There is no doubt that COVID-19 has changed the way we live. As we continue to socially distance, we become more reliant on technology for the way we live, work and shop. This is unlikely to change anytime soon, and these changes present opportunities for investors.
The world is continuing to struggle with the pandemic, as many parts of the world roll in and out of lockdowns. While vaccines are proving to be effective against the Delta variant of the virus for serious illness, individuals are still being urged to socially distance as governments keep a strong focus on minimising case numbers to avoid putting too much pressure on hospitals.
This does not bode well for physical retail stores, which have to balance high rents and low customer traffic. The move to digital ecommerce was one that started before COVID-19 and it is a trend that will no doubt accelerate.
The growth of online shopping benefits more than just online retailers. It will benefit the companies that process the payments and the delivery companies too. All of which are seeing strong year on year earnings growth.
This month we would like to introduce the e-commerce basket which includes Amazon, FedEx, and PayPal. These are some of the largest and well-known companies in the world and for good reason - everyone is addicted to the convenience of their services.
Amazon is a multinational e-commerce company, and the world's largest retail provider. The company is focused on attracting five distinct customer sets: consumers, sellers, developers, enterprises, and content creators. On the consumer/seller side, Amazon provides a platform through which users can buy and sell products in a timely, convenient manner. On the developer/enterprise side, Amazon provides cloud-based, technological infrastructure to various businesses. Amazon also provides other services, such as advertising services and co-branded credit card agreements, and has begun to develop its own consumer products, such as the Kindle.
In addition to their well-known services for online shopping, Amazon also derives 11 per cent of its revenue from Amazon Web Services (AWS). This is one of the largest cloud computing services in the world that helps host server infrastructure for Amazon, as well as other e-commerce companies.
Although AWS is a relatively small part of Amazon’s net sales, it’s a segment that generates more operating profit than either of the other two segments individually. It’s their higher-margin cash cow business, even though it’s not what most people think of when they think about Amazon. Like most of the other big tech companies, Amazon has more cash than debt, which gives it a robust balance sheet.
We believe Amazon is leveraging dual-purpose infrastructure (servers, fulfillment centers and web traffic) to profitably sell services to Enterprises. There have been ongoing concerns about anti-trust risk as it pertains to Amazon. However, the US Deportment of Justice has suggested the current laws (Section 2 of the Sherman Act) are quite capable of addressing antitrust concerns. Under prevailing laws, we see few legal risks to Amazon’s business model.
PayPal is a leading payments technology platform that enables digital commerce functionality for over 375 million consumers and merchants globally.
We like PayPal’s exposure to the rapidly growing digital commerce landscape (off a larger base because of the COVID pandemic), and believe it is positioned well to sustain upper-teens or better net revenue growth over the next 2-3 years.
We believe PayPal’s scale, new product introductions and mobile transaction trajectory can sustain a growing network effect. Additionally, balance sheet strength presents merger and acquisition (M&A) capability for transformative acquisitions, as well as ongoing industry consolidation through bolt-on acquisitions.
Major risks include but are not limited to rising competition from the proliferation of payment choices, execution risk (new product rollouts, partnership ramps, etc.,) and importantly also the management of expectations, given the current valuation levels.
Considering these opportunities and risks together, we note that recent results and commentary support the idea of continued robust secular growth at levels that in the near-term could be higher than PayPal’s traditional structural growth rate.
FedEx is a globally integrated carrier providing delivery of documents, packages, and freight through a supply chain network supported by transportation, businesses and information related services.
Our analysts expect stabilising and improving global trade trends, accompanied by a surge in ecommerce volumes, and potentially better parcel pricing. This suggests earnings estimates are headed higher.
The company has recently started to reduce their earnings guidance and this has created a buying opportunity, as we believe these lower targets will be easily met in the near future and they will eventually raise targets again, creating a powerful catalyst for future share price growth.
Our view is financials are inflecting positively, as we consider a more positive outlook in which FedEx leverage’s sticky ecommerce growth to drive positive incremental margins. On the express-delivery side, air-cargo tightness and COVID vaccine distribution should bridge the gap to a post-vaccine reflation in global trade and business-to-business (B2B) activity. In the freight segment positive less-than-load (LTL) tonnage should couple with already solid pricing to support double digit margins.
This sector has seen incredible growth throughout the pandemic and continues to grow even as vaccines are rolled out globally. Consumers have spoken loudly and the convenience of online shopping is unbeatable. The fact that we can now shop online, maintain our social distancing, and receive our goods in a timely manner suggest that growth for this sector is in its early innings. We expect these market leaders to keep and grow their dominance given their established networks, infrastructure, and the resilience of their balance sheets.
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Author: Peter Moussa, Senior Investment Specialist for Citi
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