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On Monday, a Morgan Stanley report that Amazon was contemplating “disrupting” the Healthcare Distribution sector slammed stocks in the industry, sending the sector sharply lower. Fast forward two days, when Amazon’s disruption appears to have started earlier than even MS anticipated, after a CNBC report that AWS CEO Andy Jassy is planning to announce that Amazon is teaming up with Cerner, one of the world’s largest health technology companies, to help health-care providers better use their data to make health predictions about patient populations.

Yet while Amazon is pursuing aggressive market share theft in the healthcare sector, in retail it is expected to have a more amicable approach, and according to a note by Citi, shortly after its acquisition of upscale grocery chain Whole Foods, the next corporate move by the world’s richest man will be to buy a prominent retailer. The question is which.

As Citi’s Paul Lejuez explains, when AMZN bought WFM in June 2017, it led many to believe that AMZN might have aspirations to establish more of a bricks and mortar presence in the US. Citi also argues that while “grocery is different” (and AMZN may just stop there), Amazon may next target a retailer. It also make the following explicit caveat:

To be very clear, we are not asserting that AMZN will buy any of the names we suggest in the foreseeable future. We have no insight into any AMZN M&A activity or deal flow. We are simply performing an exercise where we consider the question “If AMZN were to buy something in our universe, who could make sense?”

Below, we show who Citi believes may be the best candidates for acquisition by Amazon, and summarize some key components of each of the companies that Citi suggests AMZN may eventually buy.

Why ANF?: (1) EV of only $620MM for 2 brands (A&F/Hollister); combined sales of $3.4BN, (2) own college like campus in Columbus, OH, (3) instant infrastructure to design, source and merchandise apparel on a global basis, (4) young customer base, (5) can use flagships (in amazing locations) to sell proprietary AMZN product.

With ANF, AMZN would acquire a very impressive headquarters in Columbus, OH, which is similar to a college campus. It has a strong culture and has a young workforce that could be leveraged across the AMZN organization.

 

As far as AMZN’s apparel aspirations, ANF offers an instant infrastructure to design, source and merchandise apparel on a global basis. ANF is vertical, so the brands would become AMZN’s proprietary brands to sell on its own website. And don’t forget they not only have a teen and young adult customer, they also have the A&F kids brand (abercrombie), which could have appeal to the mom shopping for kids clothes on Amazon’s website.

 

For less than $1BN, AMZN gets three apparel brands they would own (A&F, Hollister, abercrombie  kids), a seasoned design/sourcing organization, ~850 stores (including instant access to some of the most desirable locations in the world), and a campus like headquarters they can use (with space to build on further). Oh, and we estimate ANF generates in the range of  $50-100M of FCF annually (and imagine how much more productive/profitable those flagship stores could be if they were selling AMZN product). At that small price tag, there wouldn’t be much to lose.

 

if you’re AMZN, might it be more of an asset to suddenly have control over these flagship stores that are in some amazing locations. Just look at this list:

• NYC (34,000 sq ft on 5th Ave and 56th St)
  
• London (24,000 sq ft on Savile Row)
• Tokyo (30,000 sq ft on 11 floors in the Ginza shopping district)
  
• Paris (28,000 sq ft on the Champs-Elysees)
  
• Milan (20,000 sq ft) – Corso Matteotti
  
• Shanghai (25,000 sq ft) – Nanjing West Road
  
• Singapore (20,000 sq ft) – Orchard Road
  

* * *

Why SFM?: (1) They’re already partners, (2) potential synergies with AMZN grocery delivery business, (3) compliments the WFM platform with a high/low price approach.

We outline 3 possible methods of obtaining a takeout value per share for SFM using the recent Whole Foods transaction as a guide (which may be more relevant in this case than looking at historical precedent transactions). The more likely of the scenarios is a $27-$33 takeout price, representing a 30-62% premium to the current price of $20.37 (11/16/17). Stock Price Premium Using Whole Foods As a Guide: Whole Foods was taken out at a nearly ~30% premium. This would imply a takeout price of ~$27/ share for SFM (using it current stock price of $20.37), at a ~13x TTM EV/EBITDA. Note that this would be significantly higher than the historical average of precedent transactions in supermarkets of 7.4x TTM EBITDA and Whole Foods  at 10.3x TTM EBITDA.

* * *

Why BBBY?: (1) Store space already dedicated to online pick-up, (2) access to growing furniture space, (3) logistical/fulfillment know-how for large items, (4) overlap of merchandise assortments, (5) 1,100 off-mall stores across N America.

AMZN could acquire BBBY for a similar figure as RH – about $4.4B assuming the same 20% stock price premium – and would achieve still gain a physical F&HF presence and large-items fulfillment know-how while avoiding the drawbacks associated with a potential purchase of RH…. We do not think an AMZN purchase of BBBY is imminent. Only about 8% of BBBY’s sales come from furniture, while the majority of the remaining sales are items that consumers are increasingly-willing to buy online. BBBY looks significantly over-stored, even excluding non- BB&B brands. And BBBY’s product assortment is narrow compared to a retailer like KSS. Finally, from a financial standpoint, BBBY looks to be in structural decline and while we believe AMZN could certainly turn BBBY around, it’s unclear to us whether they would have interest in investing the capital and resources necessary to do so.

* * *

Why RH?: (1) Access to growing furniture space, (2) logistical/fulfillment know-how for large items, (3) overlap of high-income consumers, (4) both run a membership model, (5) equity/recognition of RH brand.

Within our furniture and home furnishings (F&HF) coverage, RH comes up most frequently in conversations as a potential AMZN target. The F&HF market is an attractive one given it is highly-fragmented, is growing at a MSD rate overall and is seeing sales rapidly shift online. Over the last five years, ecommerce F&HF sales have grown at a 15.9% CAGR and are projected to reach 17% of the domestic industry total by the end of 2017, up from 10% in 2012. 

 

We think a F&HF acquisition makes sense for AMZN for two main reasons. First, an acquisition would aid AMZN’s build-out of large-package fulfillment, which – like grocery – is fraught with complexity. And second, an acquisition could provide AMZN with an immediate physical F&HF presence, a factor that remains important to consumers purchasing furniture and home furnishings product (again, similar to groceries).

 

RH’s valuation isn’t particularly compelling as the stock is trading at 25x FY2 P/E and 15x EV/EBITDA. Assuming a 20% stock price premium, an acquisition of RH would cost $4.7B which is far from prohibitively expensive for the online giant, but likely does not represent the best use of capital given the factors noted above.

* * *

Why AAP?: (1) AMZN’s growing interest in the automotive space, (2) price is important for the DIY customer, but convenience and immediacy is more important, which highlights the need for stores, (3) highly specialized inventory build out will take time; AAP provides inventory breadth and depth, (4) specialized supply chain, (5) even at a 20% premium, AAP is less than half the value of ORLY and AZO.

We think we can make the argument that Amazon could buy one of the auto part retailers. When considering the needs of the DIY customer, we argue that most DIY’ers aren’t going to drive to a store, ask a store associate a bunch of technical questions on what they need to buy and do and then purchase the parts on AMZN and make the repair themselves. Most DIY’ers likely don’t make the same repair more than once so they always need guidance. Therefore, Amazon owning an auto part retailer with brick and mortar presence would achieve the ability  to cater to consumers looking for the convenience and immediacy needed.

 

However, we think a buyout of AAP is likely a long shot due primarily to 1) AMZN could likely finance the deal but it’s fairly soon to do an acquisition of this size, especially with the upcoming WFM integration and 2) AAP has experienced challenging demand trends (similar to WFM) but lacks large synergistic characteristics that would make AMZN uniquely capable in improving productivity. In the end, if the argument for AMZN’s acquisition of AAP is to gain market share through buying a major player in that sub-industry of retailing, the list of targets could get fairly long.

* * *

Why KSS?: (1) 1,100 off-mall stores to sell AMZN top-sellers, use for pickup/returns, (2) would own KSS proprietary and exclusive brands, (3) middle America customer, (4) $1BN+ annual FCF, (5) already an AMZN/KSS partnership.

After AMZN bought Whole Foods, if we had to come up with a list of ten companies AMZN could target next, KSS would have been on that list. After seeing the partnership between the two companies with KSS accepting AMZN product returns in 82 of its 1,100+ stores (with 10 of the stores home to a 1K sq ft AMZN shop in shop), we would argue KSS moved higher up that list. One of the reasons we believe AMZN might have chosen KSS as a partner to test its product returns to stores is that they have off-mall locations, which offer an easyin, easy-out shopping experience. Their store base is also relatively young, as 30% of their stores have been opened over the past 10 years (vs ~10% at JCP and ~7% at M – and M and JCP are largely mall-based).

 

The 1,100 KSS stores would offer AMZN many points of distribution that could help them in several ways. And let’s keep in mind, if AMZN bought KSS, we shouldn’t necessarily think of them as simply running the KSS chain. These stores could be rebranded as Amazon stores or “Amazon Kohl’s”.

 

At a $12BN acquisition price (assuming a 20% stock premium), a KSS deal would be about 10% less than what Whole Foods cost ($13.7BN). It would cost AMZN $9BN plus the assumption of $3BN in net debt. And let’s be honest, department stores are in a tough spot in the current retail environment, which might make KSS a more willing seller. Since department stores are facing serious challenges, we believe if there is one that can link up with AMZN, the others will be in that much more difficult of a spot. And let’s not forget, over the past 4 years KSS has generated an average of $1.2BN in FCF, including $1.4BN last year. We estimate they will generate around $1BN this year and for the next several years.

* * *

Why KR?: (1) Sizeable grocery presence with assets that may be of interest, (2) provides another point of attack against WMT, (3) obtain valuable consumer data via KR 84.51 division, (4) significant click and collect presence to help with last mile grocery challenges.

KR is the 2nd largest grocery store in the U.S. and would allow AMZN a way to take a sizeable 14% share of the US grocery market (vs. the paltry 2% share they attained through WFM). KR has 2,796 store locations- of which 1,445 fuel centers and 2, 255 pharmacies reside (pharmacy and fuel centers could be additional segments of long-term interest to AMZN). KR is also one of the best run grocery chains, in our opinion, which has led to continual market share gains. Competitive advantages for KR include: real estate locations, data analytics, purchasing power, vertical integration (they own several processing/production facilities, have self-distribution capabilities which can be enhanced by AMZN, and also have a large private label sales  mix which may be of interest to AMZN), and a large loyal customer base.

 

KR has a treasure trove of data that could be useful to AMZN to better personalize promotions and improve space optimization (could improve both AMZN and KR grocery operations). Their 84.51 data analytics division tracks 2,700 consumer attributes to determine geo density from a competitive perspective (including restaurants), hobbies (spend index across entertainment, travel), and social connectedness data, which are used to create a rich picture of their customers. This data allows them to more truly personalize their offerings and the  shopping experience.

 

We outline 3 possible methods of obtaining a takeout value per share for KR using the recent Whole Foods transaction and past supermarket transactions as guides. The scenarios indicate a $29-$34 takeout price, representing a 30-53% premium to the current price of $22.28.  Stock Price Premium Using Whole Foods As a Guide: Whole Foods was taken out at a nearly ~30% premium. This would imply a takeout price of ~$29/ share for KR (using it current stock price of $22.28), at a ~6.8x TTM EV/EBITDA. Relative P/E Multiple Turns Using Whole Foods As a Guide: Whole Foods was taken out at nearly 30x ’18 P/E at the time of announcement which was ~6x turns higher than its ~24x ’18 P/E before the announcement. Adding 6x turns to KR’s current ’18 P/E of 11.3x results in a 17.3x P/E multiple. Applying a 17.3x multiple to KR 2018 EPS estimate of $1.98 results in a ~$34 / share takeout price.  EV/EBITDA Multiple Using Precedent Supermarket Transactions As a Guide: Using the supermarket precedent transaction (see Figure 3 below) average EV/EBITDA takeout multiple of 7.4x TTM EBITDA derives a $33 takeout value.

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For the second week in the last 3, US oil rig counts rose dramatically (up 9 to 747).

The 18 rig jump is the biggest since June, to the highest level in almost 2 months, as the rebound in oil prices begins to draw out more production…

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Authored by Ryan McMaken via The Mises Institute,

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The minutes for the FOMC’s Oct/Nov meeting will be released at 2pm today, and are expected to be uneventful, just like the Fed meeting during which the central bank held rates between 1.00% and 1.25% in a unanimous vote, as expected, and where the only notable tweak was the small upgrade in the language used to describe the US economy, which is now seen to be expanding at a “solid rate” (versus “rising moderately” before), despite the disruptions caused by the recent hurricanes. This implicit upgrade prompted the market and economists to assign a virtual certainty to a December rate hike; indeed according to the CME’s FedWatch, the odds of a December rate hike are 100%.

“In recent weeks,” HSBC says, “many Fed policymakers have said that they are watching inflation closely. Even so, a number of these officials have expressed the view that they would likely be willing to support a rate hike in December.”

Still, after yesterday’s Q&A by Janet Yellen at NYU Stern, doubts have emerged, and nowhere more so than with Rafiki Capital’s Steven Englander, who cautions that today’s Minutes “are likely to point to less confidence on an inflation pickup than three hikes in the dots suggest.” He references Yellen’s comments yesterday, which “suggest that she has less confidence in the three hikes that she very likely put into her 2018 dot plot.” 

Consider Yellen’s comments yesterday indicating that she is ‘very uncertain’ about the inflation path over the next year: “My colleagues and I are very uncertain that it [weak inflation] is transitory.” If you read Evans’ and Brainard’s comments they look close to a dissent on the December hike (along with Kashkari).

By contrast, the market has been pricing in more and more 2018 hiking risk. The maroon line in the chart below shows the increase in hiking expectations in recent weeks, with investors pricing in more than 1 1/2 hikes for the first time since April.”

If Englander is right, we could have “a bit of a reckoning in the two year note yield,” which as Jeff Gundlach pointed out, has soared by 15bps in November.

2 Yr UST yield now up > 50 bp in < 3 months. “Fed behind the curve” narrative joining “flattening doesn’t matter” narrative. So predictable!

— Jeffrey Gundlach (@TruthGundlach) November 21, 2017

That said, Englander concedes that ultimately tax reform will be more important for bonds “so expect any drop in yields to be temporary” unless of course, tax reform fails.

As for equities, Englander states that while “appetite for risk may still be shaky” (one wonders just what about S&P 2,600 suggests risk appetite is shaky) “look for the somewhat dovish tone to the Minutes on inflation along with increased optimism on activity to firm up risk appetite. The long term takeaway for investors is that the Fed is shifting from tightening because it worries about an inflation pickup to opportunistic tightening to move away form the zero bound without damaging activity. This is a positive for risk appetite and expectations of the durability of the expansion.”

Actually, we disagree: the fact that financial conditions have not tightened one inch since the Fed has started hiking, shows perfectly well that the market is convinced that the moment equities suffer a selloff, the Fed will either back off hiking, or will launch QE4. That is what is positive for risk appetite, and it will be up to the Fed to disabuse the market of this assumption which will lead to the “irrational exuberance” bubble Goldman warned about yesterday.

Englander’s bottom line: “December is firmly grounded, but quite possibly with dissents, and the there is more open mind on structural disinflation than the three hikes dot plot consensus would suggest.“

So what are other banks saying? Here is a breakdown courtesy of RanSquawk:

• BARCLAYS: The only real surprise in the November FOMC statement was the upgrade of the assessment of economic activity relative to prior months. Outside of that modest alteration, the remainder of the statement was in line with our expectation. We believe there is a consensus within the committee for a third rate hike this year in December and look for the minutes to provide confirmation of this intended action. That said, we also believe there is willingness by some committee members to pause and assess where inflation trends are before signalling confidence about the appropriate policy path next year. Hence, we expect language that expresses concern about recent inflation trends and whether disinflation this year is persistent or transitory in nature.
• DB: While we do not expect anything in the minutes to dissuade market participants from assigning a high likelihood of a December rate hike, several Fed officials, including 2018 FOMC voters Bostic, Mester, and Williams have signalled an openness to rethinking the Fed’s broader operating framework. In turn, we would not be surprised to see officials beginning to discuss potentially major changes to elements of its operating framework that could include the inflation target or other related strategies such as price level targeting. Former Fed chair Bernanke has also recently weighed in on this topic, arguing in favor of temporary price level targeting if the fed funds rate hits the effective lower bound in the future. While Chair Yellen’s appearance on Tuesday evening at NYU Stern Business School is being billed as a conversation with Mervyn King, the debate around inflation targeting, which has been the mantra of most central banks for the last several decades, could be a notable feature of the discussion.
• HSBC: We do not expect any major surprises to come from the minutes of the 31 October to 1 November meeting. The policy statement released in November described economic activity as “solid”, despite the recent hurricanes. In addition, the statement noted that inflation was expected to remain below 2% in the near term but to stabilise around the 2% target over the medium term. In recent weeks, many Fed policymakers have said that they are watching inflation closely. Even so, a number of these officials have expressed the view that they would likely be willing to support a rate hike in December. The November statement had little new to say about the balance sheet normalisation programme initiated by the Fed in October. However, the minutes of the meeting are likely to show some discussion by the Fed staff and policymakers regarding how the programme is proceeding so far.
• ING: The FOMC minutes (Wed) will continue to allude to diverging views within the committee and is unlikely inspire much upside in US rates or the USD this week. Nonetheless, we expect the markets’ Fed-obsession to come to a halt in 2018 as monetary policy re-pricing opportunities look to be greater elsewhere.
• MORGAN STANLEY: The FOMC minutes are often revised nearly all the way up until the release and can be edited to stress important points. We look for the Fed to resume its gradual path of rate hikes again in December.
• RBC: FOMC Meeting Minutes (Wed): We don’t expect any significant news from the minutes of the November 1st FOMC meeting, which is fortunate because most market participants will be busy baking pumpkin pies when it is released at 2pm on Wednesday. There will be a brief discussion of the impact of the hurricanes, but the statement already indicated that the FOMC believes “the storms are unlikely to materially alter the course of the national economy over the medium term”. There is also a very slim chance that the FOMC begins to discuss the ultimate size of the Fed balance sheet (short answer: unless you know the LCR rules in the future and the relative spread between IOER and short Treasuries, you can’t know the ultimate size of the balance sheet).
• TD SECURITIES: Markets all but fully expect a Dec rate hike, with around 1.5 hikes priced for 2018. Thus we expect the market to largely look past debates around Dec in the Nov FOMC minutes as old news. The bigger question is whether they give any signal about the path for rates next year. Our base case is that there won’t be enough clarity in the discussion to suggest clear changes to the Dec dot plot.

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Via LPLResearch.com,

As we near Thanksgiving Day, investors have many things for which to be thankful; from a global bull market in equities, led partly by a strong resurgence in corporate earnings, to very few signs of a recession starting over the next 12-18 months. There are a few near-term catalysts we’re watching, but there are also many longer-term positive signs. And since we’ve already talked a lot about how 2017 has so far been one of the strongest and least volatile bull markets ever, today we’ll change gears and talk turkey!

In honor of everyone’s favorite Thanksgiving Day bird, did you know that the size of your average turkey has grown substantially over the past 50 years?

That’s right: the average turkey was 17 pounds in 1960 and was more than 30 pounds last year.

Per Ryan Detrick, Senior Market Strategist,

“Although this is purely spurious and in no way should you ever invest based on it, you have to smile when you compare the average size of turkeys in the U.S. to the S&P 500 Index.

 

Both have moved steadily higher over the decades, suggesting investors and Thanksgiving dinner lovers alike have many things to be thankful for this year.”

To everyone from the LPL Research team, have a great Thanksgiving!

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A day after China’s state-run airline closed its last remaining routes to North Korea – a decision the airline’s executives blamed on a sharp decline in business travelers due to restrictive UN Security Council sanctions – Communist Party spokespeople slammed new US sanctions targeting Chinese traders doing business with North Korean businessmen, calling them “wrong” while reminding the US that China has vigorously enforced the UN sanctions.

After announcing that the US would once again designate North Korea a state sponsor of terrorism due to its missile and nuclear tests and its trading in illegal arms with terrorist groups and unsavory governments, President Donald Trump revealed that the Treasury Department would be rolling out new sanctions over the next two weeks, the US’s latest volley in a "maximum pressure campaign" against Kim Jong-Un's regime, AFP reported.

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As had been expected, the US Treasury Department announced on Tuesday that the list of North Korean and Chinese companies targeted by existing US sanctions has been expanded. It was this decision that angered the Chinese.

Only last week, Trump returned to the US from a five-nation tour of Asia with assurances from Chinese President Xi Jinping that China, the North’s primary benefactor which is responsible for 90% of its trade, would do more to economically pressure its restive neighbor.

 

Treasury sanctions trading, labor, and shipping companies and vessels
to further isolate North Korea and disrupt illicit funding of its unlawful nuclear and ballistic missile programs. Targets include one individual, 13 entities, and 20 vessels: https://t.co/CT9hMx3d6p

— Treasury Department (@USTreasury) November 21, 2017

 

The Treasury has added to a list of 10 Chinese companies believed to be doing business with the North in violation of international sanctions.

In response, a Chinese spokesman reiterated that China rejects unilateral sanctions against its companies and North Korea, saying these issues should be worked out through the Security Council.

"We consistently oppose any country adopting unilateral sanctions based on its own domestic laws and regulations and the wrong method of exercising long-arm jurisdiction," foreign ministry spokesman Lu Kang told a regular news briefing.

The sanctions are a sign that, despite Xi’s assurances, many doubts remain about China’s efforts to contain the North’s nuclear ambitions.

The spokesman called on Washington to provide "any solid evidence" that Chinese companies have violated the UN sanctions, according to AFP.

 

He added that if any companies or individuals have violated domestic laws, "we will severely deal with that in accordance with our laws and regulations".

While China has backed the Security Council sanctions – which it easily could’ve blocked with a veto – the country has been reluctant to take the more drastic step of cutting off oil supplies through a pipeline to North Korea's lone refinery, fearing that regime collapse could lead to a flood of refugees and chaos on the China-North Korea border.

Still, US authorities believe some Chinese banks and trading firms continue to do business with the North in defiance of UN sanctions, US threats of unilateral action and warnings from the Chinese government.

Since the verbal standoff between Kim Jong Un and President Donald Trump began shortly after the latter’s inauguration, China has pressed for dialogue between the two countries, saying this week that "more should be done" to hold talks to resolve the crisis. Specifically, both Beijing and Moscow have pushed for a "dual track approach" which would see the US freeze its military drills in South Korea while North Korea would halt its weapons programs. Ultimately, the Chinese hope the US will remove its THAAD missile defense systems from South Korea, since the Chinese see the purportedly defensive systems as a potential offensive threat.

A Chinese special envoy also wrapped up a four-day trip to the North on Monday, during which the two sides discussed regional concerns but made no direct statements about the nuclear standoff.

US Treasury Secretary Steven Mnuchin said the sanctions would not only increase Pyongyang's isolation but also expose "its evasive tactics."

"These designations include companies that have engaged in trade with North Korea cumulatively worth hundreds of millions of dollars," Mnuchin said.

 

"We are also sanctioning the shipping and transportation companies, and their vessels, that facilitate North Korea's trade and its deceptive maneuvers."

In all, the new measures add one individual, 13 trading entities and 20 ships to US sanctions lists.

Any property or assets of the firms involved found to be in areas under US jurisdiction are to be frozen, and Americans are banned from trading with them. Three Chinese firms – Dandong Kehua Economy and Trade, Dandong Xianghe Trading Company and Dandong Hongda Trade – are said to have sold computers, minerals and ore to North Korea. Chinese businessman Sun Sidong and his company Dandong Dongyuan Industrial are accused of exporting vehicles, machinery, radio navigation and "items associated with nuclear reactors.” A woman who answered the phone at the company said it was not doing business with North Korea and suggested that the firm had halted its operations.

"We are not operating," she said.

Another woman at Dandong Kehua Economy and Trade denied knowing about the sanctions.

"We have temporarily suspended (trading)," she said.

In a surprise move, in addition to slapping sanctions on firms and North Korean ships, the Treasury added the Korea South-South Cooperation Corporation to its sanctions list. The firm is alleged to have sent North Korean guest workers to China, Russia, Cambodia and Poland. Foreign workers are a major source of income to the regime. Trump has repeatedly exhorted the US’s allies to expel North Korean guest workers, whose remittances provide a vital source of foreign currency to the regime.

Ironically, the stringent sanctions are being applied even as North Korea has, at least temporarily, ceased its missile tests. The North hasn’t launched a missile test since Sept. 15 – more than two months ago.

Some believe the North’s reticence is due to Chinese pressure. If this is accurate, we imagine Xi’s government might loosen its grip.
 

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