Amazon’s Rufus Sales Tactics

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Have you Rufussed, Alexis? I guess let's start there. Have you paid your first visit to Rufuss?

Who is Rufuss? Like Rufuss and Chaka Khan?

No, no. Rufuss is the, the shopping bot. It's Amazon's shopping You are an Amazon shopper, right?

Sometimes, yes.

Okay, so you can ask Rufus questions. You haven't done it yet?

I haven't. Have you?

I just did it for my first time. I asked, what does my wife want for Christmas? And I'm not sure if Rufus knows who my wife is or knows anything about her shopping history. Maybe not, because he asked me a couple of questions about her interests and her personality and about my budget. And I said, I don't want to answer any of that stuff. Just give me ideas. And then Rufus had a list of stuff and there were skin cream and candles. There was cheap jewelry and expensive pajamas. There were these aromatherapy shower pods. I'm still not quite clear on how they work. And there was like a kind of a pillow that does heated shiatsu massage.

Was any of that accurate?

I don't know, but it doesn't sound like the worst. I mean, if I, if I went this route, I don't think it would be the worst I've ever done. In terms of gift selection, and Rufus will gift bag them and have them at my door in less than a day. So I'm keeping it in mind. By the way, this is the Barron Streetwise Podcast. I'm Jack Howe. With me, our audio producer Alexis Moore. I'm reading about Rufus everywhere and all the shopping bots. There's a Walmart rolled a new one out this year called Sparky. I don't want to misgender a large language model, but I'm referring to Rufus as a he because the name comes from a company dog. That was a male— what do you call those ones that when they walk, they're like, their rear end really wiggles a lot?

A corgi.

Corgi. Yeah, corgi. The male corgi that joined the company back in 1996. So Rufus to me feels like a he. Sparky, I think, is an it because Sparky sounds like it might be named for a company dog, but it comes from that Walmart logo, the spark. That's only on the app, on the Walmart app. I downloaded it just to ask Sparky what my wife wants for Christmas, and it said cheap jewelry and a soapy kind of gift box that had Rudolph socks in it. I'm not, I'm not sure. And then I asked ChatGPT, and ChatGPT gave me the whole long sermon about how I can be a better listener and how I should, quote, consider her love language. I'm using ChatGPT if I want to save on marriage coaching, but for the shopping, I think I'm leaning Rufus this year. But we'll see, we got plenty of time. I wrote a little bit about Amazon in this week's column in Barron's Magazine. This podcast episode is going to be— what's a nice way we say rerun?

Encore?

An encore presentation of a previous— boo! I know. Someone wrote me once and said, you're not a TV show. Why do you have to do reruns? It's a good question. I don't know. I mean, we could— I guess the alternative is doing nothing, or you do a rerun, but you put a spiel on the top of it like we're doing here about Amazon. And I'll make my comments here brief. Probably not, but let's see. I just want to point out that I'm pretty sure that Amazon has already won the Christmas shopping season. Let me tell you why. There's a list of things the company's done just recently. It shortened its fastest delivery option in some cities to 3 hours. What if you don't live in a big city? Well, the number of rural communities that can now get same-day or one-day Amazon shipments That number has jumped by 60% in just 4 months. JP Morgan does a yearly survey of gift items around this time of year. It finds that Amazon has a much larger assortment than Walmart or Target, and that those two stores are about 10% and 11% more expensive than Amazon, respectively. There's a separate story from an outfit called Profiteero. It's a retail performance tracker. It finds that Amazon comes in 14% cheaper than the online competition. So the merch is priced to move and the shipping is the fastest it has ever been. And that puts the holiday sales outlook for retail and e-commerce and Amazon at what I'll call good, better, and best. Retail as a whole could grow 3 to 4% during the Christmas time season. That's according to a scattering of estimates, MasterCard, Bain, the National Retail Federation, and others. And JPMorgan predicts that the e-commerce subset of retail, that'll increase almost twice as fast by 7%. And that will take e-commerce's share of retail to 24.8%, almost 25%. That's up about half a point from last year. Now Amazon already controls 46% of e-commerce, but that figure is going to rise. JPMorgan expects Amazon's retail revenue to grow 9.2% during the fourth quarter. But the most eye-catching thing for Amazon right now is not how much it's selling, it's how much it's buying. And this, I think, can give investors some insight into the stock. Take Target, for example. We're gonna hear more about Target in a moment from an episode we did this past summer that talks about some of the troubles that chain is having. Target is playing from behind in e-commerce., and it's trying to stop a 5-year 45% stock decline. It will spend an estimated $4 billion this year on what's called capital expenditures. Examples of that for Target include store remodelings, new warehouses, sorting centers, automation. After that spending, the company doesn't have a lot of financial firepower left without turning to borrowing. Its free cash flow, that's operating cash flow minus the CapEx we just spoke about, That's pegged at $2.5 billion this year. Okay, so Target is a $4 billion spender. Walmart, of course, is in a different league than Target. It's also a lot further ahead in e-commerce. Earlier this year, Walmart said it just turned its first online profit. Its CapEx is estimated at $24.3 billion this year, and that'll leave $15 billion in free cash flow. That's more than double what Walmart was spending 5 years ago. Now Amazon. As recently as 2019, Amazon was spending only a little more than Walmart on CapEx, but now it's spending 5 times as much, an estimated $124 billion this year. That'll leave $21 billion in free cash flow. So for people who think I'm being lazy by asking Rufus to handle my holiday shopping, Just know I'm leveraging the full might of all that spending. That's a 12-digit act of affection on my part. Alexis, you're not applauding.

It's okay.

Yeah, I mean, I think we can revisit the love languages thing, maybe.

You're on team love language. I'm not sure. I don't really— I have to look into how that works. Now, all this money that Amazon is spending, it's not nearly all on retail. The big push right now is artificial intelligence. And there is a lively investor debate ongoing about whether companies are spending too much on AI., but not in Amazon's case. Its Amazon Web Services business has a long record of turning big data center investments into lucrative cloud computing revenue. It's done this before. And now a part of that business called AWS Bedrock, that's a platform for building AI tools, and you can choose among hundreds of models like Claude from Anthropic or Llama from Meta Platforms. AWS Bedrock has more business than it can handle. Last quarter, Amazon reported that AI demand sent its AWS revenue 20% higher, and that was the unit's fastest growth in 3 years. And management promised lavish CapEx and shares jumped 10% in a day. So Amazon has a green light on spending right now. And in the past, its cloud computing investments came with pretty big side benefits. Like, for example, it kept its Prime Video streaming service cheap enough to be able to offer it as a freebie for Amazon Prime shoppers. Today, the video business is solidly profitable. It's got a big live sports lineup and it's part of an advertising empire that brought in revenue of $17.6 billion last quarter. That was up 22%. Okay, so that's an example of how cloud computing spending paid off in the past. Spending on AI for hire infrastructure today could do the same thing. There's no end of ways that Amazon can use AI for itself. Rufus, for example, has been used by more than 250 million customers this year. It's tracking toward $10 billion in annualized sales. Apparently Rufus users are 60% more likely than others to buy. Beyond Rufus, Amazon's AI can help sellers make their pitches more presentable, Shoppers can use it to skim highlights of customer reviews. You can use your phone's camera now to see a handwritten shopping list. You could just point it at an object and say, find me one of these. Amazon gives the example of a stain on a carpet. You could just point your camera at it and say, show me what I need to clean this stain. It's kind of a weird example. I wonder if it does Whopper grease on jeans from a New Jersey service station 3 weeks ago. Probably more specific than I have to be. Amazon supply chain workers use AI to predict demand surges and stock goods closer to buyers. This year, Amazon deployed its millionth robot. Wasn't there an Avengers movie about that? Forget it. And it treated the whole fleet to a new data model that improved travel time by 10%. And then there's the advertising. AI can improve the success rate on ads, And there's plenty of spare surface area for Amazon to use for sponsorships, including those Rufus chats. So where does that leave us? Investors should look at what is likely to happen to Amazon's free cash flow over the next few years. There are only a handful of analysts who have ventured estimates out that far. The lowest says $55 billion in 2028. The highest says $157 billion. That's a huge difference, and that kind of high uncertainty is typically not comforting. But in this case, it comes from not knowing how long these high returns for colossal CapEx will last. While we have them, Amazon should spend all that it can, and when returns shrink, so will the CapEx, and what will be left are Amazonian levels of free cash flow. And that is enough to make Amazon with a stock market value of $2.5 trillion. Look reasonably priced. I think it's going to be dominating Christmas sales for many years to come. I can't nearly say the same thing about Target, of course. I am not a shopper. I'm just a buyer. I don't take particular delight in the hunt. I just like to get it done. So I don't really go to Target or get the appeal. I might not be the best person to speak about what Target is struggling with right now. Fortunately, Sabrina Escobar at Barron's is a Target expert. And I spoke with her this past summer about what the company needs to do differently. I also spoke with Seth Sigmund, who covers Target for Barclays. Let's get to that conversation right after this quick break.

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Does Target have a chatbot?

It looks like, it looks like they're testing one currently, but nothing fully.

Right now they got a short guy in a cardboard box wrapped in tinfoil at the door to take your questions.

That hurts my feelings as a person who is shorter.

Yeah, it doesn't, it didn't have to be short. That's a good point. Let's get to Target and what it needs to do differently with Sabrina from Barron's and Seth from Barclays. For the benefit of someone who doesn't really know or think about the difference between Target and anyone else, give me the lay of the land. What is it that has historically made Target different from the types of stores that are adjacent to it? And also, what is the magic formula that had the stock doing so well for so long?

You know, you mentioned the word historically, and I think that's important in this context because historically you thought of Target as a higher-end retailer. You know, it is still big box. It is still within the realm of— I don't want to say discount, but you could go and you could get a really good price for something that felt a little bit special. The stores were really aesthetically pleasing. You know, you would grab a Starbucks when you walked in and then you browse the aisles. For many people, it was almost like a an escape, you know, it was their break. And that was an experience that really differentiated it from the rest of retailers. You go to Target, you walk in trying to buy, I don't know, milk, and you walk out spending $200 on random things like beauty or home decor. And it really did attract a lot of these higher-income consumers. In the past kind of 3, 4 years, Target has lost a bit of that sparkle, of that enthusiasm, of kind of the thing that made it Target as opposed to just Target. And they're trying to get it back. And trying is the key word here.

Are these things that you think that Target did wrong or that competitors did right or a combination, or have customer tastes just shifted? What's going on?

There's a lot going on. You know, I think it's a combination of, one, the macro, right? I think you can't really discount the fact that a lot of Target's problems started in 2022 when you did have a lot of supply chain issues that all retailers were struggling with. But Target had a particularly troubling kind of issue with inventory management and then inflation, because when prices are so high, people are looking for that cheaper price that perhaps Walmart or Amazon can offer that Target wasn't really offering. So the macro didn't help. And then the company has had a lot of missteps, I think, in terms of managing that macro and trying to differentiate itself from competitors. I don't know if you've been into a New York City Target, but a lot of things are behind, you know, theft devices and, and it's tough.

I've definitely noticed that more if I go in for one thing from like a Walmart, you get these ordinary items that they're locked behind these plastic cabinets and it's super annoying. And I guess if you're going into Walmart and you're just trying to get the lowest possible price, maybe you put up with it. But if you're going into Target and you're looking for what you're talking about, this greater shopping experience, I could see how that would be annoying.

That's exactly it. 'Cause you're right, that trend is pretty broad across many retailers, but with Target it is about the experience. And the other thing is a lot of Target's purchases are tied to that impulse buy, right? And if you have to wait for somebody to unlock it, then the impulse is gone. You're like, wait a second, actually, I, I don't need to buy this.

I also feel like maybe I wouldn't wanna have a whole discussion with the store staff, like, uh, Hey, we got a guy over here wants to buy Underarm deodorant from behind the locked case. He must be a stinker who needs some deodorant over here. Bring the keys. I mean, I don't want a whole scene.

Yes. And the other thing with the experience at Target is that they're, I don't know, struggling to adapt to the e-commerce of it all. Walmart and Amazon, they have massive distribution centers and of course they have a much bigger scale. These are huge retailers and you know, Target is a fraction of their sales, but it's really hard for Target to compete with the scale of Walmart and Amazon in e-commerce. And the way that they've built their e-commerce model, some analysts say, will make it really hard for the company to continue scaling and continue to compete. And it also is having some repercussions on the in-store experience.

That's interesting to me. When I read your story, you might have even described it as a catch-22, like Target has to go down this road of investing more in e-commerce. It has to, but it's enormously expensive and the others are so far ahead and how can it possibly catch up? And by the way, the others that have done this job already for years, Walmart and Amazon and, and all these, they took a hit to their margins while they were spending all this money and now they're starting to bear the fruit of all those investments, whereas Target is maybe at beginning, at the precipice of having to go through this period where it's going to hurt profit margins. And investors are, you know, they want it both ways. They want Target to catch up on e-commerce, but they don't want anything that's going to cause a further hit to margins. Does that describe the situation?

Pretty much. And like you mentioned, so these other big guys, the way that they built up their e-commerce was, like I said, they have really big distribution centers. A lot of it is automated now. Target, the way that it handles its e-commerce, most online orders are fulfilled in stores, right? So that means that store associates are kind of running around the store trying to fulfill these online orders. And there are pros to Target's approach. It's capital light. It didn't take such a big hit to margins when it did expand, and it has helped. Like, I think about 20% of Target sales are e-commerce, and Walmart's, for instance, are a bit below that. So they have been able to grow their overall market share in e-commerce. But like I said, this analyst I spoke to was like, I don't know what the future structural gains of this are. There's no quick fix to, to kind of make this grow and improve it because what what we do see is that as store associates are trying to fulfill these online orders, they're getting pulled in 5,000 different directions. The store experience, like I said, takes a hit. You know, now shelves aren't stocked because there was no time to restock them. Walmart and Amazon both use in-store fulfillment like Target does in things like grocery, but it's not their entire business model when it comes to e-commerce. And Target has gone all in on the in-store fulfillment, so they might have to diversify. But like you said, it's expensive.

Thank you, Sabrina. Okay, so we heard from Sabrina at Barron's about Target. A few weeks after her story ran, Seth Sigmund, a Barclays analyst, published a report on Target that caught my eye, and that report was titled, Alexis, Slipping Away: Is This Fixable? Right, just what we need to know. Is this fixable? So I reached out to Seth to hear more about that. Let's listen to part of that conversation.

Target has really accomplished a lot in recent years, but something today feels like it's lacking. And so the real question here is, can they get back on track? If we go back, there was definitely a tough spot here in 2016, 2017. Stock was around $50. There was a lot of negativity back then. You had a lot of online disruption, but they made some changes and they made some really tough decisions, and it was not favorable at the time. Stock went down on that, but they emerged from that period and did quite well in 2018, 2019. They capitalized on the investments that they were making. They capitalized on a lot of other competitors that were struggling at the time, and the stock ended 2019 around $130. If you look at 2020, 2021, that outperformance accelerated. Stock doubled during that time period, during the pandemic, to over $260, and they were really one of the biggest beneficiaries during that period. The concern today is that it's slipping away again. Stock is just under $100. It kind of feels like this is one of the few companies that did well during the pandemic that may not be better positioned post-pandemic. And the valuation here today at 13 times earnings is now towards the lower end of the retail sector. And the market is saying something, right? That something is wrong. Something's not going well here. So we and investors are trying to figure out and piece it all together. What's been changing? And why has that performance lagged?

So is this something that Target is doing wrong in your opinion, or is this a way that the market has just changed unfavorably for Target? Is it a mix of the two?

Look, at the core here, the issue is sales, right? It's the sales underperformance versus other companies. So, you know, this past quarter, their same-store sales were down 4% when the dollar stores were positive. Walmart was up mid-single digits. The warehouse clubs are growing in the mid to high single digits. More recently, it looks like it's been a traffic issue. Over time, it's been a spend per customer issue as well. And it's kind of hard to know, is that consumer just not spending as much or are they going to other stores?

Right.

But in general, it is a sales issue and the profitability will follow that over time. I think that's part of it. I also feel like there is a perception that there are cheaper prices elsewhere, whether that's Walmart or the dollar stores. I don't think it's coincidental that The dollar stores just had one of their best quarters in years.

Target sells a higher mix of discretionary items, stuff that you might want but you don't need, whereas Walmart sells a higher mix of needs. So if you have to, you know, tighten the budget a little bit, you might be less inclined to buy those items at Target. Is that correct? And does that play into this?

Yeah, I think that's right. So those discretionary categories are around 50% of Target's business. And they've done a good job of expanding more into consumable categories over time. Grocery, household products, beauty. Those have been great success stories for this company. But at the end of the day, their business is still heavily driven by discretionary, and that is still one of the main reasons why the consumer goes to these stores. Now they get the benefit when the consumer's in there, but they gotta get 'em in the store.

One thing you point out in your report— and I hadn't thought about this— that there was a period where we had a lot of retail bankruptcies. And so maybe around 2018, 2019, some of these stores would close and Target would pick up some of the traffic. And I guess we're not seeing as many of those bankruptcies now.

Is that right? If you go back to this window prior to the pandemic, it was a time when online was growing significantly. Amazon was starting to really disrupt a lot of retail categories. And so it led to a lot of different retail bankruptcies during that time period, clothing stores, department stores, and Target was a better, more modern version of that channel. And so they were a winner during that time period. They were also a great alternative when there were some big specialty players like Toys R Us that closed. Target was the destination and it was an obvious one for consumers. There have been fewer competitor store closings to date. But even with those that have closed, it's unclear whether Target is taking as much as they did in the past. So you had Party City go away. That was $2 billion of business. That seems like it's right in their wheelhouse. You had arts and crafts companies like Joann struggle and The Container Store closed. And those are all businesses that should be central to the core customer for Target. So those are a few billion dollars up for grabs. And so we continue to monitor some of the things that Target may be doing with their assortment. And the store experience to try to capitalize on these opportunities.

Let me ask you a couple of specific things that I've heard, and you can tell me whether they're having a big impact or not. I have not followed this carefully, so I don't know every detail about this, but there was a backlash about Target and its stance on DEI issues. And, you know, folks on both sides have come to take issue with the company because it had a stance and then it moved the other way and so forth. So I always wonder when I hear about this, is it affecting business? What do you see? Has that had an impact or is it difficult to say?

This topic comes up a lot and it's a very visible issue, right? Because you can see a lot of this on social media. I think it could be one of the issues. I'm not sure it's the main issue, but earlier this year, like a lot of other companies, Target scaled back certain diversity, equity, and inclusion programs, and it did seem to have an adverse impact on sales in the first quarter. The company mentioned it on the conference call, but they didn't actually quantify it. Look, if you just look at Google Trends for Target boycotts, it shows a pretty big spike this year. Actually similar to what you saw in 2023, and then it comes down. It did seem to get more impacted than other companies, and I wonder if part of that is Target actually talks about being a very emotional brand. The question is, if there has been an impact, we certainly saw it in Q1, does it linger ahead or can they get that customer back?

Has Target fallen like hopelessly behind Amazon and Walmart in terms of scale of their investments in, you know, online order fulfillment and logistics and so forth? Or does it maybe not have to be at the same level as them?

What do you think? I'm not sure it's a level of investment issue. Look, there's always competition, but a lot has changed in the last couple of years. Amazon is just much faster today with same day and next day. And yes, Target can compete against that because they have stores that are convenient in local markets. But look, Target did a lot better when those Amazon shipping times were much longer, and that's changed a lot over the last 2 years. Walmart is always going to be the lowest price, but they can also now offer faster delivery as well. Their same-day option is really gaining traction and they're delivering to a much wider radius. And so they're sort of breaking down that proximity issue they may have had in the past. They're also investing a lot in their own assortment. If you knew Walmart historically as just the place to get low prices, increasingly consumers are finding a better assortment, brands that they didn't see there in the past, and they've added hundreds of millions of SKUs to their assortment online. And so you've seen both of these companies evolve. It's not to say that Target can't compete as well, but they have to figure out where do they fit within that. At the end of the day, their business historically has been really driven by product, having product that's trendy and fashionable and at a good price, that's really where they've been able to differentiate historically.

Now for the question shareholders are waiting for, and I will read it right from the top of your report: is this fixable? And I'll point out that you have an equal weight rating, a neutral type of rating on the stock, and that you lowered your earnings estimates recently, if I have that right. But what do you think based on your sort of deep look at the company here, is it fixable? And is there any low-hanging fruit? Is there anything that can be done in short order to get shares going again?

I would say that retail investors always love a good turnaround. Okay, just within this space, Dollar General and Five Below last year, those stocks had rerated significantly on some challenges that they were facing last year. And look at how they've rallied this year, right? They were trading at the low end of retail We were concerned about the future of those businesses. They really cracked and they've recovered since then. And so there's an opportunity here. We have an equal weight on the stock. We are concerned about the current direction of the business and a lot of the, the issues that we talked about at this level. We do think it is pricing in a lot of negativity already. There's optionality for change as we've seen before, and we balance that in that equal weighting. We in general see a very wide range of scenarios. For this company. We do see a scenario where there's still downside from here. Multiple can still go lower. There's still risk to earnings if they can't get sales back to positive. If it's as simple as some of the basic merchandising fixes we talked about earlier, the macro getting better, you could see a return to positive comps and there could be meaningful upside to the earnings in that situation.

Yeah, you write here one of the widest range of scenarios in our groups. So if you're buying the stock here and Target gets it right, you could do very well in the stock, or you could do quite poorly if things continue to slip away for the company. It's hard to know. I guess that's a high risk, high reward is how you might characterize that stock.

Is that right?

Yeah, that's right. By the way, just so I know, under your coverage, you have a name or two that stand out that you've written about that are your favorite names under your coverage right now?

I mean, the name we've highlighted is Walmart, right? Walmart's gaining significant share in grocery. They're going to be better positioned to manage through the tariff environment that we're in. They're increasing their share within discretionary categories. They've always been big in those categories, but something is changing in terms of the momentum that they may have there leveraging the marketplace as well. And then there's growth in their alternative businesses. It's really changing the shape of their P&L and it's giving them an ability to invest back in the business in a way that most other companies can't.

P&L meaning profit and loss, meaning they're making good money on advertising and marketing and doing these other things.

That's exactly right. It's helping the profitability of this business and it gives them an opportunity to invest back in the business. But what shareholders like is they're also giving you better earnings growth than they've done historically.

Thank you, Sabrina and Seth. Thank you, Rufus. Thank you, Sparky. Thank you, ChatGPT. I'm gonna work on my love language. And thank you all for listening. Alexis Moore is our producer. If you have a question, the word on the street is there's a listener question special coming up. Your question could be part of it. You should— how does it go, Alexis? You got to record on the voice memo app on your phone and then send it in to us, jack.hough@barons.com.

Yes, we may play it.

We'd love to hear it. We may play it. The implication there being we may not.

Brace yourself for disappointment or joy, excitement.

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