Sector Watch: On-line retailing
Record-high gas prices this summer will likely dampen overall retail sales but may fuel increased opportunities for on-line retailers as cost-conscious consumers opt to shop on-line instead of in stores. Online sales experienced strong growth last year, rising 25% to $219.9 billion. Excluding travel, e-commerce sales rose 29% in 2006 to $146.5 billion. For the current year, online sales are forecast to grow 18% to $259.1 billion and on-line sales excluding travel are projected to rise 19% to $174.5 billion. According to a Forrester Research survey for the National Retail Federation, 10% of all clothing and accessory sales will occur on line in 2007, up from 8% last year. Overall online retail sales excluding travel are expected to account for 7% of the total retail market in 2007, up from 6% last year.
The main challenges to even faster online growth are delays between ordering and receiving products, and consumers’ desire to physically examine certain items (such as apparel) before purchasing. Online order security and data protection have also emerged as a major industry issue. Gartner Group estimates that as much as $2 billion in additional online sales were lost in 2006 because of consumers’ security concerns. Online retailers must also be better prepared for heavy holiday e-commerce traffic. Last year several major retailers experienced website crashes and slowdowns during the holiday season. Forrester’s report also noted that 83% of online retailers who responded to its survey were profitable last year, and 78% reported increased profits.
Data from comScore Networks indicates consumers spent more online than ever before during the 2006 holiday season. E-commerce revenues exceeded $100 billion for the first time ever and spending was 22% higher than last year. comScore noted the largest surge in online buying came during the three weeks leading up to Christmas; e-commerce sales rose 45% from the previous year. The strong e-commerce results stand in marked contrast to overall sales for major U.S. retailers, which showed weak same-store sales comparisons and single-digit sales growth for the 2006 holiday season.
1-800-Flowers.com
One of the small cap retailers benefiting from e-commerce growth is 1-800-Flowers.com Inc. (Nasdaq: FLWS)) Online sales for this company surged 98% in last year’s holiday season. This leading marketer of flowers and gift baskets obtains 70% of its floral gift orders online. Because of its high online order rate, the company benefits from low order handling costs and enhanced cross-selling opportunities. 1-800-Flowers.com attracts more than 3 million new customers annually and builds loyalty with 25 million+ existing customers through personalized reminder services and rewards programs. The company’s repeat order rate exceeds 50%.
According to industry sources, the company’s retail floral, specialty gifts and other markets present an $80+ billion annual sales opportunity. Because the company’s e-commerce model requires no investment in bricks and mortar, 1-800-Flowers.com has a low cost structure and achieves high returns on invested capital.
During the nine months ended April 2007, compared with the same period last year, sales grew 19% to $681 million, operating profits climbed 485% to $22.7 million, and EPS rose four-fold to $0.16 from $0.03. The company is targeting 17% to 20% revenue growth and 100% EPS growth in FY 2007 and 20-25% EPS growth in FY 2008 and FY 2009. Analysts expect the company to produce growth averaging 30% annually over the next five years. These shares currently trade at a 24 times forward P/E. My $10.50 price target for 1-800-Flowers.com is 35% above the current price.
Medifast
Another company benefiting from e-commerce trends is Medifast Inc. (NYSE: MED). Medifast, through its subsidiaries, produces and sells weight management and consumable health products, including low-calorie replacement meals and sports nutrition powders and drinks. Medifast markets its products through the Internet, call centers, weight loss clinics and direct consumer response programs supported by phone and the Web. Medifast has more than 1 million customers.
Medifast’s revenues increased 85% in 2006 to $74.1 million. Earnings grew 100% year- over-year to $5.1 million, or $0.38 per share, from $2.4 million, or $0.19 per share, in 2005. While March-quarter 2007 earnings were modestly lower than comparable prior-year levels due to reduced advertising investment, Medifast is implementing new media buying strategies that have resulted in improved month-to-month returns. The company recently reiterated its 2007 guidance calling for 15% to 19% revenue growth and 18% to 21% earnings growth. Analysts expect this company to produce 36% earnings growth next year and 25% annual longer-term growth. Medifast shares currently trade at a P/E multiple of only 10.6 times 2007 earnings estimates. My $12 price target for Medifast is 80% above the current price.
