Is Overstock.com turning into a laggard?

By John Manning – john.manning@internationalbanker.com

Consumer behavior over the last 20 years has undergone a paradigm shift. The bricks and mortar structure has been replaced by online platforms that not only offer a wide range of products but also at extremely competitive, usually lower, prices. As a result, we are observing a transition from the physical markets to the virtual markets. Riding on this wave Overstock.com (OSTK) has carved a niche for itself in spite of its unsteady financial results. Overstock has seen losses in two of the last five years. The online shopping front has also been a hub for stiff competition in recent times; there are established brands in nearly every product segment that Overstock.com has to offer consumers, for instance, Amazon.com (AMZN) has carved out the books market and Overstock.com is still stuck playing second fiddle to it.

Plagued With High Operating Expenses

In spite of the fierce competition, Overstock.com has been able to maintain a substantial growth in its sales level. Unfortunately for the company, operating cost have been eating into its margins over the course of the last five years (refer Table 1).

What we can conclude from the table is that, even though the expenditure on SG&A (Selling, General and Administrative Expenses) has transformed into higher sales; the fact is that this cost has eroded most of the net income implying a widened cost-benefit ratio. The expenses have in fact overlapped the expected outcome. Overstock.com has competed with big shot players like Amazon and eBay (EBAY) and, therefore, the need to promote itself has been the ultimate aim, a significant share of the SG&A expenditure is allocated towards search engine promotion channels. This enables the company to be visible in the Internet space, generating higher revenues from its product catalogue.

Fortunately, for Overstock.com the burden of high operating costs has been simultaneously influencing its peers too. 

Overstock.com’s Q3 Result Fails to Impress Investors

The share price of Overstock.com plunged as soon as its Q3 results were declared in October 2013. Though the results portrayed a marked improvement from the quarter a year earlier, analysts firmly believe that the earnings amiss were primarily responsible for this retraction. Taking a look at the recent performance, the plunging share prices could be attributed to the earnings miss as the stock inches towards the $30 mark in order to reinstate its original share price.

The recent quarter observed a revenue rise to $301.4 million from $255.4 million, thus, an 18% increase; 16% of this growth was attributed to the increase in average order size while 2% of this growth came from the increase in the number of orders. Selling and marketing expense were higher by 51% on account of the change in search engine algorithm of Google that resulted in a lower ranking for Overstock.com and, consequently, the company had to invest more in this platform to increase its visibility. However, net income rose by 31% from $2.7 million to $3.5 million. A significant improvement in contribution was a distinct feature of this quarter as the margin increased rapidly by 16%.

The Big Players

It is believed Overstock.com good recent run could be impacted negatively at any time by its bigger competitors. Overstock.com continues to be overshadowed by the volumes generated by players like Amazon and eBay. These companies have also attained the position of dominant market leaders in other countries across the globe and their marketing ability and brand value across the Internet is certainly recognizable. Though P/E for Amazon is considerably higher than that of the industry average of 31.20, the reality is that it has been an eminent market leader that has made investors believe that it is a much safer option for long-term investment. P/E for Overstock.com, on the other hand, is only 26.49, clearly suggesting that it is highly undervalued. It is, thus, imperative to consider this as a lucrative investment opportunity, investors are skeptical of the revenue generation capabilities of the company in the future owing to intense competition in the prevailing e-commerce industry. The emergence of debutants and the regulatory environment in this sector will also be a key driver in the future, as small and medium sized players will find it as an even more challenging situation to survive in this competitive landscape.

Optimism on the Bourses

While investors may have been bearish after the Q3 reports, there has been an upswing of late. It would be quite unfair to say that Overstock.com did not perform up-to-the-mark in this quarter. The expectations of investors might be considered to be overly-optimistic and the reaction to the results as unjustified and unrealistic. However, the upturn is a clear indication of the re-balancing that is certainly taking place of late.

Fig: Movement in the share price of Overstock.com in the past year

Since May, the stock has attained a resistance level close to $23 and it is expected to retain this position in the coming year. What needs to be acknowledged is the fact that the stock has every chance of breaching its 52-week high of $35.60 as long as the operations continue to deliver steady profits. In the short run, there is a high probability that the price could touch $30. The biggest threat for investors would come from the competitors; both existing and new, and investors should be on a constant vigil for any new developments in this front.

Short Term Value For Money

For those owning shares of Overstock.com, it would be a good idea to look for appreciation in price in the short term. Profits can be booked once the share price touches the range of $30 to $35. Unless the company is able to beat the over optimistic estimates, the share price of the company should be likely to maintain itself in the range mentioned earlier. Long term returns would be difficult to estimate considering the volatility displayed by the company in terms of earnings. The risk-return profile of this stock is quite restricted and, therefore, those with a bigger appetite for risk will not be keen on this company.