In the battle between “old” (bricks and mortar) and “new” (online) retail, few will survive although according to the market, the winner couldn’t be more clear.
As BofA’s Savita Subramanian writes in her latest relative value cheat sheet report, “retailers compete for share of the total consumer wallet, and it is old news that online retailers have continued to take share from traditional brick and mortar retailers.” Nowhere is this more obvious than in the near-50x multiple point forward P/E spread between “New” (65x) and “Old” (17x) Retail, which is close to a record high (Chart 1). New Retail’s multiple expansion has pushed the P/E of the overall retail group to another near record high of 26x.
In the context of the broader market, this puts retailers at a 46% premium to the S&P – more than double the historical average premium of 17%.
Why the gaping disconnect?
There are two possible explanation: i) the market may be ascribing too much growth to the online group, or ii) is double-counting future profits by giving full credit to New Retail for market share gains without taking it away from Old Retail. However, in a surprising twist, BofA calculates that assuming a reversion to the historical 17% market premium for the total retail group, “one-fourth of the total group’s future earnings (or one-third of Old Retail’s future earnings) may be being double-counted.”
Looking at it another way, if the market is fairly discounting the combined group’s future earnings potential, based on the overall retail group’s current P/E of 26x, then given that New Retail makes up nearly half of the combined market cap today, it should also make up half of the total group’s future earnings potential vs. just 18% of current earnings that it represents today. That implies that 35% of Old Retail’s current earnings would eventually need to shift to New Retail.
Taking this one step further, since “new” retail is mostly Amazon, what BofA is suggesting, is that just based on current valuation, the market is either flat out wrong, which would hurt “online” retailer earnings, or it is already pricing in one company (AMZN) generating half the earnings of the entire sector, which may not be the definition of a monopoly, but is getting perilously close, if only for Jeff Bezos.