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Beyond Google: 3 Internet stocks ready to rise
If the search engine's stellar launch has you thinking back to dot-com glory, consider Overstock.com, Stamps.com and 1-800-Flowers.com. They have strong growth prospects and stocks poised to move.
By Michael Brush
Google and eBay grabbed the attention with their earnings reports last week, but Internet stock investors might fare better by looking to three second-tier players -- Overstock.com, Stamps.com and 1-800-Flowers.com.
It's easy to make the case that Overstock.com (OSTK, news, msgs) will be a $100 stock in two years, and Stamps.com (STMP, news, msgs) could leap 20% at any moment in the next few months, says Jason Schrotberger, a portfolio manager at Turner Investment Partners, which owns these stocks. The case for 1-800-Flowers.com (FLWS, news, msgs) could be a little trickier. But if things go well on the acquisition front and you wait for the right price, its share gains could be nearly as impressive.
All three of these second-tier Internet plays should benefit from a major trend: Big increases in online buying. The heaviest use of the Internet is by young people, and as they mature and make a living it stands to reason they are going to use the Internet much more than their parents did, says Ken Smith, who manages the Munder NetNet (MNNAX) fund. There is still a lot of growth, maybe mid-teens growth. And in an economy growing at single digits, that is pretty big.
Heres a closer look at these companies.
Overstock.com
Its common in New York City's tourist areas to see signs plastered on store windows that scream: Closeout sale! Everything must go by the end of the month! Six months later you see the exact same sign in the same store, and the same people behind the counter.
But at Overstock, its the real deal. Lots of low-priced clearance items, all the time -- and price guarantees to make sure you get the best deal. The site is one of the best places to find rock-bottom prices on anything from consumer electronics to clothing.
While youre at the site, dont be surprised if a dialogue box from a customer service rep pops up. Customer service is one reason the site gets high marks by users, a critical factor in online retailing.
Last week, Overstock announced it attracted 500,000 new customers in the most-recent quarter and sales leapt by 79%. The company also creamed the consensus earnings estimate. Analysts more than doubled 2005 estimates to the 60-cent-per-share range. And they lifted nearly doubled estimates for 2006 to the $1.90 range. All this drove its stock up 20% and into new territory, settling in around $52 last week.
Despite these gains, Overstock still looks relatively cheap, says Schrotberger, who helps manage the Turner Small Cap Growth Fund (TSCEX), up 13.5% on an annualized basis since inception in 1993. While Overstock carries a price-to-sales ratio of 1.2, Amazon weighs at 1.8. Schrotberger expects two more years of 60% to 100% growth, which could push annual earnings up into the $3 range by 2007. Put a forward price-to-earnings ratio of 35 on that, which isnt egregious for a high-growth Internet retailer, and you have a $100 stock in two years.
A quick look inside the market for closeout goods supports the case for Overstock. Annual sales reach $60 billion per year, and Overstock has only a fraction of that. More importantly, excess inventory is more than just a bunch of junk.
It all starts with the fact that large retailers have the power over manufacturers these days, says Jason Avilio, who covers Overstock for First Albany Capital. They can cut order sizes at the last minute, cancel orders in mid-production, return unsold merchandise or refuse delivery on goods that arrive late.
Sometimes manufacturers just make mistakes in estimating demand and consumer preferences change rapidly, leaving retailers with excess inventory. Thanks to problems like these, a creature in the retail world know as the jobber constantly hunts around to pick up goods on the cheap, reselling them to discount stores.
Overstock.com has an edge over discounters like TJX Cos.' (TJX, news, msgs) TJ Maxx and Tuesday Morning (TUES, news, msgs) because it can display more merchandise. Its also more convenient for shoppers to hunt for deals online. The jobbers are warming up to Overstock.com, too. At this point we have become so well known that everyone comes to us, says Patrick Byrne, Overstock.com's chairman and CEO.
Overstock.com recently started an auction site, another potential source of growth in the coming years.
Stamps.com
Stamps.com offers an Internet-based service that helps small businesses print their own stamps and packaging labels. As part of the package, you get access to software that helps cull bogus addresses from mailing lists used for marketing, or that guides you through the U.S. Postal Service rate maze.
Stamps.com recently put through a sharp price increase, hiking monthly subscription fees by around 200% to $16. But given the convenience of the service, dont be surprised if it is still a hit at small businesses, a market ignored by private mail metering giant Pitney Bowes (PBI, news, msgs). The cheapest service Pitney offers costs about $75 per month.
CEO Kenneth McBride says Stamps.com has about 338,000 small business and home office customers now, a sliver of the market.
Stamps.com also has a moat of sorts around its business. Potential competitors would have to spend years going through regulatory hurdles at the post office.
Heres the wild card for investors: A personalized stamp service that got a flurry of media attention, including a spot on "Live with Regis and Kelly" when it was tested for two months last summer. The service lets you upload personal pictures to Stamps.com for approval to print them on stamps. Stamps.com charged $16.99 per sheet of 20 stamps, or 85 cents for a 37-cent stamp. The price drops the more you order.
Despite the hefty markup, the service was a big hit. Consumers loved putting their own images on stamps used on wedding invitations and holiday greeting cards. Stamps.com, however, took a licking in the experiment when a Web site known as thesmokinggun.com slipped through images of "Unabomber" Ted Kaczynski, who used the postal service to deliver his homemade bombs; Jimmy Hoffa; and New Jersey Gov. James McGreevey with his purported gay lover Golan Cipel.
This was an embarrassment for the Postal Service, and theres little doubt that hand-wringing over how to prevent further pranks like these is holding up final approval of personalized stamps. Likewise, it doesnt take a genius to figure out that the post office will find a way to go forward given the income potential, says Schrotberger.
Schrotberger estimates the core Stamps.com business is worth $12 to $13 per share, about the stock's current price. But heres the kicker. Owning shares also positions you to profit from Postal Service approval of personalized stamps, expected by year end. If they do it, the stock will gap up 20% that day, says Schrotberger.
Its not hard to see why. During the two-month experiment, Stamps.com sold 2.6 million personalized stamps for $2.3 million. Thats around 25% of current quarterly revenue of $10.7 million. In short, a single decision by the post office has the potential to kick up revenue by 30% or more.
The company has a strong balance sheet, with $3.60 per share in cash. And insiders were recently snapping up shares. Since August, Kevin Douglas, a director, has bought 277,500 shares worth $3.3 million between $10.71 and $14, adding to an already large position. And directors Mohan Ananca and Bradford Jones bought $120,000 worth for around $10 to $11 each.
1-800-Flowers.com
The concept here is simple. If you want to send flowers or a food basket to someone who lives in another city, just go to the Web site. But growing this business in a way that rewards investors has been more of a challenge.
The company knows it needs to buy other companies, cut costs and run more products through its online channel. Part of the strategy is to buy brands that are attractive and centralize the functions, the order processing, the information technology, all the back office stuff, says finance chief William Shea.
But 1-800-Flowers.com has a mixed record. Its done a great job with the Popcorn Factory, a specialty food retailer that was doing $30 million in annual sales and losing money when 1-800-Flowers bought it in 2002. The division now is profitable on $41 million in annual sales.
But it has had trouble with Plow & Hearth, a home dcor and garden merchandise retailer it picked up a few years back. Its growth was weak in the most recent quarter.
The question is what is really going on. Are they losing share? Has the market matured that much? says Smith at Munder, which holds the company's shares. Going into the holiday season, 1-800-Flowers.com has tweaked the Plow & Hearth catalog and stepped up advertising, which could do the trick. But Smith suggests waiting for the stock to fall near $7 before buying because of these concerns.
1-800-Flowers.com has plenty of firepower to support its acquisition strategy. Its low inventory allows it to produce a lot of free cash flow. And the company has about $110 million on hand, or $2 per share. The company is confident it can increase sales by 8% to 10% in the coming 12 months, which will translate into earnings growth of 30% or more, thanks in part to acquisitions and cost cutting.
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