Weekly Small Cap Market Review: June 12 – June 16
By Mark Spatt, CFA, Investment Analyst at Cornerstone Investment Partners, sub-advisor of the AdvisorShares Cornerstone Small Cap ETF (NYSE Arca: SCAP)
I suppose the only news that mattered last week was the acquisition of a certain grocery store specializing in overpriced kale (“Kale”) by the biggest online retailer of, well, everything (“Prime”) for $13.7 billion (including debt). I’ve seen some funny tweets in response:1
Jeff Bezos: “Alexa, buy me something from Kale.”
Alexa: “Sure, Jeff. Buying Kale now.”
“Prime buys Kale for $13.7bn, roughly equivalent to 11 shopping bags of their organic berries.”
What’s unique about this deal is both the madness of it and the genius of it. The madness is simple: the largest deal in Prime’s history is based on a business model Prime was specifically created to disrupt, Kale’ growth is a shell (pardon the pun) of what it once was now that it’s not the only game in town, and grocery stores trade at less than a fifth of Prime’s current multiple.2
The genius is less simple, but not less compelling. For around 3% of its enterprise value, Prime gets access to over 450 urban and suburban distribution centers much closer to customers, access to deeper purchasing data on an affluent customer base, access to grocery supplier relationships to fill out its own offerings, and access to a pre-built laboratory to test retail innovations such as automated checkout3. Prime and Kale combined now share around 2.5% of the US grocery market, which seems small, but it makes them the sixth biggest grocer in the United States4. Valuation is more of a debate, but it bought Kale for 25% less than the price at which it was trading only two years ago, when it had nearly the same EBITDA.5
I don’t know whether this means Kale will start to cut price and run its operation more like the rest of Prime’s retail business, leveraging the footprint to service the mothership, or whether Prime will increase store efficiency to improve the business and drive margins upwards. I don’t know whether shopping habits will materially change, particularly outside of the wealthy urban demographic that shops at Kale. This may be a huge folly, after all. But what I do know is that the rest of the grocery space, and investors behind it, are certainly scared, for the next 800 pound gorilla (remember, a certain mega-sized mass retailer’s market share of US grocery increased from 7% to 25% in the last 15 years6) has just walked into their camp and sat down.
It’s an indicator that for even the largest businesses, and particularly for smaller ones, the competitive environment can change quickly, and companies need to respond just as quickly.
The small cap market, as defined by the Russell 2000 Index, was down 1.0% overall during the week. Small-cap stocks were negatively impacted by both macroeconomic and microeconomic factors, with Fed releasing its plan to shrink its balance sheet, and commodity inventories weighing on energy stocks. Telecommunications Services (+1.5%), Utilities (+0.5%), and Real Estate (+0.4%) were the strongest sectors in the Index, likely as a bond proxy in response to a flatter curve, even as the Federal Reserve raised short-term rates. Energy (-4.6%, as oil prices declined on a lower US inventory draw), Materials (-3.3%, driven by industrial-linked companies), and Consumer Staples (-3.1%, with food-related companies the drivers in response to the major grocery acquisition) were the weakest. Overall, small caps underperformed large caps as the Russell 2000 Index returned around 110 basis points less than the Russell 1000 Index (up 0.1%). Among small caps, growth outperformed value by 45 basis points, as Health Care’s strength and Energy’s weakness offset bond proxies.
The information, statements, views, and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.