Is This Rally for Online Retailers Sustainable?

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

Shares of major e-commerce companies have started off the year rising, most notably Netflix (NASDAQ: NFLX) that spiked by 97%. Shares of eBay (NASDAQ: EBAY) and Amazon.com (NASDAQ: AMZN) have also increased but at a lower rate. Is their rally sustainable? One way of answering this question is by examining these companies' performance compared to the e-commerce industry: If these companies' revenues grew at a faster pace than that of the entire industry, then demand for their stocks is likely to further rise. So let's examine the growth in sales in the e-commerce industry and compare it to the growth in sales of the above-mentioned companies. 

E-commerce Sales Continue to Rise

E-commerce [opens pdf] still accounts for a small but growing percentage of the entire retail sales market. In the third quarter of 2012, e-commerce sales reached $57 billion (adjusted), which accounts for nearly 5.2% of total retail sales. This represents a 17.3% growth from the parallel quarter in 2011.

In comparison, total retail sales rose by only 4.6% during this period. Furthermore, in the first three quarters of 2012, e-commerce sales rose by 15.9% compared to the first three quarters of 2011. In 2011, the growth in sales was similar to 2012 – 15% (compared to 2010). This number of nearly 16% growth in 2012 could serve as a benchmark for the average growth of this industry. Let's examine how the leading online companies have done in 2012. 

eBay

This company has done well in 2012 with a rise in revenues of 20.8% (year -over-year) and a steady operating margin of nearly 20.5% (in 2011 it was 21%). Thus, the company’s growth in revenues was higher than the industry average. So the rise in demand for this high-growth company is reasonable.

Nonetheless, it's worth noting that this company's free cash flow is nearly non-existent (by the end of 2012 it was $75 million). The company's cash flow was sustained by raising debt of nearly $2.5 billion in 2012. If eBay were to face problems raising debt to maintain its net cash flow positive, this could impede its future growth. 

Netflix

Even though this company might not be labeled as a hard core retailer it does provide a service (TV shows and movies in streaming) that is slowly replacing products – DVDs.

The growth in revenues of Netflix may have been among the main factors for the spike in the company’s stock price. Even though the company’s growth in revenues in 2012 was 12.6%, which is lower than the industry benchmark, I have already gone over the recent developments in this company’s stock.

I will only point out that even though the company’s revenues grew by a higher rate than earlier projected, its operating profit fell from 12% in 2011 to 1.4% in 2012. Furthermore, despite the rise in revenues, Netflix’s free cash flow declined from $52 million in 2011 to ($245) in 2012. These figures should put an asterisk over the rally of this company’s stock in recent months.

Amazon

This e-commerce leader's revenue grew during last year by 27%, which is also well above the industry benchmark we have set of 16%. Its free cash flow fell in 2012 from $1.9 in 2011 to $585 million in 2012. But part of this fall in cash flow is due to the company’s rise in investment in software and website development by nearly $2 billion in 2012. This provision could suggest the company’s revenues will further rise on account of new products it will develop in the coming years. But this company’s profit margin, unlike eBay, is much lower at 1.1% in 2012. If the profit margins will continue to fall, this could impede the company’s stock growth.

I won’t suggest that these companies are the same or their recent rise in the stock market is related. I only wanted to point out that among the online companies listed above eBay and Amazon were able to outperform the market average. Therefore, the rise in shares of these companies is much more convincing than the rise in shares of Netflix.

For further reading:

Gold and Silver Yearly Outlook For 2013

Will Gold Continue to Dwindle?



Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article.This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact. The Motley Fool recommends Amazon.com, eBay, and Netflix. The Motley Fool owns shares of Amazon.com, eBay, and Netflix. 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!

blog comments powered by Disqus