Is There Room for Growth in Online Retailers

Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the highly competitive and low barrier Internet retailing industry, three companies lead the segment in the Americas. In the north eBay (NASDAQ: EBAY) and Amazon (NASDAQ: AMZN) fiercely fight for the lead; down south, MercadoLibre (NASDAQ: MELI) is the undisputed front-runner. In this article we will look into the main reasons to invest in these companies as e-commerce develops and more people chose to buy online over going to shops.

MercadoLibre: Latin America's bet  

MercadoLibre, Latin America’s eBay, had been outperforming the market and its peers, having become a strong buy. However, a few weeks ago it announced its Q1 results, missing EPS analyst estimates. Earnings came in at $0.40 per share, 14 cents below analyst consensus, mainly due to the Venezuelan devaluation. Nevertheless, without the losses caused by this conjunction, earnings would have reached $0.53 per share, still 1 cent below consensus. On the other hand, net revenues were up by 36% in local currencies (or 23% in U.S. dollars), reaching $102.7 million.

Oddly, the stock was up by 17% the day following this announcement, and reached over $125 per share by mid May. Now stabilized at $114 per share, is this company still a buy? I would say it is, given its fair moat provided by its access to network effects and economies of scale in both the marketplace and payment platforms (Morningstar).

Although trading at a high price, it is still valued similar to its peers; at 51x P/E, it exchanges slightly above the 49.5x industry mean, and the premium is worth paying. Moreover, solid first quarter results portray a promising outlook, especially as transaction volume expansion is expected to be one of the main growth drivers in the long-term. During 2013’s first quarter, items sold increased by 20.5% to 18.1 million while total payments transactions through its MercadoPago system increased 37.9% to 6.7 million.

Furthermore, just like PayPal does for eBay, MercadoLibre´s own payment system, Mercado Pago, has been expanding beyond the site´s transactions, into a standalone business.

In a market like Latin America where online sales have not yet fully penetrated, this firm seems headed in the right direction, establishing in the region new shopping and payment methods, which have proven very successful in other parts of the world.  As disposable income grows, this leading company´s market share should only increase, as it is certainly poised to benefit from these trends. In addition, not having to compete with Amazon, as it hasn't penetrated much in the region, the company will most likely conserve and extend its undisputed dominant position in the e-commerce segment. Although it will face some competition from Amazon in the years to come, the threat shouldn't be too high. Even better, competition from eBay can be discarded: as a 20% owner of MercadoLibre, the firms do not compete for jurisdictions; Latin America is MercadoLibre’s, North America is eBay’s.

eBay: in search of new markets

The e-commerce giant has been lately migrating to other commercial areas, becoming a leader outside of the web as well. Among its assets, PayPal, which accounted for 40% of 2012’s revenue, will most likely drive the firm’s growth in the future. However, eBay plans further expansion through other means, especially through its mobile technology which, according to the firm’s President and CEO John Donahoe, will lead a commercial revolution. Consequently, the company expects to enable $300 billion of global commerce by 2015, compared to $175 billion in 2012. Similar great expectations revolve around revenues for 2015: management projects them to grow by 50%, to $21.5 billion. If these reasons are not enough for you, here are some other reasons to buy eBay’s shares now.

I would say that, in terms of valuation, eBay is a bargain. Trading at 25.4x P/E, way below the industry average of 72.5x, it provides a highly attractive entry point for investors. The stock becomes even cheaper if its forward P/E of 16.2x (Morningstar) is taken into account.

With a presence in over 40 countries, the firm currently generates more than half of its revenue at overseas markets, and expansion plans are still big, but cautious –particularly with margins management. Underpenetrated markets, particularly Brazil, Russia, China and India, are expected to provide 25% of eBay’s active users and 12% of its global sales by 2015. Moreover, several investments in regional companies like MercadoLibre will most certainly help the firm further augment its market share within the next few years.

PayPal is has been strongly penetrating the offline arena lately through several deals with retailers. But also, the Discover (U.S.’ fourth largest credit card company) agreement will most certainly boost its revenue, transforming it into a mainstream payment system by adding in-store payments to 7 million locations.

As a result of improving gross merchandise volumes (GMVs), both the Marketplace and Payment segments have provided consistent growth during each of the last eight quarters (Zacks Research), a trend that is expected to continue in the long-term, resulting in an expected EPS average annual growth rate of over 15%, about 23% above the industry average.

Amazon: a big online competitor

Lately, plenty of discussion about tax reforms has been taking place and pressures to impose sales taxes to Internet retailers have gained field. Formerly opposing this policy, Amazon is now lobbying for taxation as it would not affect it as much as it would hit eBay and some other online competitors. The reason behind this shift is that Amazon owns so many physical (and therefore, taxed) distribution centers that the impact would not be so great compared to the relative advantage it will provide versus its peers.

Although opinion between analysts is pretty divided about this firm, consensuses tends to recommend buying this stock, though not as strongly as eBay, for now. Below I will list the main reasons that lead me to believe that this stock is a buy despite its high and constantly rising price that almost doubles its sales and is about 64 times higher than its forwards EPS. The stock has been down by about 2.5% since it scratched $274 by the end of January. Although it is still not cheap, an interesting entry point is provided, especially as consensus estimates project an annual EPS growth rate of over 37% for the next five years to come.

Amazon has been, for many, the main entity responsible for the deterioration of brick-and-mortar retailers. As stated by Morningstar analyst R.J. Hottovy, its “low-cost operations, network effect, and laser focus on customer service provide the company with sustainable competitive advantages that traditional retailers cannot match; this should yield additional market share in coming years. Armed with one of the most capital-efficient models in e-commerce, Amazon generates economic returns well ahead of our cost of capital assumption, supporting our view that it has a wide economic moat.”

Several other growth factors can be named, including the ongoing success of its Kindle Platform; its robust presence worldwide and continuous double-digit international expansion, even through the last economic crisis; its diversified business that includes other e-commerce websites like Zappos.com, Diapers.com, Soap.com and LOVEFiLM (an online movie rental subscription service); and its strong balance sheet and cash flows.

Bottom line

As described above, all three of these companies offer great growth prospects and investment opportunities. However, I feel a little discouraged by Amazon’s stock price and would rather pick eBay or MercadoLibre at the moment. Buy either one of them; they both seem poised to grow in the short and middle term by expanding dominance in underpenetrated, especially emerging, markets while still moated enough to endure and keep on delivering consistent growth in the longer run.

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Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, eBay, and MercadoLibre. The Motley Fool owns shares of Amazon.com, eBay, and MercadoLibre. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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