Dead Shopping Malls Rise Like Mountains Beyond Mountains – $AMZN

by Dan May 12, 2016 1:26 pm • Commentary• Trade Ideas

This is a bit of a think piece so please bear with me, but if you get bored skip to the bottom, there is an options trade idea on Amazon (AMZN).

With Kohl’s (KSS) down 11% today on a weak quarter and outlook, a day after Macy’s (M) disaster, both stocks making new 52 week lows, and dragging the entire sector down with them, its hard not to contemplate the damage being inflicted from (AMZN). Sure technology will move on, and businesses will adapt or die, but AMZN’s gain may ultimately inflict pain for U.S. consumers.

Let me explain. I like you am a happy AMZN Prime customer. AMZN has done everything, and I mean everything in their power to make us very happy customers.  Over the last 10 years the company has grown annual sales from $8.5 billion in 2005 to last year’s $107 billion and close to $500 billion on a cumulative basis.  A bulk of those sales have come from other retail outlets.  And here is the important part, AMZN has only booked $5 billion in GAAP net income on a cumulative basis on those nearly $500 billion in sales.  That’s astounding when you consider the AMZN’s stock trades at an all time high, with a $337 billion market cap. Amazon is being empowered to crush other retailers to gain market-share as result of investors willing to pay a ridiculous valuation for revenue growth. Rinse and repeat.

There is a little debate that AMZN put up a massive quarter for March, both in retail and AWS, RBC’s Internet Analyst and AMZN bull had the following comments on the Q1 financial results in a note to clients on April 28th (emphasis mine):

1) Really Robust Revenue Trends…North America Retail grew 27% Y/Y (second-fastest growth in 3 years); International Retail grew 26% Y/Y ex-FX (fastest growth in over 3 years); & AWS grew 64% exFX (almost same as Q4);

2) Strong Segment Margins…NA Retail Margin @ record 5.4% & AWS Margin @ 28% — sure, that was down Q/Q, but it still means that AMZN has the best Revenue Mix Shift Story in Tech: Emerging Segment growing 2X Core rate with 5X Margin Profile;

Walmart (WMT) and Target (TGT) have been positioning for a couple years to better compete with AMZN, while increasingly desperate department (M, DDS, KSS, JWN & JCP) and apparel stores (GPS, ANF) are seeing their business models torn to shreds.

As regular readers know my commentary has been skeptical of AMZN and its business model. I have not been short AMZN but on CNBC’s Fast Money I have routinely taken the other side of the bullish case for AMZN from a long term risk standpoint. I think for the most part much of the financial news commentary on the stock and the story is unoriginal and old. Here was my commentary from my Q1 preview two weeks ago:

My View Into the Print: This is just not my cup of tea. I was wrong the whole way up last year as their lack of profitability and investor focus on a small but high growth part of their business (AWS), and their willingness to disregard all else in the name of AWS growth spooks me.  Just to put the lunacy in context, last year on their $107 billion in total sales, the company recorded a net profit of $596 million on a GAAP basis, operating profit of only $2.23 billion. While bulls will point to eBitda of $10.8 billion, I think it is important to note that its the B in the whole ebitda thingy that should not be forgotten. And any way you slice it net income or operating profits are ridiculously low levels of sales.  If you have solely focused on valuation for reason to not own, or short AMZN then it has been a volatile 20 years for you. The stock has never traded at a multiple where one could make the argument for growth at a reasonable price, as can be done with FB.

So I can’t be of help. I’m a very happy long time AMZN customer I can tell you that the company’s lack of focus on profits has benefited me immensely on a personal level. But it does not motivate me as a prospective investor.  I know that’s not very helpful, but wanted to lay out some color prior to tonight’s earnings for those who are motivated either way.

I can’t help you navigate the stock if you are long and strong. It has been right to be long. But on a longer time frame the story defies conventional logic.

In fact, the wrecking ball that has been AMZN on U.S. retail may be one reason why the U.S. Fed has been unable to materially stoke inflation. And worse, it could be one impetus for a deflationary spiral.  Yeah AMZN’s cheap shipping options, massive variety and cheap prices has been a boon for consumers, but I am hard-pressed to think we will not soon see massive consolidation in department and apparel stores, resulting in thousands of store closings and tens of thousands of job losses. At that point Amazon may be able to increase prices and reign in spending. But at what cost to consumers?

I know this is a nuanced point, but take a quick look at AMZN’s expected 2016 sales and the number of employees to achieve those sales. You get a sense that the department stores listed below are running zombie bricks and mortar operations: (AMZN) at all time highs
$337b bil market cap
$134 bil 2016 sales sales
231,000 employees
Macy’s (M) – down 60% from all time highs
$9.5 bil market cap
$26 bil 2016 sales
158,000 employees
JC Penney (JCP) – down 90% from all time highs
$2.4 bil market cap
$13 bil 2016 sales
105,000 employees
Nordstroms (JWN) – down 47% from all time highs
$7.7 bil market cap
$15.7 bil 2016 sales
72,500 employees
Kohls (KSS) – down 57% from all time highs
$6.3 bil market cap
$19.3 bil 2016 sales
32,000 employees
Dillard’s (DDS) – – down 57% from all time highs
$2.1 bil market cap
$6.6 bil 2016 sales
21,000 employees
Winter is here for Bricks and Mortar retail, and the question is whether or not it brings with it the long cold winter for the U.S. economy. Amazon of course benefits from this transition in the near term. And in the medium turn they can turn the spigot off on spending and finally increase profitability. But who will be left to buy the products and the stock in a a world that Amazon drones fly through empty suburban retail wastelands?

But that’s all long term. How would I trade AMZN near term? If I were inclined to fade the recent breakout I’d want to make a near term bearish defined risk bet isolating a move back to $650.

Short dated options prices look cheap relative to recent movement. For instance the chart below shows 30 day at the money implied vol at its 2016 lows at 26% (blue line) while 30 day realized vol (white below) is a bit elevated as it includes the post earnings bounce of almost 10%:

From Bloomberg
From Bloomberg

Outright options purchases for those with a directional bias are likely as cheap as they have been in a while with the stock at all time highs.  But for those trying to pick a top in one the largest and strongest stocks in the entire world, you will want to look for ways to mitigate premium outlay for long premium structures.

Which brings me to a put butterfly. I want to isolate the $700 breakout level and target near term support at $650:

AMZN 1yr chart from Bloomberg
AMZN 1yr chart from Bloomberg

When the fever breaks, I suspect we get a pullback to the $650 area, timing will be an issue, so despite relatively cheap options prices I wan to attempt to offset some decay of near the money puts.

Trade: AMZN ($$716.50) Buy June 700 / 650 / 600 Put Butterfly for $8.50
  • Buy to open 1 June 700 put for 16.50
  • Sell to open 2 June 650 puts at 4.65 or 9.30 total
  • Buy to open 1 June 600 put for $1.30

Break-even on June Expiration:

Profits: between 691.50 and 608.50 with max gain of 41.50 at $650

Losses: up to 8.50 between 691.50 and 700 & between 600 and 608.50 with max loss of 8.50 below 600 or above 700. Risking less than 1.5% of the underlying stock price.