For fans of Amazon (AMZN) — and there are plenty of them — or followers of the Overstock (OSTK) saga, the past several days have been all about the pricing tussle between the two companies.
Overstock announced on July 25 that it was going to beat Amazon’s prices on select books by 10%. Amazon immediately responded by lowering prices on those same titles to match the newly lowered Overstock.com prices.
It only took a matter of hours for the market to frame the debate as an escalating price war between the two companies … and arguing who would win. But that was a big mistake.
In so doing, investors were distracted from the fact that, in so many ways, Overstock has already pulled ahead of the dominant name in e-tailing.
Last Quarter’s Results a Microcosm
Just as a refresher, Overstock ramped up profits in a major way last quarter, from 2 cents per share in Q2 from 2012 to 15 cents this time around. Sales were up a solid 22%. Amazon also saw its sales grow by 22% on a year-over-year basis, but that’s the extent of the similarities.
Rather than posting the expected profit of 5 cents, Amazon lost 2 cents per share, down from the 1 cent per share the e-tailer earned in the year-ago period. It was the third loss in a row, and underscores something that’s been evident for a while: Amazon’s constant heavy spending and low margins are finally catching up with the company.
Not that the market cares. Shares of AMZN reached new all-time highs despite the shortcoming, largely fueled by — no surprise — an encouraging outlook.
To be fair, Overstock shares have done well too, advancing more than 350% during the past 12 months to reflect the underlying corporate success. But it must be maddening for Overstock’s management, though, seeing traders reward Amazon for what would be considered failure for any other company, while OSTK created profitable success rather than continuing to whittle away net margins.
Thing is, last quarter’s relative strength or weakness aren’t new or surprising. But the oddly long grace period Amazon has been granted by the market might truly and finally be ending … revealing Overstock.com as the better opportunity within the online-retailing arena.
While Amazon is clearly the category leader for online retail, it has gotten into the bad habit of spending — heavily — to win new business. What was spent to develop the Kindle Fire and all those new warehouses should have made a measurable positive impact by now. But they haven’t. Instead, net margins have fallen steadily from an already paper-thin 2% in early 2011 to nil as of Q2.
Supporters of the company will rightfully point out that a company has to spend money now to make money later. But, with quarterly capex growing — reliably — from less than $100 million in 2004 to more than $800 million last quarter (with no end in sight), the critics can also rightfully ask “How much spending is it going to take before getting to the promised land?”
The company’s supporters will counter with “soon”, but that’s a song and dance we’ve heard before from or about the company. Back in 2000, the Motley Fool wrote,
“In 1999, Amazon spent $320 million on capital expenditures. This year, the number should drop to between $200 million and $250 million. Overall, the number should continue to slide from there.”
Nope. Spending didn’t even come close to sliding from there, short-term or long-term.
As was noted, few really cared then because the company was profitable, and it was fun to tell people you owned AMZN when attending a cocktail party. The downside of loose purse strings, however, has started to become evident for nearly a year now, with Amazon being forced to dip into the red ink for the first time in a long time.
Yes, Amazon had to spend to build a cloud storage division, which wasn’t on the radar in 2000. Same for the Kindle in 2003 and more warehouses in 2006. But that’s the point: It’s not the known that’s going to force Amazon to incur spending in the future — it’s the unknown.
And now competition is everywhere. What’s AMZN going to do to keep some distance between itself and its rivals in the future? And more than that, how much is it going to cost to do so?
As for what any of this has to do with Overstock, the contrast rather than the similarity is what makes OSTK the wiser bet.
While Overstock pales in comparison to Amazon in terms of technology and digital content, it’s gotten really, really good at selling physical goods. The pros think it’ll keep getting better at it too, with per-share earnings expected to grow from 98 cents this year to $1.22 next year. Sales are projected to grow by 8.2%.
To be fair, Amazon’s projections for next year are bullish too. Just bear in mind that the company has missed estimates in four of its past five quarters, even with those estimates getting progressively smaller. Overstock.com, on the other hand, has topped estimates in three of the past four quarters, and has grown earnings to meet and beat those targets.
Amazingly, the market has remained in love with AMZN shares, bidding them up to record levels. The rhetoric has clearly changed over the last several months, though, as more of the media has started to pose the same queries explained above. It hasn’t affected the stock’s price yet, but the tolerance AMZN has enjoyed for more than a decade is finally starting to wear thin.
The deterioration of that undertow might be enough to finally make Amazon’s risk/reward ratio a little too heavy on the “risk” side of the equation.
On the flipside, Overstock remains a distant second to Amazon in most investors’ minds, though the company is slowly closing that gap. That’s because the pro-OSTK undertow is accelerating at Amazon’s expense as the market starts to see a certainty with Overstock that it doesn’t have with Amazon. The reason? Possibly because Amazon is trying to be so many things to so many people that it’s not doing any of them exceedingly well.
Time to rethink how to play the online-retailing space.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.