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  • Signal from Noise
Apr 22, 2020

– AVLR SaaS is leveraged to some of the same e-commerce catalysts as AMZN – US Supreme Court 2018 decision on states sales tax likely increasing customer base – Major barriers to entry; inexorable growth of online retailing can boost stock These are unusual times, but it seems the market still sees a bright future for online commerce, even two decades on, to go by Amazon’s (AMZN) 40% stock rise in the past five weeks.  It is hardly a value play, and many simply can’t bring themselves to buy it after such a ferocious run. Source: Bloomberg If that describes you, perhaps take a look instead at Avalara (AVLR), which is a much smaller and lesser known company, but one that also could benefit from similar e-commerce catalysts and one uniquely its own.  Before we get too far, there is one thing to note:  I’m assuming that the U.S. and global economies get back to some semblance of normal after COVID19 fades. I don’t know when but that’s my working thesis. If you don’t, then you should likely be in cash or gold.   There remain two things you can always count on in this world, death and taxes. Avalara’s business model doesn’t address the former but does the latter, a fundamental characteristic that could drive the stock for years.  Through the use of cloud-computing and software as a service (SAAS), AVLR provides a tax compliance platform to midsized firms, with a database of sales tax content and technology for executing compliance across thousands of tax jurisdictions, like states and municipalities. Currently, many such firms accomplish this function internally and sometimes even manually. I see this as an essential service that isn’t going away. I like Avalara because it should benefit from some of the same e-commerce tailwinds that help AMZN, particularly in a post-COVID-19 world. Avalara has a first mover advantage in a business where there are relatively high barriers to entry. American consumers spent $602 billion online in 2019, up 14.9% from the prior year, according to the U.S. Dept. of Commerce. Moreover, while e-commerce growth rates had been slowly declining from very high levels, in 2019 the rate rose and was higher than the 13.6% seen in 2018. According to , e-commerce sales should almost double worldwide to $6.5 trillion in 2023 from 2019. (See chart below.) You can bet taxes will be collected on that. And that’s where Avalara comes in. When someone buys something online, increasingly they will have to pay sales tax in the U.S.  That comes from a 2018 Supreme Court ruling that states can mandate businesses without a physical presence in that state collect sales taxes on transactions in the state. “That unleashed the ability of states and municipalities to look at their respective tax codes and collect,” says Craig Giventer, a portfolio manager at Financial Partners Capital Management, which owns shares for its clients. This suggests that more tax jurisdictions will be moving to collect sales tax where they hadn’t before. Indeed, according to a mid-2019 report from Vertex, a private competitor to AVLR, there were 335 standard sales tax rate changes in the first half of 2019, a 5% increase from the same period in 2018. In addition, the report says there have been 6,230 new and changed standard sales and use tax rates over the past 10 years. Companies need to deal with that, and outsourcing to an expert is one way to accomplish it efficiently. Secondly, this thicket of tax rules and changes will not be something many firms will want to spend resources on. As a bullish Giventer adds, collecting the sales tax isn’t necessarily the retailers biggest concern. The “horror,” he adds, is that they will have to navigate a tax compliance labyrinth of hundreds if not thousands of government entities all wanting their tax portion of the sale and many regularly changing their rules. The software compliance that Avalara provides must remain fresh and updated. Another of AVLR’s appealing characteristics is that it uses a subscription model, which helps to maintain a recurring revenue stream. As of the end of 2019, 2018, and 2017, AVLR had 11,960, 9,070, and 7,490 core customers, respectively, representing less than 50% of the total and 80% of total revenue. In 2019, AVLR posted $382 million in sales, up 40% from $272.1 million in 2018, in turn up 27% from $213 million in 2017. The biggest negative is that AVLR is not profitable. It posted a loss of $50 million or 68 cents per share in 2019, down from red ink of $69 million or 94 cents in 2018 and $76 million or $1.95 in 2017, but the trend is going in the right direction. Nevertheless, it sports SaaS type 70% gross margins.  The losses come from reinvesting almost 60% of revenue back into the business for sales and marketing, as well as in research and development.  As it continues to grow net margins should improve when it captures more share.  The company, which has roughly a single-digit percentage market share, estimates the U.S. addressable midsize market at $8 billion, so there’s room to grow. An investor buying AVLR is purchasing a potential multi-year growth period in the future. Currently, it supplies mostly small and midsize businesses, as larger retailers tend to do their tax collecting in house, or in concert with their accounting firms, typically the big four, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG. Giventer says that over the long-term Avalara has a shot at the big market cap retailers. Using a mix of potential scenarios, Giventer’s discounted cash flow (DCF) valuation of AVLR is $135, some two-thirds above the current $82 price. There is also potential from ALVR’s international business, where it’s expanding in the European Union and Brazil, among other places, but it is early days yet. However, the same catalysts apply and it could turn out to be a significant part of AVLR’s future value.  Where I could be wrong:  The stock could fall if a competitor, some of them much larger, takes a large share of the market or AVLR makes a misstep in its software. Bottom Line:  Retailers will increasingly have to be more tax compliant on their online sales in the future.  If online commerce is growing and more governments are trying to collect sales tax, that should be a natural boost for Avalara. Prior “Signals” Date Topic Subject / Ticker The Signal 4/15/20 Stock First Republic (FRC) First Republic Stock Looks Cheap in Post COVID-19 World 4/8/20 Stock Galapagos (GLPG) If Galapagos Arthritis Drug Is Approved, Stock Looks Cheap 4/1/20 Stock DaVita (DVA) In Uncertain Markets, DaVita’s Stable Rev/EPS Look Attractive 3/25/20 Q&A InsiderInsights In Roiled Market, Insider Activity Could Offer Directional Clues 3/18/20 Market US Stock Market Market Discounts Recession; GDP, EPS Growth Worries Mount 3/11/20 Market COVID-19 COVID-19 Worry Overblown; Market Discounts Recession 3/4/20 Stock iHeartMedia (IHRT) iHeartMedia Stock Could Rise on Cost Cuts, Digital Revenue 2/26/20 Market South Korean Stock Market When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap 2/19/20 Q&A Atlantic Investment Management Atlantic’s Concentrated Approach Yields Strong Returns 2/12/20 Stock Casper Sleep (CSPR) Casper Stock Might Not Let You Get a Whole Lot of Sleep 2/5/20 Stock Arch Coal (ARCH) After Sentiment Plunge, Arch Coal Stock Looks Inexpensive 1/29/20 Sector Healthcare Healthcare Looks Inexpensive; Some Healthy ETFs to Play 1/22/20 Stock Spirit Airlines (SAVE) Why Spirit Airlines Shares Could Take Off in 2020 1/15/20 Market 4Q19 EPS Season Market to Focus on SPX EPS Growth after 4Q19 EPS Season 1/8/20 Stock Alibaba (BABA),Tencent (700 HK) Alibaba, Tencent Look Attractive on Strong Growth Potential 1/2/20 Stock 2019 Report Card Signal From Noise 2019 Picks: 74% Win Rate, Beat SPX

  • Signal from Noise
Jun 12, 2019

Bricks and Mortar Target Thriving in an E-Commerce World

Let’s retire the scary term “Retail Apocalypse,” shall we? It’s oft repeated in the media and on Wall Street, inducing herd-like fright among investors interested in the retail sector because, let’s face it, bad news sells and the news has been bad. Indeed, Amazon (AMZN) remains a threat to the bricks and mortar channel. That challenge, however, is hardly new and after a decade of headlines about it, I believe this worry now applies mainly to companies that don’t have a strong online strategy. Target (TGT) does, which should serve it well in the ongoing battle with Amazon. Pay attention to Target because its management seems to get it. What’s Target’s secret? One of the nation’s biggest general retailers, with 1,800 stores, the company has embraced the power of the internet, investing in programs like same-day fulfillment, as well as more traditional tools such as offering exclusive brands shoppers can’t get elsewhere. While Target’s e-commerce business remains significantly smaller than Walmart’s or Amazon’s, the Minneapolis-based retailer’s growing prowess is clear in recent results. For example, in the fiscal 2020 first quarter ended May 4, online sales grew 42%, up from 28% in the year ago quarter. That compare to 9% at Amazon; 37% at Walmart (WMT), and 15% at Best Buy (BBY) in their respective first quarters. Target comparable sales grew 4.8% on traffic growth of 4.3%. Seems like pretty good sales momentum, doesn’t it? Comparable digital sales contributed 2.1 percentage points to Target’s overall comp sales growth and its same-day fulfillment services (Order Pick Up, Drive Up and Shipt) drove well over half of the digital sales growth. Not bad for bricks and mortar. By the way, first-quarter operating income of $1.135 billion was 9% higher than a year ago. GAAP first quarter EPS from continuing operations were $1.53, up 15% from last year. And in the February ended fiscal 2019 year, GAAP earnings per share (EPS) were $5.51 vs. $5.29. Target expects $5.75 to $6.05 EPS in the current year, fiscal 2020. Source: Target 2018 Annual Report The company continues to invest intelligently in e-commerce and improvements to the consumer experience, a move that is driving sales and helping the company to succeed in the long term, according to New Constructs, an independent stock research firm specializing forensic accounting. Capital expenditures doubled from 2016-2018, while investments to remodel and improve existing stores more than tripled, as Target remodeled 400 stores over the past two years. Another 600 will be redone over the next two years. The remodels also improve Target’s ability to fulfill digital orders. The stores are now the centerpiece of its digital fulfillment strategy by offering customers curbside pickup options and even same-day delivery through the acquisition of Shipt. Target’s strategy shows how brick and mortars can be a competitive advantage in an e-commerce world, New Constructs notes. Using stores as distribution centers and pickup locations lets Target leverage its geographic footprint to provide a service that is even more convenient than Amazon. And customers who used to shop at Sears, Toys R’ Us, Gymboree, and other recently bankrupt retailers will be looking to shop elsewhere, and Target’s convenience makes it an attractive alternative. According to New Constructs, if the stock were to trade at parity with its peers, it would be worth $110/share – 25% above the current stock price. With Target taking market share from other brick and mortar retailers, it arguably deserves a premium valuation compared to peers. Source: FS Insight, FactSet As Target continues to take share from competitors and increase traffic through store remodels, it should be able to continue to beat expectations on the top and bottom line as it did in Q1, the report says. I concur. More strong earnings reports should reassure investors that Target’s growth is part of a larger trend, not an aberration. Oh, there’s also a dividend yield of 3%. For all the hand wringing about the internet threat, investors of a certain age will remember that Walmart was once going to wipe out the retail competition. Well, certainly many companies, particularly mom-and-pop shops, went under, but retailing survived. Online shopping is undeniably convenient but the urge to visit your favorite store isn’t going away. Target’s stock looks appealing in the long run, though the recent 20% pop to $88 might make some investors hesitate. Even after that rise, Target’s price/earnings ratio of about 15 times is in line with stock’s historical median P/E. My guess is that, given the regularity of the screaming headlines about the “Retail Apocalypse,” investors might get another temporary crack at Target at a lower price. If that happens, it could prove to be a nice entry point. A look at Target’s stock action over the past ten years shows volatility inside of a general upward sloping trend. Shares have gone from $40 in 2009 to $88, but with plenty of 10% to 33% drops in between. Another ugly industry headline could lay the sector low again. Where could I be wrong? There are market concerns about recession in the near term, and that would knock lots of retail stocks like Target’s for a loop. Nevertheless, the last few quarters suggest Target is getting the internet right, and that’s important for the long run.

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