“I think it’s Best Buy, BBY for all you home gamers. It reports December 15th and I think it will deliver, yes, indeed… We went to a local Best Buy, under cover, of course, and found that…They have 47 different sets of flat panel TVs, versus 11 at Walmart. Average price, $957, cheaper than Walmart. This best buy beat Walmart on price. Hallelujah! Best Buy had great Black Friday traffic. The crowds were quote, materially bigger than last year.

I don’t think it’s expensive. With a 12.4% growth rate at this point, it’s cheaper than target and Kohl’s and JC Penny. The consumer wants gadgets. Best Buy has the devices in demand in holiday season and Best Buy has the devices in demand in holiday season.”- CNBC’s Mad Money 12/2/2009

On Wednesday night’s Mad Money, Jim Cramer reiterated his stance that this is one of the most despised bull markets in history as investors just refuse to believe in the prolonged rally of the past 9 months.  His belief in the continuing bull market relies on the consumer coming up big this season and outpace the analysts expectations.  If that is the case, there are some seriously attractive stocks in the retail sector and last night’s show revolved around two of Cramer’s favorites Amazon.com (AMZN) and Best Buy (BBY).  We will focus our attention on Best Buy in this post, as Cramer’s love for Amazon has been well documented already.

Consumers want the latest gadgets this season and they saw bigger crowds for their Black Friday deals than last year which will help them better manage their inventory coming into the holiday season.  Cell phones from the likes of Nokia (NOK) and Apple (AAPL) could very well be hot gifts again this season.  The iPhone was recently made available at Best Buy and could draw more customers into their stores.  Also, as you can see from Cramer’s quote above, he was pleased to see the selection and prices of their flat screen televisions.

In his piece last night, Cramer was advising investors to buy the stock ahead of earnings later this month because he expects the company to beat.  However, from a longer term view that we have at Ockham the stock appears to be Fairly Valued.  Among our reasons for this rating, the stock is trading right around the low end of its historically normal valuation ranges of price-to-cash earnings and price-to-sales.  We can see why Cramer is excited about this holiday season at Best Buy, but so much of that has already been reflected in the price as it has more than doubled from this point last year.  Market share gains from the collapse of Circuit City has made Best Buy more attractive as well, yet with the stock hitting a new 52-week high this morning off of the “Cramer Bounce” the valuation is not exactly pricey but it is certainly not the most attractive stock in the retail space.

As anyone who shops online is well aware, today is Cyber Monday, the day where online retailers strut their best deals in order to capture more holiday shoppers.  The days following Thanksgiving are among the most important for the retail industry as many workers have those days off.  More recently, ecommerce sites have latched onto the concept in trying to grab market share and capture the attention of workers returning to their desks still with holiday shopping in mind.  Judging by the markets first reaction to retail stocks following the important weekend, it seems that increased traffic to ecommerce web sites has trumped the mixed results from bricks-and-mortar retail outlets.

Initial reports from bricks-and-mortar retail spending over the weekend are mixed as overall spending was up about .5%, but that is compared to very rough spending from a year ago when the U.S. financial system appeared to be near a meltdown.  In general, foot traffic was up but average spending was down.  Considering the fact that many retailers have shuttered stores in the last year (Circuit City and Linens ‘N Things come to mind), you would expect the remaining stores to have more shoppers all other things being equal.  According to the National Retail Federation, 195 million shoppers sought out discounts last weekend a 13% up-tick from last year.  However, shoppers were more disciplined spenders this year, on average spending $343 down 8% from a year ago and the lowest in four years.

A mixed picture indeed, as overall spending inched up but the shopping activity was likely limited beyond deeply discounted sale items and should put pressure on retail margins. In response to the results over the weekend, in Monday trading nearly all bricks-and-mortar retailer stocks suffered on the day with Saks (SKS), Macy’s (M), GameStop (GME) and Barnes and Noble (BKS) among the worst decliners.

In contrast, ecommerce sites like Amazon.com (AMZN) and eBay (EBAY) were treated to gains in Monday’s market action.  A survey by Shop.org states that 100 million Americans will shop online on Cyber Monday versus 85 million a year ago.  Ecommerce sites often offer no cost shipping and are afforded easy marketing through emailing promotions to existing customers.  Perhaps the biggest advantage is the hassle free shopping experience.  However, this year “Cyber Monday” deals started as early as Thanksgiving Day as there was really no reason to hold back sales for Monday.  Payment processing service Paypal, owned by eBay, said that its Black Friday transactions increased 20% from last year.

Clearly, ecommerce and bricks-and-mortar stores are not always at odds as many retailers like Best Buy (BBY) and Walmart (WMT) are increasing the percentage of sales derived online.  However, it is clear that the overall trend shows shoppers are logging-on more often and hitting the malls less.  This could mean additional concerns for commercial real estate going forward.  If early holiday shopping is an indication shoppers will likely continue looking for deals and are less likely to buy on impulse.  And you can bet that more consumers than ever will do most of this from the comfort of the web.

“But while media products still account for a majority of Amazon’s sales, the company’s added dozens of new products. It’s become the online Walmart, not the online Borders… Amazingly, it is much lower than Walmart, which allows it to undercut Walmart’s prices. That’s unheard of until now. Periodically, you’ll hear Walmart slicing prices…With a retailer like Target or Walmart we can look at the number of stores they have and figure out how many more they have before they reach saturation and can’t grow anymore…” — CNBC’s Mad Money 11/23/2009

There is no doubt that Amazon’s (AMZN) stock has enjoyed an outstanding run over the last year rocketing nearly $100 from $38 to $134 in that time.  The stock’s performance has led to skepticism over valuation from many analysts and investors.  The company is an attractive growth candidate but with the P/E ratio of greater than 70x obviously there are concerns that it is just too hot.  Even when factoring the growth of the company the PEG ratio looks pretty rich at 2.73x, so it is understandable that there is a significant portion of float that  are short AMZN.

On Monday’s Mad Money, Cramer looked at the case of Amazon which he described as a misunderstood and underestimated stock.  He thinks that many of the doubters conceive Amazon to be an online version of Borders (BGP) that mainly sells books, music and movies.  Instead, as anyone who uses Amazon knows, it is more like an online Walmart (WMT) where the product selection is diverse and the prices are tough to match anywhere. 

Amazon is not limited by the same constraints as a bricks and mortar retailer like Walmart, and they can sell to anyone, anywhere as long as they have an Internet connection.  That is one reason that Cramer likes the sustainability of Amazon’s growth rate because they need not worry about saturation of actual store front.  Furthermore, e-commerce has continued to boom in the last year growing 21% in the last year, or four times the pace of traditional bricks and mortar retail.

We cannot disagree with the recent success of Amazon and the stock’s climb seems justified.  However, from a value investor’s standpoint we maintain our position that Walmart is more Undervalued than is Amazon.   Amazon receives our neutral or Fairly Valued stance because the growth, while impressive, has largely been priced in and the upside from here may be limited.  Whereas Walmart, a stock that has been range bound for years, has slowly and steadily grown in sales and cash earnings.  Earnings growth for the next two years will come in at the mid to high single digits.  This progression has made the stock by comparison more attractive from a fundamental perspective.

In the past, the market has been willing to pay about .68x to .87x revenue per share, whereas the market is currently only giving WMT .52x price-to-sales.  Similarly, the historically normal price-to-cash earnings ratio has been 13.6x to 17.7x, but it is currently only 10.2x.  This is a classic case of the tortoise and the hare; long term investors could do worse than to stick with the tortoise until the market comes around on its fundamental strength.

Barnes & Noble (BKS) reported today that their new eReader product has sold out of the entire supply for delivery before the holidays.  This may be a positive sign for Barnes & Noble in the long run as demand appears to be quite strong, but it is clear that production limitations are restricting sales this holiday season.  Yesterday, Sony (SNE) pushed back the shipping date for their Daily Edition Reader to between December 18th and January 8th.  This puts Sony’s August promise to have the Reader available for holidays in serious jeopardy.  All of this is great news for Amazon.com (AMZN) and their Kindle device, and these delays are just another reason why it is great to be the among the first products to market and letting the others play catch-up.

Amazon is ready to roll with Kindles in stock and ready for sale in the rapidly growing segment of consumer electronics.  There is no doubt that the holiday shopping season is of massive importance to a consumer electronics product, and eReaders should be some of the hottest gifts on the market.  It appears that this will be another step forward in their market leading position, and it is a lost opportunity for the competitors.  It is too early to tell if BKS’s Nook or Sony’s Reader will be the equivalent to Microsoft’s (MSFT) Zune, but extending Amazon’s lead is troubling.

The Kindle has a year head start on its primary competitors, remember it was the Kindle that sold out prior to last year’s holidays.  Sony has other models of readers available already, but the Daily Edition Reader is the closest competitor to the Kindle.  It is also a bit surprising that a seasoned electronics manufacturer like Sony would be caught off guard by supply chain and manufacturing hold ups.  For Barnes & Noble, it is much more understandable given their history as a retailer.

All the while, Amazon.com’s stock just continues to set new all-time highs which is truly amazing considering the stock was under $40 less than a year ago.  Now trading at nearly $130, we are reiterating our Fairly Valued stance on the company.  The Kindle has been a hit thus far and has the potential to dominate the digital book market the way the iPod has for digital music.  We all know how that has worked out for Apple (AAPL) in the last decade.  Not to mention, Amazon’s ecommerce site has never been hotter and should be a major destination for holiday shoppers.

“The problem with Gamestop is you need to be able to have both good hardware and software sales. Not until later next year do I expect Grand Theft Auto. We had Rock Band, Guitar Hero. Those are all played out. I can’t get behind GameStop not because they’re not a great company but because they don’t have enough good stuff to sell.” — CNBC’s Mad Money 11/17/2009

The quote above is a bearish recommendation on GameStop (GME) from Jim Cramer in Tuesday night’s Lightening Round, but we think he has missed a great opportunity.  Cramer refers to his lack of faith in both video game hardware (consoles) and software (games) sales this holiday season.  There is no doubt that the conventional wisdom of video games being resilient to recessionary spending trends has proven to be less true than most believed.

We find it a bit strange that Cramer would single out video games as the segment of retail he sees struggling this holiday season.  In the same show, he reiterated his stance that the market continues to be too pessimistic about retailers (retailers are “en fuego”) coming into the holidays and recommended buying Guess (GES), J. Crew (JCG), and The Home Depot (HD).  He may be correct that clothing retailers could start to get some traction this holiday season, as clothing is always a common gift.  But can he really think more families will buy a new appliance or flooring for the holidays? 

I know I am selling Home Depot short because there are plenty of gifts sold at The Home Depot each year, but GameStop is the quintessential gift shopping destination.  Look at the seasonality of these companies; current estimates have GameStop making 62% of profit and 40% of sales in the upcoming quarter, whereas Home Depot claims only 10% of profit and 21% of revenue.  Clearly, this time of year is the bread and butter for the gaming industry which makes logical sense.

Furthermore, the timing of this is suspect as surely Cramer heard of the unbelievable sales last week from Activision Blizzard’s (ATVI) new “Call of Duty: Modern Warfare 2″.  The game’s release blew away all previous launch sales records.  Investment blog 24/7 Wall St called the game, “the biggest launch in history across all forms of entertainment,” and the numbers back it up.  “MW2″ sold 4.7 million copies for $310 million in the U.S. and U.K. alone in the first 24 hours!  Not being an expert on the industry, I do not know what other games are expected to be a hit this season but clearly the demand has never been higher.  As far as hardware goes, makers of consoles have gotten aggressive and lowered prices recently, but these are not where GameStop makes its profits anyway.  The vast majority of margin comes from new and used game sales.

Even with the seasonality being an attractive piece of the investment thesis, perhaps the most compelling thing about GameStop is the valuation.  GameStop’s stock has taken a tough hit in the last few years with the troubles in the video game industry.  However, fundamentally the stock has held up remarkably well despite growing competition from the likes of Amazon.com (AMZN) and Walmart (WMT).  Earnings are expected to be 5% better than a year ago on sales increases of nearly 3% in fiscal 2010 (ends Jan.).  The market has historically been willing to pay between 9.2x and 20.9x cash earnings per share but the current level of price-to-cash earnings is only 7.2x.  Similarly, the market has historically given GME a multiple of .51x to 1.18x sales, and the current metric is well below that at .44x.

At Ockham, it is clear that we have an Undervalued stance on this stock, and are confused by Cramer’s recommendation on it.  He is overall so positive that retail is going to surprise to the upside, but when it comes to video games he retreats.  We believe there is substantial upside for long term investors in GME, and we could reasonably see it trading at $30 in the next year.