CIO WM Research 24 October 2014

US equitiese-Commerce: beyond Amazon - anupdate

• Explosive growth in e-Commerce continues to alter theconsumer landscape and omni-channel companies will lead theway.

• An omni-channel retailer is one that is completely agnostic tohow, where and when a consumer shops or interacts with abrand.

• Long-term positive drivers of digital growth, including the rapidadoption of mobile devices, will hasten market share-shiftsonline.

• Near-term catalysts include the potential for an improvingconsumer environment in 2H14 and easier comparisons.

"Over the last month or so I've heard many traditional brick-and-mortar retailers attributed the downturn in their core business duringthe holidays to factors such as a shortened holiday shopping season, aweakened consumer, the U.S. government shutdown & poor weather.Respectfully, those explanations ignore a larger fundamental truthand that truth is that traditional brick-and-mortar retailing is atan inflection point. No longer are many retailers only required tocompete with stores on the other side of the street. They are nowrequired to compete with stores on the other side of the country."

- Howard Schultz, Starbucks Chairman, President & CEOJanuary 2014

e-Commerce thesis still on trackA year ago we published a report arguing that opportunitiesaround the e-Commerce theme extend beyond just owning pure-playonline shopping or e-Commerce companies like Amazon. US-basedcompanies in consumer-focused industries such as retail, apparel,consumer packaged goods and restaurants will benefit as they takean omni-channel approach to their business and more consumers

Robert Samuels, Sector Strategist, UBS FSrobert.samuels@ubs.com, +1 212 713 2825

Sally Dessloch, Sector Strategist, UBS FSsally.dessloch@ubs.com, +1 212 713 9667

George Lambertson, Sector Strategist, UBS FSgeorge.lambertson@ubs.com, +1 212 713 9035

Dean Ungar, CFA, Sector Strategist, UBS FSdean.ungar@ubs.com, +1 212 713 3751

13

Websites

Smartphone

Physical Store

Kiosks

TabletsGaming Consoles

Computers

Big DataFulfillment

Payments e-CommerceEnablers

Source: UBS CIO WMR

Source: UBS CIO WMR

A version of this report is available withspecific security recommendations for USonshore investors. For a copy, please consultyour UBS Financial Advisor.

This report has been prepared by UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosuresthat begin on page 4.

shift their shopping and spending on-line. In addition, firms areusing digital marketing strategies to complement their on-line efforts,including social media, search, and big data, to name a few. Com-panies that facilitate e-Commerce transactions, from IT providers tothe payment of goods, should also be beneficiaries of the e-Com-merce theme. Since our initial report, the pace of change continuesto accelerate as companies undertake omni-channel investments andthis theme remains on track. All of the arguments that we laid out inour original report (8 August 2013, e-Commerce: Beyond Amazon)are still valid today. Longer-term, rapid adoption of mobile devicessuch as smartphones and tablets, combined with the convenienceand selection on the Internet, will hasten market share-shifts online.The digital shift has continued to gather speed with the transition tomobile happening even faster than expected.

Relative performance has been challengingWhile absolute performance of our stock basket has been positive,relative performance has been more difficult. We attribute this largelyto the poor performance YTD of the consumer discretionary sector,which has lagged the S&P 500 this year. Remember, e-Commercestill represents a small percentage of overall sales for most con-sumer-related companies. And, although digital sales continue togrow at a strong double-digit pace almost across our universe, thesecompanies have not been immune to investor dislike of the sector asa result of challenging weather and a highly promotional retail envi-ronment. That said, we view this as a longer-term theme and our con-viction level has not wavered at all.

What is omni-channel . . . a refresherThere is no bigger buzz-word among retailers today than omni-channel. You hear it in conversations with management teams andon almost every quarterly conference call. So what does it actuallymean? Essentially, a true omni-channel retailer is one that is com-pletely agnostic to how, where and when a consumer shops orinteracts with their brand. The goal of omni-channel retailing is thata retailer’s stores become an extension of the supply chain, in whichpurchases may be made in the store, but are researched throughvarious methods. At an omni-channel retailer, all purchase channelsare effortlessly connected providing a convenient and seamless way toshop. Pricing is typically consistent across all channels and purchasesmade online can easily be returned in store, and vice-versa.

Food retailing on-line creating "buzz"One of the retail formats that has generated the most excitementsince our August 2013 work is food and staples retailing. In ourinaugural report, we wrote that food retailers had been relativelyimmune to the move to omni-channel, given that on-line grocerysales were estimated to be a very low percentage of total grocery pur-chases. Skinny food retailer margins, combined with the cost of homedelivery, have long been viewed as impediments to more widespreadadoption of on-line grocery retailing. However, we also noted thatAmazon was testing its AmazonFresh concept in several cities on theWest Coast.

Fast forward to today, and there is increased "buzz" about thepotential for growth in on-line grocery retailing. AmazonFresh con-tinues to be offered to Amazon Prime members in Seattle, San Fran-cisco, Los Angeles and San Diego, but the big news is that it has

When including mobile, e-Commerce growth farexceeds offline retail growth

-10%

-5%

0%

5%

10%

15%

20%

25%

2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14

YOY Digital Commerce Sales Growth YOY Retail Sales Growth

Source: comScore e-Commerce/m-commerce Mea-surement, U.S. Census Bureau

AmazonFresh Comes to Brooklyn

Source: UBS CIO WMR

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CIO WM Research 24 October 2014 2

quietly arrived on the East Coast. On 17 October, AmazonFreshbecame available in select neighborhoods in Brooklyn, NY, shortlyafter several AmazonFresh trucks had been spotted in our colleague'sneighborhood. It seems reasonable to assume that Fresh is destinedto roll out to more markets in the not-too-distant future.

To review, AmazonFresh is offered on a 90-day trial basis to existingAmazon Prime members, with the promise of free same-day deliveryfor orders over USD 35 (if the order is placed by the prescribed cut-off time). The annual cost of the enhanced AmazonFresh membershipis USD 299, and it provides all of the benefits of an Amazon Primeaccount combined with the perks of Fresh, including access to tradi-tional food retail goods as well as products from local restaurants andspecialty purveyors.

We continue to think that Amazon is attracted to this conceptbecause of the high frequency of grocery trips by most consumers;more regular visits to the Fresh site may well spark more frequent pur-chases of higher-margin non-grocery items. We believe the Amazon-Fresh model is best suited to densely populated urban areas, whereit may be able to achieve scale given the fixed investments necessary.That said, we believe that Amazon is willing to invest over the long-term, and may accept lower margins as it builds out the program.

Beyond AmazonFreshIn addition to AmazonFresh, the e-Commerce behemoth is growingincreasingly active in selling consumer packaged goods. Oneprogram, Amazon Subscribe and Save, allows members to enroll inan automatic replenishment program for a wide variety of consumerproducts; subscribers receive a discount and free shipping, plus addi-tional savings if they sign up to receive five or more subscriptionson the same monthly delivery day. And it recently launched AmazonPantry, also targeting consumer packaged goods. Pantry is for theexclusive use of Amazon Prime members; for a flat delivery fee, theycan order a variety of products in a single shipment box designed tohold up to 45 lbs of product or four cubic feet in volume. We believea number of CPG manufacturers are working with Amazon to makefulfillment of these types of orders more efficient. We find it inter-esting that both Coca-Cola and PepsiCo recently selected Amazon forthe exclusive launch of several new beverages: Coke's Surge relaunchsold out quickly and Pepsi True has just begun taking orders.

Investment considerationsWe recommend investing in this theme through select companies,across multiple industries, that are exposed e-Commerce. Ourselection process includes our best ideas in retail, restaurants, con-sumer staples, technology and financial services, was first publishedin our 8 August 2013 report. In developing our recommended list,we have sought to identify companies that are omni-channel leaderswith a growing percentage of sales coming from e-Commerce.

See the full version of this report for security specific recommenda-tions.

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Appendix

Terms and AbbreviationsTerm / Abbreviation Description / Definition Term / Abbreviation Description / Definition1H, 2H, etc. or 1H11,2H11, etc.

First half, second half, etc. or first half 2011,second half 2011, etc.

A actual i.e. 2010A

COM Common shares E expected i.e. 2011Ep.a. Per annum (per year) Shares o/s Shares outstandingUP Underperform: The stock is expected to

underperform the sector benchmarkCIO UBS WM Chief Investment Office

YTD Year-to-date

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