Amazoned Means Look for Potential Buys
It looks like there is another word in the English language. The word “amazoned” appeared in headlines last week after Amazon.com announced its entry into another new market. The word means businesses are going to be hurt by Amazon and implies Amazon is unstoppable.
The latest sectors to suffer were home improvement stores and consumers electronics retailers. The headline was simple, “Wall Street flat as home improvement retailers get Amazoned.” The story was more detailed.
Reuters reported, “Retailers and appliance makers fell after Sears (Nasdaq: SHLD) said it would sell its Kenmore home appliances on Amazon (Nasdaq: AMZN) and integrate the brand’s smart gadgets with the online giant’s Alexa digital assistant. Sears was up 10.6% at $9.60 and Amazon shares rose 0.2%.”
The list of losers was relatively long, “Home Depot (NYSE: HD) fell 4.1%, shaving off 40 points from the Dow and weighing the most on the S&P 500. Retailers Lowes (NYSE: LOW) and Best Buy (NYSE: BBY), as well as appliance maker Whirlpool (NYSE: WHR), were down between 3.9 and 5.6%.”
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Some Perspective Can Be Useful
This announcement merely indicates Sears will begin selling its Kenmore appliances on Amazon.com. Sears will also develop smart appliances that can be synced with Amazon’s voice assistant, Alexa.
Sears simply announced they will be making appliances that are more competitive in the marketplace. Amazon announced they will be adding Sears to their list of vendors. The deal could be worth a significant amount to Sears, but it may not hurt other stores as much as many traders seem to fear.
Appliances are significant purchases. Many customers will always want the ability to see a kitchen range, for example, before they buy. Traditional brick and mortar retailers will be needed to meet this demand. But, customers may simply look in physical stores and buy online for a better price.
Brick and mortar retailers have long understood this possibility. They have countered that problem with price matching policies. It’s now common for retailers to offer free wifi to customers and allow them to check prices, promising to match the price on the spot.
In this environment, it is possible Kenmore will add some sales. But, it is not likely that 100% of the appliance business will move to smart appliances that are bought online. That means the traditional retailers may present buying opportunities after the selloff.
Best Buy Has Been Amazoned Before
Last week was not the first time Best Buy faced a threat from Amazon. The truth is the company’s business model has been under threat from Amazon and other online retailers for some time. Best Buy responded by adapting.
Its stores offer an extensive selection of products that are all available on Amazon. Best Buy responded by hiring knowledgeable sales associates. While some consumers can set up a smart home hub on their own, others will want some explanation. Best Buy offers that help.
After explaining products, Best Buy sales associates often walk away. They are allowing customers to search for prices online. They then return asking if they can help, and providing the customer a chance to request a price match. The customer often buys at this point.
Best Buy also offers the Geek Squad, a service to install products at home or in businesses. The Geek Squad can also repair products bought in the store or at other retailers, even online.
The Geek Squad seems to be a business Amazon is interested in. Shares of BBY fell 7.5% when that news was revealed.
Reports in early July revealed that Amazon had quietly been hiring an army of in-house gadget experts to offer free Alexa consultations as well as product installations for a fee inside customer homes. These reports were confirmed by multiple sources and job postings data also confirmed the news.
The new offering, which has already rolled out in seven markets without much fanfare, is aimed at helping customers set up a “smart home,” the term used to describe household systems like heating and lighting that can be controlled via apps, and increasingly by voice.
As the chart above shows, Best Buy had almost fully recovered from that news when the Amazon deal with Kenmore was announced.
Value, and a Potential Bounce
After the recent selloff, Best Buy could be attractive to value investors. The stock offers a dividend yield of about 2.2% and carries a price to earnings (P/E) ratio of about 14.4. The average P/E ratio for large cap stocks is 19.9 and the average yield is 1.9%. BBY is undervalued based on these averages.
Less popular value indicators confirm that the stock is undervalued. The enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA) is a ratio that is widely used by investment bankers.
EV includes the company’s debt which would need to be considered if an investor was buying the whole company. In this way, it provides a more complete look at the company’s value. EBITDA considers earnings from operations, providing a comprehensive value of the business’s potential earnings.
For BBY, the EV/EBITDA ratio is 6.4. The retail sector average EV/EBITDA ratio is 8.0. By this measure, BBY is potentially undervalued by 25%. This confirms the stock’s valuation based on the more widely followed P/E ratio or dividend yield.
From a technical perspective, the stock is oversold. The chart below shows the 2-period RSI at the bottom of the chart. This is the popular relative strength index (RSI) calculated with just two weeks of data, in the weekly chart, instead of the usual 14 weeks.
The 2-period RSI is more responsive to the market action that the traditional RSI which is shown in the next chart. You may notice that there are no actionable trade signals in this chart, unlike the first chart which showed multiple buy and sell signals.
BBY is oversold on the weekly and the daily charts. This indicates the stock is likely to bounce higher in the short run.
A Specific Trading Strategy
To benefit from potential gains in BBY, an investor could buy shares of the company. This requires a significant amount of capital and exposes the investor to standard risks of owning a stock. It’s possible traders will continue selling every time Amazon announces a new initiative.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership.
Both the potential profit and loss for the bull call spread are very limited and very well defined. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
For BBY, the August 18 options can be used. BBY closed at $54.14 on Friday. The August 18 $55 call option can be bought for $1.35 and the August 18 $57.50 call could be sold for $0.55. This trade would cost $80 to open.
The potential gain is $170, a potential 125% gain on the amount of capital risked. BBY is likely to rally after becoming deeply oversold and this trade could provide a large gain on a small amount of capital if that happens.