‘Amazon Effect’ on Retail Margins Not Over, Morgan Stanley Says

(Bloomberg) -- Hardline retailers are in for continued margin pain following the prevailing third-quarter theme of “profitless growth,” according to Morgan Stanley.

“The margin damage isn’t done” for companies like Lowe’s Cos., Target Corp., Best Buy Co., Williams-Sonoma Inc. and BJ’s Wholesale Club Holdings, wrote analyst Simeon Gutman in a note. Third-quarter Ebit dollars fell for four of the five companies, he said.

The key threat to margins is the need for traditional brick and mortar retailers to step up their e-commerce game. And many have responded, resulting in an online mix shift, or ‘The Amazon Effect,’ as it’s becoming known. While Best Buy and some other retailers are “further along in transformation journeys than others, it still feels as if the ‘all clear’ is at least a couple of years away,” according to Gutman.

The margin structure of the e-commerce business is highly dilutive for most of these companies. While sales in the digital channel are certainly gaining traction, the profit flow through continues to be poor. Meanwhile, “the intensely promotional” fourth quarter likely won’t help, and the cost of doing business “should only rise again in 2019,” the analyst said.

Gutman cut his price targets on equal-weight rated Best Buy, Williams-Sonoma and BJ’s Wholesale, as well as on underweight-rated Target. He maintained his target on Lowe’s, which is rated overweight.

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