"Death by Amazon" a Real, Though Not Indiscriminate Threat

by Clay Creek, Thornburg Investment Management

Stocks of some innovative companies with differentiated business models may be unfairly punished along with those genuinely vulnerable to Amazon’s disruption.

When the curators at Merriam-Webster convene to select their Word of the Year for 2017, they might consider “Amazonization” for their short list. Since the June 15th announcement of Amazon’s acquisition of Whole Foods, shares of brick-and-mortar retailers, particularly grocers, have lost tens of billions of dollars in market capitalization.

The spread between Amazon’s share price and Bespoke Investment Group’s “Death by Amazon” index of 54 consumer retail businesses with a limited online presence and a reliance on third-party brands has also continued to widen. Even firms with business models less obviously open to disruption, such as industrial supply company W.W. Grainger and auto parts retailer O’Reilly Automotive, have been the subjects of much hand wringing as well.

Investors should really take a harder look at which businesses may be more resilient or vulnerable to Amazon’s impact, based not on the sector in which they’re classified—usually consumer discretionary—but on how an individual business is handling its competitive landscape. In many cases Amazon is no doubt the largest threat on the horizon. But even in consumer discretionary, some businesses are addressing that threat better than others, including some whose efforts the market may not be accurately assessing.

Morgan Stanley recently added to the growing body of literature on investing in the age of Amazon with its release of five factors that can insulate a business from competition. Investors who routinely incorporate analysis of a firm’s competitive landscape will recognize them, though they can really be summed up in three categories:

1. Products that are customized or one-off. Amazon’s superior scale and logistics give it an advantage in selling more commoditized items for which user reviews are broadly applicable and features easily compared, such as consumer technology or household goods. More subjectively evaluated and customized goods or services such as travel, luxury products, and custom-made or private label clothing undercut some of Amazon’s advantages. These businesses often entail more interaction with customers pre- and post-sale, something that Amazon, which is basically an information technology firm classified in the consumer discretionary sector, is less-well equipped to offer.
2. Products that are less economical to ship or needed quickly. This can take a variety of forms, from large and fragile items like household furniture for which delivery is expensive, to small, low-margin goods commonly purchased at dollar stores, to auto parts suppliers that can make merchandise mechanics need immediately available.
3. Businesses with complex supply chains or service-oriented operating environments. These may constitute higher barriers to entry, as seen, for example, in the automotive, health care, and financials sectors. The latter two are more regulated and require a larger up-front investment. Amazon has so far steered clear of the far more regulated financial tech industry that many see as ripe for disruption. Nor, for that matter, does it appear to be threatening outpatient health care service providers.

Amazon is clearly reshaping the retail landscape, but in some cases retailers are responding by upping their game, providing better customer service, and higher-end or more customized products. They may be investing more in technology to improve their logistics, supply chains and inventory management. And they may be worth investing in, not running from. Unless they’re analyzed on a fundamental, bottom-up basis, however, it’s hard to tell.

Amazon certainly isn’t burying sundry well-run businesses with differentiated business models and capable leaders who go to work every day thinking about how to compete and win new customers. Amazon’s competitive threat may, in fact, be motivating them to become better companies and potentially attractive investments.

Market panic and indiscriminate selloffs can be opportunities for investors who do the fundamental work of assessing competitive strengths and weaknesses, model prospective risk and reward, and are able to sort through the chaff to find strong, innovative companies that have been cast off with the weak.

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