don’t like RH (formerly known as Restoration Hardware). This luxury home furnishings company just completed an extraordinarily aggressive share buyback program (they bought back nearly 50% of the shares outstanding in less than six months), and that drove the price way up (it more than doubled) and the valuation (price-to-earnings) is way up too.

RR: I don’t care about valuation, share buybacks, or other fundamental aspects, but I can appreciate that RH isn’t the pick for everyone right now.

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BH: According to Stock Rover, however, next year’s sales growth forecast is only around 6%. The recent actions of the company seem very aggressive (especially since they used some expensive debt to buy back the shares). The market also believes there’s something odd going on with RH considering short interest has risen dramatically to an enormous 63.2%. Further, it’s concerning that RH’s cost of capital is higher than its return on capital, which basically means it is destroying value for each new dollar it invests. And considering RH could suffer significantly (they could have liquidity problems) under even a slight recession, this stock just seems expensive and risky. Perhaps management has something interesting up its sleeve, but I am staying away.