The “Amazon Apocalypse”: Rummaging through the Retail Wreckage, Part I – A Factual Review of Retail’s Basic Characteristics

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One of the things we have noticed over the last year or so has been the rise of highly opinionated articles about Amazon. They can be exciting reads and their titles offer insights into the topic the writers intend to review. Below, and in no particular order, is a list of 10 titles of articles Kailash Capital has read over the last several months: 1. JEFF BEZOS WILL CRUSH YOU, How The Rise Of Amazon Has Destroyed Retail Chains, In One Charti 2. Competing with Amazon is crushing retailersii 3. Here are the consumer industries Amazon will crush nextiii 4. Why Amazon crushes Walmart in paid search for consumer electronicsiv 5. The cutthroat jobs strategy Amazon uses to conquer retailv 6. Proof that Amazon has ravaged the retail industryvi 7. Amazon is Completely Destroying These Iconic Storesvii 8. Amazon Just Revealed How It’s Planning to Destroy All Grocery Storesviii 9. Amazon’s Retail Trade War Is Bad News For Neighborhood Stores and Minimum Wage Workersix 10. Amazon is going to kill more American jobs than China didx Considering all the crushing, ravaging, and killing that is being reported Kailash Capital finds itself relieved that all this violence is occurring in a contained commercial sphere. Reviewing the articles however, it is remarkable that a business largely made famous selling goods to Americans could be so successful while the media constructs a narrative about the firm that one might easily confuse with that of Genghis Khan or Attila the Hun. While there are plenty of more cheerful articles with names like “3 Retail Stocks That Amazon Won’t Crush” and “Amazon May Not Kill Big-Box Retail After All” our anecdotal observation is that there may be a consensus that the rise of Amazon has not been great for its competitors. Looking at Figs. 1 and 2 below we believe the market has validated our anecdotal observation and taken the above media narrative to heart. Over the last one, two and three years, investors have awarded Amazon with remarkable levels of outperformance while punishing the rest of the retail sector severely. While a little difficult to see due to the scaling issues on the chart, retailers excluding Amazon have underperformed by nearly 20% and 50% in our S&P500 and Small & Mid Cap universes respectively. https://kailashconcepts.com/wp-content/uploads/2021/11/icons8-vertical-line-50.pnghttps://kailashconcepts.com/wp-content/uploads/2021/11/icons8-lock-50.pngSubscribe now to unlock the full content 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YOU ARE NOW READING PREMIUM MEMBER LEVEL CONTENT Figures 3 and 4 below show further evidence of how lopsided market sentiment may have become by showing the outstanding short interest in Retailers ex AMZN, the Universe ex Retail and Amazon. Kailash Capital believes there are four items worth noting: Short interest peaked in Amazon in May of 2007 after which time the stock outperformed the S&P500 by 39% into the bottom of the https://kailashconcepts.com/wp-content/uploads/2021/11/icons8-vertical-line-50.pnghttps://kailashconcepts.com/wp-content/uploads/2021/11/icons8-lock-50.pngUpgrade your subscription now to unlock the full content Figures 3 and 4 below show further evidence of how lopsided market sentiment may have become by showing the outstanding short interest in Retailers ex AMZN, the Universe ex Retail and Amazon. Kailash Capital believes there are four items worth noting: Short interest peaked in Amazon in May of 2007 after which time the stock outperformed the S&P500 by 39% into the bottom of the Great Financial Crisis which saw the S&P500 fall 50% by February of 2009 Since Amazon’s short interest peaked the stock has risen 20-fold beating the S&P500 by 1,964% through the end of February 2018 Short interest in Amazon has never been lower despite the incredible rise noted in Figs. 1 and 2 above Short interest in retailers excluding Amazon has almost never been higher than it is today in both our S&P500 and Small & Mid Cap Universes. Figure 5 helps contrast the sentiment variance between Amazon and all other retailers in a simple table. The numbers are impressive indeed. What you can see is that Amazon now has a market cap of $732 billion dollars while the 32 other retailers in our S&P500 Universe have a combined market cap of $1,450 billion - barely twice that of Amazon. This despite the fact that the 32 non-Amazon retailers have revenues and FCF that is roughly ten times and 12x that of Amazon respectively. The market, it would seem, has very high expectations for Amazon and very low expectations of all other listed retailers. For long-time readers of our work you know what is coming: where expectations are low due to market anxiety and fear, Kailash Capital is going to take you there! The Rise, Fall, Resurrection and Failure Rates of Retail & Other Firms While the media articles are often scintillating stuff, unfortunately for our readers, Kailash Capital has not changed much if at all in its approach to equity markets as we enter our 8th year of operation. Kailash has and will continue to do our best to drive our partners away from hyperbole and towards what we can learn from the facts to the best of our imperfect abilities. In the spirit of hewing to an unbiased reverence for what we can learn from the past we started our analysis of the potential opportunity, or lack thereof, in the retail space by trying to get a grip on some basics. The Rise: Figure 6 below shows that historically, if you buy a Small & Mid Cap retailer the probability it will perform strongly enough to rise into our S&P500 Universe and stay there for at least 12 months is 7% (first bar). Once there, these retailers historically average 67 months of maintaining that status (second bar). Looking at the right two bars in Fig. 6, you can see that these numbers are roughly equal to that of any Small & Mid Cap stock you might buy that is not a retailer.1 Conclusion: the graduation rate and duration for retail are no worse than the rest of the Small & Mid Cap universe. The Fall: Figure 7 shows the rate at which retailers and all non-retail firms underperform and fall from our S&P500 Universe back into our Small & Mid Cap Universe for at least 12 months. You can see that the historical rates at which this occurs is 30% for retail and 31% for the rest of the universe ex-retail. These “fallen angels2” follow a roughly similar pattern once they have been knocked out of our S&P500 Universe. Conclusion: the “fall” rate and subsequent duration for retail are, again, no worse than the rest of the Small & Mid Cap universe. The Resurrection: Figure 8 below shows the odds that retailers and ex retail go from our S&P500 Universe to our Small & Mid Cap Universe, and then outperform their way back to our S&P500 Universe. We understand that is a mouthful – a potentially more colloquial description might be “here are the odds a big stock falls from grace but then retains its former glory.” Conclusion: the statistics show that this is more likely to happen in retailers than in the universe ex-retail.3 Further to that, when retailers regain their status in our S&P500 Universe they hang on for 165 months or 3x that of non-retail stocks. Kailash Capital readily admits that Figs. 6, 7 and 8 confounded our preconceived notions. We think of retailers as being an atypically temperamental group where brand moats are difficult to maintain as consumer preferences can rapidly change.4 Figure 9 however provides meaningful substantiation for this preconception. Regardless if you are a S&P500 or Small & Mid Cap firm, the odds you go bust are almost precisely twice as high as that of non-retail firms. While Fig. 8 may indicate that the “fallen angels” of retail are more likely to resurrect themselves than stocks in other sectors, this fact is, in our view, dwarfed by the data in Fig. 9. Figure 9 highlights that retail is indeed a more dangerous place for those averse to a permanent loss of capital.5 The Batting Averages and Payoff Structures of Retail Pre and Post Amazon Looking at the above data Kailash Capital wanted to get a sense of how AMZN’s rise has impacted the batting averages and payoff structures of retailers ex Amazon over time. Figure 10 below shows the following three groupings for our S&P500 Universe: Since Inception, the odds retail ex AMZN beat the S&P500 were 45%. When the sector won it did so by an average of 11%. When it lost it underperformed by only 8%. Surprisingly, since Amazon’s IPO those batting averages and payoff structures remained largely static. In the last five years – a period where Amazon has seen revenues grow by over $100bn – the batting average remained relatively healthy but the upside payoff deteriorated; when retail wins it has only done so by 6% Figure 11 below presents the identical data for Small & Mid Cap but obviously changes the benchmark to the Russell 2500. Unlike what we see in Fig. 10 above, Fig. 11 shows that AMZN’s growth may have caused devastating carnage among Small & Mid Cap retailers over the last five years. Small & Mid Cap retail has seen a catastrophic decline in batting averages over the last five years with SMID retailers beating the R2500 in an abysmal 27% of rolling 12-month periods. Similarly, this collapse in win rates for SMID retail has been accompanied by an equally disastrous decline in outperformance in the rare instances they win. In the last five years, when SMID retailers outperformed they did so by a meagre 4%. Where Kailash’s Models Stand on Retail Figures 14 and 15 below shed some light on how Kailash’s models feel about Retail relative to history. As can be seen in Fig. 14, the average retailer in our S&P500 Universe has an aggregate rank that is over 2.5 standard deviations higher than its historical average. While Fig. 15 does show that the average retailer in our SMID Universe is ranking 1 standard deviation higher than the model’s historical average, the underperformance of the stocks vs. the evolution of the fundamental financial metrics has simply not made them materially attractive enough to make retail a meaningful piece of our Small & Mid Cap portfolios. In summary: We believe the market has a very pessimistic consensus view on all retailers excluding Amazon (Figs. 1-5) Retailers historically provided odds similar to non-retail stocks of both hitting it big and falling from grace (Figs. 6 & 7) Notwithstanding #2 above, Retailers do present investors with a more dangerous set of downside outcomes as they are two times as likely to go bankrupt than their non-retail peers (Fig. 9) Retail in our S&P500 Universe has never scored higher on Aggregate Rank than they do today while they are at rarely reached levels in our Small & Mid Cap Universe Our models have responded to the underperformance in S&P500 retailers in the very recent past by ramping our exposure to them in a material way We will be publishing an in-depth review of the fundamentals explaining the “WHY” behind where we stand shortly in Part II of this series. If you wish to see Part II of this series, please contact broddy@kailashconcepts.com. Part II will include aggregate fundamental data that: Further demonstrates that the world appears to have priced in a new paradigm where Amazon becomes a “winner take all” company in the world of retail Fundamental metrics around retailers excluding Amazon have rarely if never been healthier in both our S&P 500 and our Small & Mid Cap Universes We review our models’ poor performance in Retail over the last five years As we wrote near the start of this paper, where expectations are low due to crowded market sentiment and anxiety we are going to “take you there” Having done the work in Part II, we believe the fundamentals provide compelling reasons for fund managers and analysts to begin digging in on select retailers As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded. i Digg. “Jeff Bezos Will Crush You: How the Rise Of Amazon Has Destroyed Retail Chains, In One Chart” 10 August 2017 http://digg.com/2017/amazon-vs-walmart-size ii Krystina Gustafson “ Competing with Amazon is crushing retailers” 31 March 2017 https://www.cnbc.com/2017/03/31/competing-with-amazon-is-crushing-retailers.html iii Tae Kim “Here are the consumer industries Amazon will crush next: Bernstein” 13 November 2017 https://www.cnbc.com/2017/11/13/consumer-industries-amazon-will-crush-next-bernstein.html iv David Kirkpatrick “Why Amazon crushes Walmart in paid search for consumer electronics” 7 December 2017 https://www.marketingdive.com/news/why-amazon-crushes-walmart-in-paid-search-for-consumer-electronics/512482/ v Lisa Fickenscher “ The cutthroat jobs strategy Amazon uses to conquer retail” 25 April 2017 https://nypost.com/2017/04/25/amazon-is-great-for-consumers-but-is-it-great-for-america/ vi John Crudele “Proof that Amazon has ravaged the retail industry” 17 July 2017 https://nypost.com/2017/07/17/proof-that-amazon-has-ravaged-the-retail-industry/ vii Megan Elliot “Amazon Is Completely Destroying These Iconic Stores” 26 February 2018 https://www.cheatsheet.com/money-career/stores-destroyed-by-amazon.html/?aviewall viii Lindsay Rittenhouse “Amazon Just Revealer How It’s Planning to Destroy All Grocery Stores” 25 August 2017 https://www.thestreet.com/story/14283531/1/amazon-just-revealed-how-it-s-planning-to-destroy-all-grocery-stores.html ix Panos Mourdoukoutas “Amazon’s Retail Trade War Is Bad News For Neighborhood Stores and Minimum Wage Workers” 24 August 2017 https://www.forbes.com/sites/panosmourdoukoutas/2017/08/24/amazons-retail-trade-war-is-bad-news-for-neighborhood-stores-and-minimum-wage-workers/#6a5856505fda x Rex Nutting “Amazon is going to kill more American Jobs than China did” 15 March 2017 https://www.marketwatch.com/story/amazon-is-going-to-kill-more-american-jobs-than-china-did-2017-01-19/print In order to be counted as a “Riser,” a firm must have been in the Small & Mid Cap universe for at least 12 months and upon rising into our S&P500 Universe, must have maintained its status there for at least 12 months. In order to be counted as a “Fallen Angel” a firm must have been in our S&P500 universe for at least 12 months and upon falling into our Small & Mid Cap Universe, must have maintained its status there for at least 12 months. In order to be counted here, a firm must have been in our S&P500 Universe for at least 12 months and upon falling to our Small & Mid Cap Universe, must have maintained that status for at least 12 months and upon moving back to our S&P500 Universe must maintain that status for 12 months. Caveat: Due to our stringent data inclusion criteria in Figure 8, the sample sizes are dangerously low – we show this for informational purposes only. Please reach out if you would like details. The writer will admit that this view may stem from his utter and total lack of aesthetic awareness. Using Compustat definitions we included all firm bankruptcies, liquidations and all firms that no longer file with the SEC whether or not pricing continues thereafter. Disclaimer The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. 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