Ecommerce Stock with explosive upside?

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.

US Ecommerce Penetration
Chinese Ecommerce Penetration
Global Ecommerce Penetration

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.

3rd Party Sellers on Amazon
Biggest online retailers in the US

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.

AIMee Technology
  • 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.

Ticker: MWK
Stock Price (when post published): $30.38
Verdict: Bullish
Timeframe: 5 Years

Riding the tailwinds of Chinese E-Commerce

China will overtake the US to become the world’s largest economy by 2028, five years earlier than previously forecast, according to the UK based CEBR (Centre for Economics and Business Research)[1]. This bodes well for the e-commerce sector which accounts for a whopping 36% of total Chinese GDP today, compared to only 15% in 2008 [2]. In this post, I will look at the particularities of Chinese e-commerce and how and why retail investors should want a slice of this pie.

Market Size

Growth Trajectory

The global e-commerce market is expected to grow at 16% compounded over the next four years (having already grown at 17% compounded over the last seven years). For context, that’s 1.5x the expected growth rate of the global smartphone market, 2.5x expected growth rate of home ownership and about the same as the forecasted growth rate for the Electric Vehicle market over the same period…so it’s a pretty big number[3],[4],[5].

Global E-Commerce Sales Growth

Shopping Experience

This is being driven by changing consumer preferences over how and where shopping takes place and improvements in mobile technology to facilitate this transition. 67% of millennials already prefer to shop online (and 56% of Gen X-ers), when compared to brick and mortar. Of these, about half make purchases whilst sitting in bed, 23% at work (and 20% from the bathroom or in the car!), representing how mobile technology has been able to make shopping more convenient and fulfill our endless desire to do things on our own terms.[6] These structural trends are not expected to go away any time soon particularly as a result of COVID-19 which has spurred increased online sales in most industries.

China led growth

Whilst the current global e-commerce market is around $4tn (roughly 5% of Global GDP), the bulk of this market share is in China, which boasts an e-commerce market almost twice the size of the US equivalent. E-commerce accounts for almost 35% of Chinese total retail sales, compared to only 10% in the US[7]. To put this into perspective, approx. 50% of global online transactions each day, happen inside of China and the largest online retailer in China, Ali Baba, has almost double the number of active users on its platform that Amazon has globally (600m vs 330m).[8]

As the first major economy to post GDP growth in 2020, the Chinese e-commerce market is facing two very strong tailwinds; a global structural trend away from brick and mortar to online, and high sensitivity to a booming Chinese economy, which is set to continue to grow 5-8% per annum over the coming decade.

Chinese e-commerce market

The Chinese e-commerce market is not identical to other markets.

  1. Mobile shopping

Mobile platforms generate 80% of retail ecommerce sales in the country (and 95% of total e-commerce activity) vs 64% globally. Put simply, this is because the average consumer in China spends more time on their smartphone (5 hours, compared with 3 hours globally)[9]. Given smartphone penetration is still far from reaching saturation (50% of the Chinese population), existing operators need to have a large-scale mobile retail presence to continue to expand[10].

2. Mobile Payments

This mobile technology has gone hand-in-hand with mobile payment platforms (such as Alipay, Wechat and Union Pay). In fact, 80% of smartphone users use mobile payments compared to only 27% in the US. The opportunities for newcomers in this space however are limited with Alipay (owned by Ali Baba) and Wechat (owned by Tencent) controlling 92% of the Chinese mobile payments market combined[11].

3. Omni-Channel Retail & Brand Awareness

The third distinction is that Chinese consumers are more discovery oriented than US consumers (i.e. they don’t always know what they want before they’re online), indicated by the former having more touchpoints with the brand before item purchase (8 touchpoints versus only 4 in the US).[12] This has made omnichannel retail (selling across multiple platforms), international brands and interconnectivity with social networks, particularly important to drive retail sales in China.

Current State of Play

All three main players in the Chinese e-commerce market (Ali Baba, JD and Pinduoduo), cover some form of mobile retail, mobile payments and omni-channel retail but Ali Baba is miles ahead. This is because, whereas, JD and Pinduoduo both have secured strategic investments from Tencent to add additional services to their primary retail presence (e.g. mobile payments and social networking) Ali Baba has been able to integrate these functions across its existing businesses (such as Ali Pay and Lazada).

Resultingly, Ali Baba has the biggest slice of the pie with 60% market share, led by its Business-to-Consumer marketplace, Tmall. To put that into perspective, Amazon accounts for 40% of online retail sales in the US and is widely considered an e-commerce behemoth in the US[14].  

List of Chinese e-commerce players

Tmall China (Ali Baba) – The third most visited site in the world and a brand driven B2C marketplace.

60% Market Share

JD.com (JD) – marketplace with in-house delivery and logistics.

20% Market Share

Pinduoduo – Group buying marketplace (like Groupon).

5% Market Share.

Others – (Wechat Store and Red/Xiahongshu)

~15% Market Share

Ali Baba as an E-Commerce Stock

Whilst Ali Baba is by no means a pure play Chinese e-commerce stock, 68% of FY 2019 revenues came from Ali Baba’s China based marketplaces (compared to 7% from international wholesale, 7% cloud computing, 6% entertainment and  4% logistics services). 85% of this in was via mobile sales. This illustrates that whilst Ali Baba touches many different industries, it is still very much a Chinese consumer focused, mobile e-commerce giant.

Ali baba strikes me as the most defendable business model within the Chinese e-commerce space. This is principally because it meets the threshold of having the strongest mobile retail penetration for the Chinese consumer (with higher gross margins), mobile payments integration and cross border retail presence to drive brand awareness.

Why Ali Baba is superior to competition

Overview of Ali Baba E-Commerce Businesses

Strong Mobile Customer Penetration (and a more profitable business model)

Based on Chinese internet users of over 855 million, Ali Baba boasts an 83% penetration rate for its B2C and C2C platforms (Tmall and Taobao), which are the two largest online marketplaces in China. About half of the Chinese population are users of Ali Baba and over 85% of total yearly sales on Ali Baba’s platform, come from mobile (with total GMV larger than Amazon and Ebay’s yearly sales, combined). This deep penetration has allowed Ali Baba to leverage network effects across its platforms (the platforms drive traffic to each other thereby lowering acquisition costs) and as a result, Ali Baba is usually the first shopping experience for Chinese customers. This deep penetration has allowed the company to maximize revenue per user relative to its competitors (GMV per active user was CNY 730 versus CNY 143 for Pinduoduo and CNY 362 for JD).

Direct Customer fulfillment

Ali Baba is often described as the Amazon of China whereas in fact, it operates more as an ‘Ebay’ of China. Tmall, it’s B2C platform, gives businesses direct customer fulfillment so they manage the warehousing and shipping of goods to the end customer. This allows Ali Baba to charge servicing fees for marketing on its platform but it does not have to take inventory on its own balance sheet. This vastly improves the overall net income margin for Ali Baba which is 22% (vs 5% for Amazon, 1% for JD) and Gross Margin OF 44% (vs 40% for Amazon, 15% for JD).

Mobile Payments Technology

Ali Baba also owns a 33% stake in Ant Financial, a mobile payments and microlending platform. Ant has the largest share of the Chinese mobile payments market (54%) in an industry which is set to double in size by 2025. Wechat is second in size at only 38% market share. This dominant position has allowed Ali Baba a virtual monopoly on mobile payments as it can integrate this with it’s online e-commerce platforms.

Omni-Channel Retail via cross border e-commerce

Outside of China, Ali Baba is the furthest ahead in integrating its business with global brands and cross border e-commerce. This is primarily facilitated by Ali Baba’s controlling stake in Lazada, a South East Asia focused e-commerce business (with 200million active internet users across these regions). In these regions, e-commerce accounts for a meagre 3-5% of total sales reflecting lack of existing providers and strong runway of growth ahead. In 2009, Ali Baba also purchased Koala from rival Netease (integrated into Tmall) to build out its import strategy; allowing global merchants direct access to the Chinese consumer. This will allow Ali Baba to accelerate import/export services, have (exclusive) access to international brands selling into China, and drive brand awareness.

Risks

The biggest risks to backing this tech behemoth is regulatory uncertainty in China. The two specific risks to the price of Ali Baba stock (though these developments still have a corollary impact on the broader sector) are:

  • Ant Financial

Ali Baba has a 33% stake in Ant Financial, whose long awaited IPO came to a grounding halt as Chinese regulators suspended the offering and proposed last minute changes to Ant’s business model. Whilst founded as an online payments platform, Ant has grown beyond this and this has become the sticking point for the regulators. 63% of Ant’s revenues come from matching consumers to lenders via its platform (this was 44% of revenues in 2017 speaking to the spectacular growth this division has experienced). Ant uses its own proprietary technology to provide customers with credit scores (Zhima credit scoring system), compiles lending risks and then securitize debt via third parties or to pass this on to conventional banks.

Chinese regulators want to treat these type of platforms as financial institutions and not tech companies, and resultingly want Ant to put up its own capital against these loans (30% of capital for joint loans with banks versus current 2%). This resultingly limits Ant’s leverage and growth rate, particularly if Ant also has to apply for new banking licenses.

Whilst Ant is not Ali Baba’s core business, the elephant in the room here is the Microlending/P2P scandal in 2008. During this period, China saw a rise in scandals and mismanaged debt which the government is keen to avoid the second time around[15].

My take on this is that unlike in 2008, the tech giants are providing a service which conventional banks have been unable to provide. Credit cards are not pervasive in China and financial records are largely inadequate in rural areas. This has limited access to credit in remote areas and to date, the biggest four conventional banks give out 75% of their total loans only in the form of mortgages (in 1H 2020). This has left a gaping hole for new microlending entrants who have the digital footprint and know-how to provide this service (and pick good borrowers from bad ones). Whilst Ant may be hamstrung by new regulations, this will likely come at the expense of short-term growth as this service cannot feasibly be performed by existing conventional banks or other private businesses without the same scale and expertise. In other words, the overall business opportunity remains intact but Ant will have to wait longer to achieve the same outcomes or at least, until regulators are more comfortable.

  • Anti-monopoly Laws

The second major risk to Ali Baba is an overhaul of the existing competitive framework in China for e-commerce. As we established above, Ali Baba relies on its massive network to be as effective within the e-commerce space. However, in 2020, the Chinese government first applied a monopoly law to fine Ali Baba (alongside others).

The newly contested issue is platform integration or exclusivity arrangements that Ali Baba may have for that prevent users from going on other platforms. This is a big blow to the company and so far, it is unclear how this will play out, particularly as there are so many avenues that they could pursue this with Ali Baba. For me, this is the single biggest risk to the stock as Ali Baba relies heavily on its expansive network to be effective.

Conclusion

I am bullish China and Chinese e-commerce. Ali Baba is the natural choice for investment, as it’s the biggest, most exposed and the most defendable business operating in the sector. Ironically, the biggest risk to this position is that regulators see these strengths and force Ali Baba to concede market share to allow new entrants in the market. Despite this, Ali Baba is sizably ahead of the competition and has cemented a strong position with the Chinese consumer. This should make policies short of actively breaking up Ali Baba, to be nothing but a slow burn; as what pieces of business Ali Baba may eventually lose to competitors will likely be more than offset by its levered position (and natural monopolies) in this fast growing industry.

Verdict: Cautiously Bullish (pending impact of regulatory investigation)
Timeframe: 3-5 Years

[1] https://www.bbc.com/news/world-asia-china-55454146

[2] https://tenbagroup.com/12-china-e-commerce-market-trends-2021/

[3] https://www.mordorintelligence.com/industry-reports/smartphones-market

[4] https://www.globenewswire.com/news-release/2020/04/14/2015310/0/en/The-Global-Electric-Vehicle-Market-is-expected-to-grow-from-USD-146-902-20-Million-in-2019-to-USD-359-854-56-Million-by-the-end-of-2025-at-a-Compound-Annual-Growth-Rate-CAGR-of-16-.html#:~:text=%2F%3Futm_source%3DGNW-,The%20Global%20Electric%20Vehicle%20Market%20is%20expected%20to%20grow%20from,(CAGR)%20of%2016.10%25.&text=The%20Battery%20Electric%20Vehicle%20commanded,Electric%20Vehicle%20Market%20in%202019

[5] https://www.mordorintelligence.com/industry-reports/us-homeowners-insurance-market

[6] https://kinsta.com/blog/ecommerce-statistics/

[7] https://kinsta.com/blog/ecommerce-statistics/

[8] https://business.cornell.edu/hub/2020/02/18/impact-e-commerce-china-united-states/

[9] https://tenbagroup.com/12-china-e-commerce-market-trends-2021/

[10] https://www.statista.com/statistics/321482/smartphone-user-penetration-in-china/

[11] https://www.paymentscardsandmobile.com/alipay-continues-mobile-payments-expansion-in-japan/

[12] https://digovation.com/2020/06/15/understanding-the-e-commerce-landscape-in-china/

[13] https://www.sellmasters.it/en/2020/01/28/e-commerce-usa-vs-china/

[14] https://www.emarketer.com/content/china-ecommerce-2020

[15] https://www.scmp.com/tech/innovation/article/3113410/how-chinas-online-microlenders-reached-tipping-point-worlds-biggest