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Making picks as pandemic accelerates an online transition

admin | August 21, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

As retail earnings continue to roll in, the overarching theme remains the robust online growth fueled by stay-at-home orders. While online shopping is not new, the broad adoption of digital buying across all generations fueled by the pandemic is accelerating the transition away from brick-and-mortar. Target, Home Depot and EBay have all seen windfall digital sales growth. Strong liquidity, a commitment to a high ‘BBB’ rating and forward guidance help make EBay a particularly good value.

Target (TGT – A2/A/A-) witnessed digital comparable sales growth of 195% in the most recent quarter, which accounted for over 55% TGT’s total comparable sales growth of 24.3% in 2Q20, its strongest quarter of growth on record. Additionally, Home Depot (HD – A2/A/A) witnessed digital sales growth of 100% in the quarter, with 60% of those customers choosing to buy online or pick up in store, which helps the gross margin by saving on shipping costs. The accelerated digital shift bodes well for names like EBAY (Baa1/BBB+/BBB+), which witnessed a 5% increase in active buyers in 2Q20, producing gross merchandise volume growth of 29% (ex fx). EBAY’s total organic revenues were up 22% year-over-year in the quarter comparing favorably to similarly rated retailers such as ORLY (Baa1/BBB), which witnessed comparable store growth of 16.2%. From a margin and credit profile standpoint, EBAY stacks up favorably to ORLY with EBITDA margins nearly 800 bp higher and net adjusted leverage a turn lower (0.9x versus 1.9x).

Exhibit 1. Retail 7yr-10yr Curve (A to BBB)

Source: Bloomberg TRACE; APS

Cash is king

EBAY’s balance sheet benefits from its sizeable cash and equivalents position, which stood at $5.8 billion at the end of 2Q. Additionally, EBAY maintains an untapped $2 billion revolver, which lends to the company’s overall liquidity position. EBAY has historically kept a large cash position on its balance sheet with the average cash position over the last five years totaling $6.5 billion. Management noted on its last earnings call that a strong cash position helps to preserve its financial flexibility, which enables the company to execute on its strategies and help drive long-term value creation. Looking out, EBAY looks to target a cash balance of $3.5 billion. Even its long-term cash target of $3.5 billion compares favorably to its retail peers. While ORLY currently has $872 million of cash on hand, its average cash balance over the last five years has been closer to $75 million. Additionally, EBAY generates very strong free cash flow which totaled $2.95 billion on a LTM basis, translating to a 27.5% free cash flow-to-sales ratio. ORLY, which has witnessed solid free cash flow growth over the past 12 months, still has a free cash flow-to-sales ratio that is 10% below EBAY’s.

Committed to high BBB ratings

Management highlighted that its capital allocation strategy remains unchanged, which is based upon its commitment to maintaining its current high ‘BBB’ ratings. That said, EBAY continues to target net leverage of 1.5x while gross leverage is expected to remain below 3.0x. Currently EBAY stands at 0.9x and 2.5x, respectively, on both those leverage targets. We expect management to remain balanced with respect to debt reduction and shareholder rewards. While EBAY currently has $3.2 billion of share repurchase authorization remaining, its demonstrated its balanced approach to the balance sheet in 2Q having repaid $830 million of debt while spending $145 million on dividends and repurchases. EBAY’s most recent taps of its 5-year and 10-year notes ($750 million in total) was used to execute a make whole call of its 2021 debt maturity. EBAY now has nothing maturing until 2022.

Full-year guidance raised

With many peers still reluctant to provide full year guidance given little transparency (ORLY included), EBAY not only has provided full-year guidance but recently raised it given the strength witnessed in 1H20. Revenue guidance was raised to the $10.56 billion to $10.75 billion range representing an organic growth range (ex fx) of 12% to 14%, which is up from its previous range of 1% to 3%. Full-year operating margin is now expected to be in the 30.5% to 31.5% range, which is 50 bp higher from previous guidance. Free cash flow guidance was increased to the $2.55 billion to $2.7 billion range, up from $2.1 billion to $2.3 billion. Management expects to conduct $4.5 billion of share repurchases for the year, of which $4.0 billion have been executed already.

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