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E-tailers May Be Bottoming Out

It's a sector desperate for good news, or at least news that will be interpreted positively by Wall Street.

Now e-tailers and their investors are hoping that Pets.com's (IPET) recent surge after picking up a "buy" rating from Merrill Lynch and other investment banks signals a turnaround for many stocks in the sector.

Pets.com had a weak debut on Feb. 11, offering at $11 per share and finishing the day at the same price. From there it was downhill to as low as 5 7/8 before it rebounded Thursday, gaining more than 25 percent to trade at 8 11/16 by mid-afternoon.

Normally, a "buy" rating is not treated as a ringing endorsement, but for e-tailer investors, any kind of enthusiasm is a dramatic turnabout. Since last fall, when e-tail stocks stalled even as online holiday traffic and sales exceeded forecasts, the sector has been in a downward spiral.

In the past three months, 10 e-tail stocks have lost more than 50 percent of their value through Wednesday's trading. They are:
eToys -74%
CyberShop.com -73%
E-Stamp -66%
VitaminShoppe.com -65%
barnesandnoble.com -58%
Value America -58%
SmarterKids.com -57%
Emusic.com -57%
drugstore.com -56%

Most of the market's lack of support for e-tail stocks is based on concerns about sustainable business models. Selling below cost to build market share will only work for a handful of companies, even in the short run, but low (and even negative) margins are routine among e-tailers pitched in fierce and expensive combat for online customers.

Add to that the heavy spending required to build "brand" awareness -- seen as indispensable to capturing market share -- and you have a recipe for huge losses.

A recipe Pets.com knows well. The company posted a net loss of $61.8 million against $5.8 million in revenues. A new distribution center that opened this week in Indianapolis will greatly reduce shipping costs and soon lead to positive gross margins, according to CEO Julie Wainwright.

There was a time not long ago when enough investors accepted on faith that heavy losses could be recouped once an e-tailer established itself as the leader in its respective market, and that strong branding virtually guaranteed eventual profits.

A look at the above list of companies indicates that those days are over. (At least for now; things can change fast in the world of Internet stocks.) eToys (ETYS), E-Stamp (ESTM), barnesandnoble.com (BNBN), drugstore.com (DSCM) -- these are supposed to be strong brands, yet shares are plummeting.

There is some evidence that the e-tail sector may be bottoming out. In the past three months, only four of the 40 e-tail stocks listed in internet.com's Internet StockTracker newsletter have gained in value. They are SciQuest.com (SQST), up 73 percent; ebookers.com