E-commerce: Some key stocks analysis

There were few positive business stories during the pandemic lockdown, but arguably for those positioned to benefit, there was the increase in online sales. While a national lockdown could not have been predicted any more than the pandemic that led to it, some savvy investors may have foreseen the repercussions for those businesses that would be most hit and those that would most benefit, and invested or disinvested accordingly.

While Zoom meetings continue and many still work from home, shoppers have been out in force and on the High Street. But is it likely we will see online retail sales decrease significantly from the highs of lockdown spending, especially with the uncertainties of other variants impacting on the return to normality?

Online spending values did fall in October 2021 by 0.8% when compared with September 2021, according to the Office for National Statistics (ONS).¹ The monthly fall in online spending values resulted in a fall in the proportion of online sales to 27.3% in October 2021, from 28.1% in September.

The ONS reports that while this is the lowest proportion of online retail spending since March 2020 (22.5%), it remains far higher than the proportion of online retail spending in February 2020, before the coronavirus pandemic, of 19.7%.

We are not yet able to predict quite how the omicron variant will impact on our liberties, but it is timely to look at the e-commerce sector and how our fund managers are investing.

Sands Capital says e-commerce’s share of retail spending has been growing by about 1 percentage point each year since 2000. In its report E-commerce: A Play in Multiple Acts, - it says, “At the beginning of 2020, that share was at 16 percent and by April 2020, it had soared to 27 percent.² That’s a decade’s worth of growth in less than one year. While we don’t expect penetration will remain at this level, we also don’t expect it to fall back to 16 percent; our research shows that the pandemic cemented new consumer habits, and that many expect to continue to shop online and do so more frequently even after the pandemic ends.”

Sands says as consumers make more and more purchases online, it believes e-commerce companies able to extend into adjacent businesses, leveraging consumer mindshare, technological know-how and data, will be best positioned to become the next great internet franchises, leveraging multiple engines of growth.

So which are the key e-commerce stocks our fund managers are researching? As of 31 December 2021, Alliance Trust holds Amazon, eBay, Qurate, MercadoLibre, DoorDash, JD.com, Sea Ltd, and Shopify. The portfolio’s exposure to JD.com is marginal, and its largest allocation is Amazon.

The level of competition in the e-commerce sector, especially among these companies, is high: Amazon may be dominant in e-commerce in the US, but it is facing competition from Shopify as a direct-to-consumer brands platform. And in China, Alibaba, JD.com, Pinduoduo and Meituan are all competing for customers in the online grocery market. Here our managers outline some of those key stocks: Amazon, DoorDash, eBay, MercadoLibre, Qurate, Sea and Shopify.

Amazon - Online Retailer 

Sands, SGA and Vulcan are some of the managers that bring Amazon into the portfolio. CT Fitzpatrick, CIO at Vulcan Value Partners, sees Amazon as one of those companies that can be both a value and a growth stock.³ It has, he says, experienced meaningful compounding of its intrinsic value since Vulcan has owned it, and seen solid, double-digit stock price returns over the last 18 months. He believes it is deeply discounted due to the growth in the value of the underlying businesses, which is outpacing price appreciation. “This incredible company produces robust free cash flow, which we expect to endure and compound well into the future,” says Fitzpatrick. “The Covid-19 pandemic accelerated many trends directly benefiting Amazon’s major business segments: retail, Amazon Web Services (AWS) and advertising. Amazon has experienced exceptional returns through thoughtful capital allocation and astounding top-line growth.

“As long-term investors, we consider Amazon’s value stability and growth over the next decade, rather than its stock price over the next quarter. Through that 5+ year lens, we believe the market continues to underestimate the value of this truly wonderful business.”

Doordash - Food Delivery Company

DoorDash is one of those companies transforming by moving into adjacent businesses that lengthen and expand their runways for growth, according to Sands Capital.

Katherine B Okon, research analyst at the fund manager, says, “In early December 2020, investors got a chance to buy a piece of DoorDash, one of the breakout businesses of 2020. Throughout the year, the company became a household name and established itself as the market-share leader in the US food delivery market. Its annual gross order volume (GOV) grew 207% in 2020, as the spread of the coronavirus pandemic curtailed restaurant activity and fuelled the rise in takeout, with delivery evolving into the main connection between restaurants and their consumers.

DoorDash was able to expand its restaurant options and improve its local logistics experience, which we have found to be the most expensive and time-consuming part of the food delivery process, but the key to customer satisfaction. In 2020, the company leaned into this competitive advantage, reporting deliveries of more than 800 million orders, 23% faster than its average 2017 delivery time. DoorDash has also moved towards delivery for groceries as well as convenience stores, which we expect will account for about 15% of DoorDash’s GOV in 2021.”⁴

Ebay - Online Marketplace

Lyrical says there are some wonderful e-commerce companies it owns at a fraction of Amazon’s lofty multiple.

“One of them is eBay,” says Andrew Wellington (Co-Founder and CIO), “the world’s largest marketplace for used and out-of-season goods. eBay may not be growing as fast as Amazon, but it still is growing at 15% per annum, roughly triple the historical rate of the S&P 500.

“Despite its faster growth, once you adjust for the cash and investments eBay holds, you can own the business for about 12.5x forward earnings, a 40% discount to the S&P 500 multiple and 70% less than Amazon. At 12.5x forward earnings, eBay provides an attractive earnings yield of 8% and growing, as it focuses on growing the wallet share of its core customer, who is seeking the treasure hunt experience.”⁵

Qurate Retail - Home Shopping

Lyrical’s Andrew Wellington says even cheaper than favoured stock eBay is Qurate Retail, the leader in home shopping, with live shopping streaming channels, QVC and HSN. Qurate is held in the portfolio by both Lyrical and Metropolis Capital.

“Qurate’s earnings have basically doubled from 2018 to 2021, and the stock is valued at less than 5x forward earnings,” he says. “That is an earnings yield of over 20% for a virtual retailer with one of the most loyal customer bases in retail (the company’s core 8 million shoppers return each year at a 90% rate). “Qurate operates a flexible business model, holding limited inventory and quickly shifting to sell whatever its customers want. As a result, in the last two economic downturns when most traditional retailers saw significant revenue declines, Qurate’s revenue fell only 1% in the Global Financial Crisis and grew 5% during the pandemic. The business is so cash-generative that it made two special cash dividend payments in 2020, worth about 30% of today’s stock price.”⁵

Mercadolibre - Argentine Online E-commerce Company

MercadoLibre is the largest, in terms of market share, e-commerce and financial technology company in Latin America. Judy Jiao, research analyst at Sands Capital, says e-commerce adoption rates in Latin America are still low, leaving a significant growth potential.

“In Latin America, the lack of an established logistics infrastructure is one of the main barriers to the spread of e-commerce,” she says. “This means current shipping costs can be high – as much as $8 per package – and delivery time is long, with packages sometimes taking several weeks to arrive.”

“To reduce the cost of shipping to merchants, MercadoLibre launched its Mercado Envíos service in 2013, through which it negotiated a volume-based discount directly with the postal carriers and passed on the savings to merchants. To increase the speed of shipping, in 2017 MercadoLibre launched its own managed network services, to directly handle warehousing and shipping using technology. Thanks to its ability to deliver products to consumers fast and cheaply, MercadoLibre’s gross market value (GMV) consistently grew more than 100% on a year-on-year basis for the last three quarters of 2020.”

MercadoLibre has also created an electronic payments system accessible to the region’s large population of unbanked and underbanked. It launched Mercado Pago in 2003, to process online payments. In subsequent years, this payments business has spawned numerous systems that support buy now/pay later programmes, as well as consumer and merchant loans.

“Over time, we expect MercadoLibre has the potential to become the largest financial institution in Latin America,” says Jaio.⁵

Sea Ltd - E-commerce and Digital Payments Platforms

Singapore-based Sea, now a leading emerging markets internet company, used its early success in its gaming business, Garena, to fund its e-commerce (Shopee) and digital payments (SeaMoney) platforms. Sands Capital saw the potential of the company’s growing e-commerce platform Shopee turning into expectations for future value. Neil Kansari, senior portfolio manager at Sands, says, “For us, our key insight was the opportunity we saw in Sea’s e-commerce (and beyond). Because of low internet penetration and e-commerce adoption rates in the region, we believed Shopee’s prospects were immense. “However, what really powered its growth in e-commerce, and gave the company early success in this expansion, was familiarity with Southeast Asian markets, their demographics and their emerging technology needs. This familiarity, combined with on-the-ground execution and cash flows from gaming, all became key factors that allowed the company to create a powerful network effect, connecting buyers and sellers in a virtuous circle of scale begets scale. Of course, once at scale, we find that network effect businesses, such as Sea, are often able to defy the traditional laws of mean reversion for much longer than a non-platform business, because the value of the network grows as each user is added, while the cost of acquiring each additional user declines.”⁴

Shopee, he says, has now emerged as the clear e-commerce leader in terms of market share in Southeast Asia, was the most downloaded shopping app in the region, and was among the top three downloaded apps worldwide, according to App Annie.⁶

Shopify - Canadian E-Commerce Software Provider

Shopify is not exactly an e-commerce business per se, but rather helps businesses to move their operations online. Shopify’s revenues roughly doubled in the second and third quarters in 2020, compared with the same period in 2019.

It is a Cloud-based multichannel platform employing more than 5,000 people. More than 1 million small and mid-sized businesses in more than 175 countries use the Shopify platform, which provides online retailers with access to services, including marketing, payments, shipping and customer engagement tools.

Michael Sramek, senior portfolio manager and managing director of Sands, says, “Shopify says it wants to make e-commerce better for everyone. To do so, it seeks to reduce barriers to business ownership, by making it easier for anyone to start, run and enlarge their businesses. It offers tools for businesses to expand, and educational resources for current and aspiring entrepreneurs.

“As part of its efforts to leverage the power of e-commerce to create a more equitable and sustainable future for everyone, Shopify is focusing on four groups of business owners who face systemic barriers: Indigenous people, youths, newcomers and social-impact businesses.

“Shopify also launched a Sustainability Fund to contribute to a low-carbon future for the planet. It has a carbon-negative commitment to invest at least $1 million a year to remove carbon from the air. In 2020, when shoppers rang up a record $5.1 billion in sales in the stores of Shopify merchants on Black Friday and Cyber Monday – up 76% on 2019 – Shopify purchased offsets of nearly 62,000 tons of carbon emissions from the proceeds from its deliveries that weekend.”⁴

Survival of the E-fittest

The competition in the e-commerce sector that was referred to earlier can be brutal, as has been evident to e-commerce players and those looking to expand.

Laird Abernethy, managing director, Australia and New Zealand at GQG Partners, for example raises two primary risks in Sea Ltd’s expansion: 1) the investment required to sustain market share and 2) the challenges associated with international expansion.

“After observing many e-commerce models over the years, a strong investment in logistics is often required to sustain market share, as we believe that network effects alone do not create sufficient barriers to entry,” says Abernethy. “Sea itself appeared to come out of nowhere to become the leading Brazilian e-commerce player by revenue within just 18 months. What prevents another company from similarly offering low take rates, coupons and free shipping to disrupt Sea, given that we have seen this in other markets?”

Abernethy highlights that in South Korea, eBay operated an asset-light model, but lost its leading position to South Korean e-commerce company Coupang, which invested aggressively in logistics.

And similarly, he says, MercadoLibre sacrificed its margins and pivoted to a more capital-intensive model to fight off competition.

“Over time, as many of these e-commerce companies, such as Coupang, Amazon and JD, have become more capital-intensive, their price-to-sales multiples have generally fallen to low, single-digit multiples.”

Abernethy points out that markets being expanded into are already competitive.

“India is a highly regulated market with large incumbents such as Amazon, Reliance and Flipkart, Poland is currently dominated by Allegro (but Amazon is entering this market as well), and Brazil is a volatile macro environment with large incumbents, including MercadoLibre as well as Amazon.”

“Great companies, as you all may know, can still be overvalued. In our opinion, those companies with the fastest growth, and which have continued to become increasingly more expensive in price, are the most vulnerable to a shift in expectations.”

The views expressed are the opinion of Sands Capital Management, Lyrical, GQG and Vulcan Value Partners and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of December 2021 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.

1.https://www.ons.gov.uk/businessindustryandtrade/retailindustry/bulletins/retailsales/october2021
2. Galloway, Scott, Post Corona: From Crisis to Opportunity. Page xvii, Bank of America, U.S. Department of Commerce, Shawspring Research.
3. Source: Vulcan Partner
4. Source: Sands Capital.
5. Source: Lyrical Asset Management
6. App Annie 1 July 2020; https://www.appannie.com/en/insights/mobile-minute/mobile-e-commerce-marketplaces-expand-covid19/