Top 2 E-commerce Stock Picks

E-commerce stocks are facing a tough economic environment as consumers pull back on spending. But growth should continue as big players take market share from brick-and-mortar retailers. That gives investors an opportunity to put money into attractively priced online consumer retail stocks.

“Much has changed in the retail landscape over the past four years, but one thing has remained constant. The shift from brick-and-mortar to online is set to resume its inexorable march as consumers emerge from the tough times,” says Morningstar senior equity analyst Sean Dunlop. “Investors would do well to stock up on high-quality names that are trading at deep discounts.”

Dunlop points to two stocks as his top picks in this group:

Allegro ALLEG
Chewing CHWY

“In the long term, e-commerce’s position as a low-cost channel should drive sustained market share gains. As fulfillment costs fall with route density and utilization rates, we expect the channel to be cost-competitive for a wider range of lower-priced, higher-turnover items,” says Dunlop. “Even after adjusting for fulfillment costs, the average online marketplace operator in our footprint is about twice as profitable as the average brick-and-mortar player, driven by large footprints and employee productivity,” he explains.

Dunlop also highlights four other companies:

Amazon AMZN
Ebay Ebay
Etsy Etsy
MercadoLibre MELI

Retail Equity Landscape Post Covid

U.S. e-commerce sales surged during the global COVID-19 lockdown, increasing 42.7% between 2019 and 2020. That pace has slowed significantly, with growth of just 7.4% between 2022 and 2023. While the outlook for the coming year is challenging, Dunlop predicts the industry will see a gradual increase in growth over the next few years, rising to 10.3% in 2028 from 5.5% this year.

He said the outlook “reflects gloomy expectations for consumer spending in the near term, with higher interest rates and recovering savings rates acting as significant headwinds.”

Revenue growth in the U.S. industry will slow over the next five years, averaging 7.8% per year, down from 18% annual growth over the past five years. That’s still 3.9 times faster than projected brick-and-mortar retail spending numbers, Dunlop says.

By 2028, nearly 20% of U.S. retail sales will come from online sources, up from 15% to 16% today. “We don’t see a plateau in the near future, and the online retail model in terms of headcount and space seems to be cheaper to run (on average) than brick-and-mortar stores,” Dunlop explains. At the same time, “the largest online marketplace operators in our coverage area are expected to see their download rates grow by almost 2.4 points cumulatively over the next five years as they expand into ancillary services such as advertising, financial services, and logistics.”

More than half of that growth, 53%, will be driven by advertising. Dunlop expects Amazon, MercadoLibre and Allegro to emerge as “clear winners” from these trends, “with high customer frequency and high share of online spend, solidifying their positions as key partners in their markets. We continue to see Etsy, eBay and Chewy as likely beneficiaries as well, although lower gross merchandise sales per user and lower regional market share make them tier two partners in the broader retail ecosystem.”

Top e-commerce stocks

“Our key takeaway is that in an industry that naturally favors winner-take-all, or at least winner-take-most, dynamics, investors should be cautious about directing capital to companies that dominate their niche and benefit from persistent, self-reinforcing network effects in the marketplace,” Dunlop says.

“Investors would do well to invest in e-commerce platform winners like Amazon, MercadoLibre, Etsy and Allegro, at attractive prices, with winner-take-most competition suggesting that their competitive position is growing year over year,” he says. It’s worth being more cautious about “companies that have yet to consolidate market share and operate without a proven economic model, like The RealReal REAL,” which are at risk of depreciation.

Ultimately, Dunlop believes that the second-tier players could become irrelevant, especially given their positions in smaller vertical markets that may not have to stand alone. “E-commerce investors should invest in a small group of winners and avoid everyone else like the plague, or at least wait until their competitive position becomes more secure.”

Below are excerpts from commentary on Dunlop’s recommended e-commerce stocks.

Allegro

Estimated fair value quantitative: $6.70
Morningstar Quantitative Rating: 3 stars
Quantitative economic moat: wide
Morningstar Quantitative Uncertainty Rating: High

“We see significant growth from Allegro’s BNPL lending partnerships and under-penetrated retail media network, which we believe is undervalued. Strong regional markets have been able to defend their territory to date, and we see no structural impediments to Allegro advertising expanding beyond 3% of GMV, from just 1.8% today.”

—Sean Dunlop

Chewing

Estimated Fair Value: $29.00
Morningstar Rating: 3 stars
Economic moat: narrow
Morningstar Uncertainty Rating: Very High

“Chewy seems like an attractive long-term investment because the pet food, retail and online healthcare markets are split between Chewy, Amazon and, to a much lesser extent, Walmart WMT.”

—Sean Dunlop

Amazon.com

Estimated Fair Value: $193.00
Morningstar Rating: 3 stars
Economic moat: wide
Morningstar Uncertainty Rating: High

“It’s no coincidence that Amazon generates head-over-heels better monetization per user, reflecting its large global customer base, the high frequency and volume of purchases by those customers, and the proximity of transactions, and the company scores exceptionally well across all four dimensions of effective marketing platforms: automation, identification, shoppability, and attribution.”

—Dan Romanoff, Senior Equity Research Analyst

eBay

Estimated Fair Value: $54.00
Morningstar Rating: 3 stars
Economic moat: narrow
Morningstar Uncertainty Rating: High

“We view eBay’s strategic framework positively. After divesting a number of non-core segments, its marketplace looks similar to the dynamic platform of the early 2000s, when the company focused on its core competency of price discovery for seasonal, non-novelty items. After unsuccessful forays into fulfillment services and low-value customer segments, the company prioritized its core “focus categories,” expanding into authentication services, tuck-in acquisitions, and vertical investments that are driving healthy growth in eBay’s most distinctive assortment. These categories now account for 30% of eBay’s gross merchandise volume, or GMV, and disproportionately serve the 16 million high-value “enthusiastic” buyers who spend more than $3,000 annually on the marketplace.”

—Sean Dunlop

Etsy

Estimated Fair Value: $100.00
Morningstar Rating: 4 stars
Economic moat: wide
Morningstar Uncertainty Rating: Very High

“Etsy has carved out an interesting competitive niche for itself, competing for e-commerce wallet share across a variety of heterogeneous verticals in the long tail of unbranded products. The company’s marketplace properties—Etsy, Reverb, and Depop—all target non-commoditized inventory, generate commissions on third-party peer-to-peer sales, and seek to create a “treasure hunt” experience around a unique, customizable, and consequently less price-elastic set of products. The company’s primary marketplace, “Etsy,” accounts for about 90% of consolidated gross merchandise volume.”

—Sean Dunlop

MercadoLibre

Estimated Fair Value: $1,500.00
Morningstar Rating: 3 stars
Economic moat: wide
Morningstar Uncertainty Rating: High

MercadoLibre is a local market winner in Latin America. “The net effects of Mercado Pago’s solid, multi-pronged growth are increased penetration of the formal financial system, with some of the strongest annual e-commerce growth rates in the world across the company’s Latin American operations, and growing market share in its trading business, with more than a third of regional online trade volumes now being transacted through MercadoLibre’s trading platform, up 5 percentage points since 2019.”

—Sean Dunlop