Amazon Vs. Retail ETFs: Not So Easy

Holiday shopping season is upon us, and this year, it's hard not to be captivated by the slow-motion apocalypse happening in the retail sector. Already in 2017, 35 large retailers have filed for bankruptcy, while some 6,800 brick-and-mortar stores have closed. And the year isn't over.

Amid this industry earthquake, only two retail ETFs have notched gains: the $140 million Amplify Online Retail (IBUY) and the $53 million VanEck Vectors Retail ETF (RTH), which have risen 36.8% and 11.1% over the past 12 months, respectively.

All other retail ETFs have lost money. With a 2.6% decline, the liquidity-weighted $1 million First Trust Nasdaq Retail ETF (FTXD) has dropped the least, followed by the multifactor $14 million PowerShares Dynamic Retail Portfolio (PMR), at a 6.3% fall.

The largest fund in the space, the $523 million SPDR S&P Retail ETF (XRT), fell 9.5%, while the greatest underperformer was the $35 million Direxion Daily Retail Bull 3x Shares (RETL), a leveraged fund that tracks the same index as XRT, and which plunged 35.4%.

E-commerce Tail Winds

For the two retail ETFs that actually made money in 2017, e-commerce was key. RTH has a sizable weighting in Amazon (18.6%), whose stock price has risen 50% year-to-date, and a meteoric 400% over the past five years (see: “Big Differences In 3 Biggest Retail ETFs.”)

IBUY, meanwhile, holds only a small weighting in Amazon (3.5%), but e-commerce is the lifeblood of the fund; IBUY tracks a basket of e-commerce companies that make 70% or more of their revenues online.

Performancewise, however, no retail ETF can beat just directly investing in Amazon.

Amazon At The Heart Of Change

Over a one-year period, Amazon outperformed all retail ETFs by double digits. In fact, the stock creamed RETL by a whopping 89%:

Source: Bloomberg.com

Once you factor in the costs of investing in ETFs—annual expense ratios, spreads, tracking error, trading commissions (none of these ETFs listed trade commission-free—the diversified retail exposure these ETFs offer seems less like a smart and sensible approach and more like tossing your money on a bonfire. Even IBUY leaves 17% on the table, just by including in its basket 39 other stocks that aren't named Amazon.

Numbers like these might lead some investors to conclude they should just ditch the ETF wrapper for Amazon stock. Yet that would be a big mistake, because in this case, Amazon's outperformance is a red herring.

Tech Firm In Retailer's Clothing

For starters, Amazon isn't a pure-play retailer. Though everyone knows Amazon for its online marketplace, the company's real growth driver, at least according to its Q3 earnings report, is its cloud computing division, Amazon Web Services (AWS).

AWS, by far the dominant player in the cloud computing space, is the company's most profitable division, and it finances the investments Amazon makes in other, less profitable, business lines—such as its signature e-commerce division.

Amazon's other major nonretail-oriented business lines include Amazon Video and Twitch, both video streaming services; Amazon Studios, a television and movie production company; and Alexa, a voice-enabled digital assistant. Amazon even owns a series of wind farms across the U.S. Amazon is a tech company—or maybe a conglomerate—in retailer's clothing.

Although Amazon's retail operations remain its largest division, they aren't nearly as profitable as AWS; in fact, operating profits fell last quarter across the company's core businesses, including its online marketplace, such that Amazon's total operating margin was just 0.8%.

Other retailers don't have a cloud computing division to boost their revenues and pad their margins. Their poor margins are out in the open for all to see.

E-Commerce Not A Threat

But what about the fact that e-commerce is growing? Doesn't that pose a threat to traditional retailing, especially during the holiday season?

It's true that the annual Black Friday buying binge has increasingly become a digital stampede rather than a physical one. Data show shoppers spent a record $5.03 billion online this Black Friday, a 16.9% year-over-year rise, and the largest amount of Black Friday digital dollars spent on yet. Foot traffic in brick-and-mortar stores, meanwhile, declined an estimated 4-6%.

And where are those online shoppers going? Amazon. According to a study by Slice Intelligence, Amazon alone accounted for 43% of all online sales last year, and drove more than half (53%) of all growth in e-commerce.

Initial estimates suggest Amazon, by itself, could account for as much as 44% of 2017's holiday shopping dollars. It's no wonder many retailers think of Amazon as one of the four Horsemen of the Apocalypse (see: "These 4 Stocks Are Breaking The Market.”)

That said, however, holiday shopping represents only 30% of retailers' total annual revenues, and in the grand scheme of things, Black Friday purchases, whether made online or in store, are a drop in the bucket: Last year, shoppers dropped roughly $656 billion over the six-week holiday shopping season. Compared to that, $5 billion spent in one day online barely registers.

Furthermore, e-commerce still represents less than 10% of all retail sales, according to statistics from the Census Bureau of the U.S. Department of Commerce. Online sales on a percentage basis are rising, but on average, more than 90 cents of every dollar is still spent in a physical brick-and-mortar store.

Retailers are struggling right now, not because online stores are treading on their turf, but because they overexpanded their brick-and-mortar presence and took on billions of dollars in highly leveraged debt that's now come due.

Dwindling disposable income from the middle class consumer—retail's most reliable customer base—just isn't enough to support poor business practices any longer. If anything, the rise of deep-discount e-shopping is a symptom of the retail apocalypse, not its cause.

ProShares Retail Doomsday Play

On Nov. 14, ProShares rolled out two ETFs specifically designed to capitalize on the brick-and-mortar doomsday: the ProShares Decline of the Retail Store ETF (EMTY) and the ProShares Long Online/Short Stores ETF (CLIX).

EMTY provides equally weighted, inverse exposure to retailers with significant brick-and-mortar presence, including department stores, supermarkets, clothing stores, consumer electronics and home improvement stores.

CLIX takes the idea one step further, offering 100% long exposure to online/nontraditional retailers and a 50% short exposure to traditional retailers with brick-and-mortar stores.

The two funds, which both carry expense ratios of 0.65%, are the first to attempt to explicitly capture retail's brick-and-mortar collapse. But it remains to be seen whether CLIX or EMTY can achieve the same lofty gains as Amazon—or at least fare better than other retail ETFs.

It may come back to this: Everybody buys online, but they don't buy everything online. Not even close. And as long as that remains true, ETFs that proclaim the death of brick-and-mortar are putting the horseman before the cart.

Contact Lara Crigger at [email protected]