The global retail market is growing at 14% annually and it’s not close to slowing down. Even in 2020, an abysmal year for the US economy, total US retail sales grew by 7% (vs 2019), which in fact was the highest annual growth recorded since 1999.
Ecommerce leading the way
The key driver of this growth in retail sales is online ecommerce. In 2020, ecommerce sales accounted for 101% of the growth in total sales (it’s over 100% because it also off-set declines in catalog/call center sales). This was the first time in history that ecommerce sales growth accounted for all of the total retail sales growth (the last time it got close was in 2008, when ecommerce growth accounted for 63.8% of growth that year).
The pandemic clearly had a lot to do with this. When you’re under lockdown and need essential supplies, online retailers like Amazon prove to be extremely useful. This trend also incentivised traditional retailers to step up their online presence to keep up.
US Ecommerce penetration is still in its early stages
What’s surprising however, is that even after accounting for the pandemic led boost, ecommerce penetration in the US still isn’t very high. In China, 45% of all retail sales are made online today, and that’s expected to reach approx. 60% by 2024. Meanwhile, in the US, this is closer to 21% (pre-covid, this was 15.8%). The global average, which includes countries where infrastructure is lacking, is 18%.
For the US to only be 3% above the global average is pretty shocking, especially as the US economy is largely consumption driven (70% of GDP) and is still a global technology leader (fast internet speeds, high level of tech integration, mobile adoption etc.). This tells me the shift to online retail is still very much in its early stages in the US and whilst it is a global trend, the US is prone to a much faster rate of ecommerce adoption than most other countries.
There is sizeable room for new entrants
Amazon effectively has a monopoly on online retail in the US. It accounts for around a third of all online sales (around 7% of total retail sales). Nonetheless, as the ecommerce market continues to expand, Amazon is having to concede market share. Some of this market share is going to other established retailers that have geared up their online presence but it’s also going to local businesses that have only just started to transition online (made more convenient through channels such as Shopify, Etsy and Amazon marketplace). In 2020, the top 100 retailers had a 74% share of total ecommerce sales compared to only 49% in the previous year. On Amazon, now more than 60% of their sales are fulfilled by Third Party Sellers (hosting on Amazon’s marketplace). This speaks to how increasingly fragmented the market is becoming.
Short term Tailwinds?
One frequent criticism I hear is that as the US comes out of the pandemic we will see a reversal in the trend towards ecommerce. The theory is that as people are allowed out, they will go back to buying things in person than online. Whilst I think this may be true for some purchases as people are no longer forced to buy almost everything online, I think there are two tailwinds that will keep us going.
The first is the sheer size of pent up demand, combined with rising personal incomes. No matter how you cut it, personal incomes, disposable incomes, personal debt/income ratios, all point to the US consumer coming out of the pandemic stronger than where they went in. This is mainly being supported by the size of stimulus but also because people spend less overall when they are under lock down (less Starbucks coffees, commuting, nights out etc). So whilst we may see some things being purchased in person as opposed to online, the sheer size of the amount of spending we are going to experience is likely to lift the entire sector (and therefore, in absolute terms ecommerce sales will continue going higher).
The second is a cultural shift. We can argue that you might order less takeout and eat out more, but the convenience of online shopping is evident. Many of these habits are likely to be sticky; if you’ve tried it once, you’re more comfortable with the idea of doing it again. This is creating a secular trend in the market towards online retail.
Mohawk: Ecommerce disrupter
Ok so enough big picture stuff. I know ecommerce is a sector with structural growth, low current penetration and short term tailwinds. But what I want to know is which companies will be potential multi-baggers because they are truly disrupting the industry.
This is when I came across Mohawk (Ticker: MWK). They are a pure play ecommerce business but they have focused on two particular aspects of the future of the ecommerce market; increased fragmentation and low technology integration for entrants. They have three key USP’s that are focused on these structural trends.
- AIMee Proprietary Tech Platform
Mohawk hosts a tech platform called AIMee. This replaces some of the old fashioned, inefficient aspects of the retail business with a far superior tech based alternative. AIMee allows MWK to understand their customers better; it analyses customer feedback (through NLP) to quickly identify what customers like/don’t like (through text based reviews), it computes market trends by monitoring the features that the best-selling products have, and it optimizes pricing/logistics based on consumer feedback. These are not new ideas but their proprietary tech platform allows MWK to do these things more efficiently than others using a combination of Artificial Inteligence and programming.
This type of bottoms up analysis has become particularly important in markets with low brand loyalty (think iphone cases, essential oils, kitchen appliances). This is because by focusing so closely on the data from customers, MWK can get a bigger slice of the market share. I was surprised to find out that only 22% of searches on Amazon have a brand attached to them, and 51% of millennials have no preference between private label and national brands. This nonchalance towards major brands is a key driver for MWK’s growth, because they can then use their technology to gain a competitive edge.
- Reducing Go-To-Market Time
The second aspect of Mohawks business is one which I didn’t initially consider. A typical product takes around 18-24 months to go to market. The key hindrances that traditional retailers have is that they have to initially research/test the product and find distributors. Mohawk can use their AIMee platform to cut this down to 6-8 months, by replacing these two roles with a technology alternative.
Instead of having focus groups, AIMee can identify what’s trending and therefore, become an idea generator. This reverses the traditional role of product origination; instead of asking customers what they like, the AIMee platform tells you what customers are going to like. Similarly, the trading engine can figure out the optimal go to market strategy (inventory, pricing, product lifetime management).
For products which rely on a lot of hype (think fidget spinners, kids toys, smart gadgets), being the first is key to profitability. Most users will buy the item, use it for a short while and then move on. I see AIMee is helping to find this product.
Anecdotally, I know time how critical time to market can be. I launched a repair app (www.fixlee.co.uk) late last year and even whilst I’ve been busy making new iterations/testing the beta, I’ve seen multiple new players pop up trying to do the same thing that I am with my repair app.
- M&A strategy
MWK traditionally relied on organic growth to fund their business but as more ‘mom and pop’ businesses have been set up, MWK has found it more cost effective to pursue an aggressive M&A strategy to integrate these businesses under their technology infrastructure (than to establish brand new businesses). The competitive edge for MWK remains their tech (by acquiring more businesses, they can spread a fixed cost over more products) but they have also proven to find very attractive M&A deals more broadly, buying companies at 3-4x EBITDA. Since 2020, they have already added 1000 different products and have 40 new product launches. The pool of potential acquisition targets is expected to increase with third party sellers expected to grow at 16% CAGR over the next five years.
Business financials
I had two concerns with the MWK business model that I wanted to see addressed in their financials. (1) Whether their tech had proof of concept in being able to generate incremental sales (2) their ability to scale their M&A strategy.
MWK have increased revenues every year since 2017 and expect to have 50% CAGR in revenues over the period 2017-2021. In the latest estimates, MWK forecast a 100% y/y increase in revenues 2020/21. They have also managed to turn this incremental revenue into growing EBITDA margins which turned positive for the first time last year. This shows the business is able to sell more and is now starting to return profits (using EBITDA as a proxy).
With regards to their M&A strategy, MWK have some attractive businesses they have managed to acquire which has helped to cement their ecommerce position. The good thing about this is that they’ve managed to add more businesses with generally no additional headcount and with a very quick turnaround time (~48hours to integrate), which speaks to their competitive advantage.
- Healing solutions (31 Oct 2020) – 3.8x TTM EBITDA, 3300 products
- Smash acquisition (30 Sep 2020) – 3.7x TTM EBITDA, 43 products
- Truweo (8 April 2020) – 2.5x TTM EBITDA,
Valuation
Now I know what you’re thinking? Why do all of this analysis to buy an ecommerce tech business. Just buy Amazon, right? Strong, steady, growing….
This is where I think it gets interesting. I want to find the businesses with the best risk/reward and big upside. Call me skeptical but I struggle to see Amazon being 2-3x in the next 5 years (if Amazon doubled from where it is today, it would have a market cap the same size of German GDP)…This is where high growth, small cap stocks, become more interesting.
Here’s a quick and dirty optimised margin model on MWK.
Let’s start with Revenues. MWK experienced 62% growth 20/19 vs 100% forecast 21/20. Their 2021 Revenue guidance is between $350-$380m, and their long term optimized margin forecast is around 13-15%.
Basis achieving a long run operating margin of 13-15%, this implies earnings of $36-$45m. Assuming the business can grow in line with the rest of the market (i.e. 16%-24%), this implies 2025 Revenues of $735m-$1.14bn. Assuming the business is valued at a Price/Earnings multiple of between 10-20x, I am seeing 189% upside against 17% downside risk, with base case upside of 65%, at current prices (as of COB March 15).
Conclusion
Ecommerce is a secular trend that’s here to stay. As the market continues to grow, new entrants will emerge and MWK is providing fundamental value through its proprietary technology platform, AIMee. By being able to do things more efficiently, the company has strong growth prospects which it has shown through aggressive M&A expansion, consistent revenue growth and speedy product integration. I’m bullish the entire sector but I see this as a potential multi-bagger, that’s disruptive, consistent and trading at a good entry point.
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