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Amazon (AMZN) - Expensive but Huge Growth Ahead

May 15, 2012 | About:
Federico Flom

Federico Flom

6 followers
Amazon (AMZN) shot up after first-quarter earnings came back better than expected. AMZN finished the day after earnings at $226.85, a price that is mind blowing to me. I am a very heavy user of Amazon.com and I completely buy into everything as a consumer, but this stock now has a P/E of 186!

Although I sit here and tell you that I think the stock price is insanely high, I wouldn’t be surprised if this stock continued to grow on hopes and dreams. When it comes to investing, no one wants to “miss the boat.” That is also why Facebook’s IPO will most likely be a success. It’s not about fundamentals, it’s about speculation and getting on the bandwagon.

When scanning the list of the best stocks, there is one Internet giant you should never ignore, and that is Amazon (AMZN). This stock has both strong fundamentals and a pretty price performance. Almost no one will question the profitability of the company and its leadership in the online e-commerce field. Over the past ten years, this stock has grown from $16.05 to the current $226.85, representing an increase of more than 1240%.

Last Earnings Release

Amazon released fiscal 2012 first quarter financial results, showing that net sales were $13.18 billion, an increase of 34% compared to a year ago, and exceeded the consensus estimate of $12.9 billion; net profit reached $130 million, or 28 cents per share, down 35% compared to the same period last year, and outperformed the average analyst estimate of 6 cents share.

Amazon’s pretty first-quarter financial performance played a positive role in convincing investors to believe that the effort put into transforming the company into a technology company has begun to pay off.

Following the good financial report, AMZN's stock price rose sharply by 15.75% in Friday’s regular trading, recording the biggest intraday rise since October 2009. Calculated by the increase in AMZN shares, the company’s market cap increased nearly $10 billion in one day.

In recent quarters, the company’s large sums of expenditures had negative impact on its profit; therefore, AMZN stock saw sluggish performance recently. However, Amazon’s gross margin increased 120 basis points in the fiscal 2012 first quarter, and reached the 24% expectation of the Macquarie analyst Ben Schachter.

According to the latest report released by the Internet traffic monitoring firm comScore, Amazon Kindle Fire tablet has accounted for a share of 54.4% in the U.S. Android Tablet PC market this February and occupied the first position. Compared to the data for December 2011, Kindle Fire’s market share almost doubled while the product market share of the other manufacturers is shrinking. The researchers did not explain the reason for the change, but Kindle Fire’s $199 price should be the crucial reason for the consumer's preference in Kindle Fire. Amazon’s Tablet PC is currently able to directly compete with Apple iPad.

Amazon CEO Jeff Bezos has been trying to convince investors to continue the long-term investments in Amazon, despite the fact that the company has suffered consecutive losses over the past several quarters. Bezos is trying to transform Amazon from a large online retailer into a technology service provider. Some investors strongly advocate that Amazon’s valuation is equivalent to 70 times the forward earnings. Investors believe this valuation is reasonable, because Amazon’s profit will rise substantially, as the company is expanding their business in the cloud platform service area with higher profitability and becoming an online marketplace linking the buyers and sellers from a hosting site.

Analyst Opinion

Credit Suisse’s Spencer Wang raised his rating on the shares to outperform from neutral, with a $270 price target, up from $190 previously, writing that his latest “deep dive” into the business suggests rising costs for fulfillment are not a structural change in the business but rather increased activity delivering orders for third parties.

That, suggests Wang, means the company’s own “first party” (1P) sales are maintaining basically the same 8% spending. And that, in turn, suggests upside can come as other parts of the business reach a steady state:

We believe CSOI [consolidated segment operating income] margin will stabilize in 2H12 and trend higher in FY13 driven by 1) gross margin upside from a growing mix of 3P, digital, and AWS revenue and 2) fulfillment productivity gains as new FC’s opened over the past 2 years mature As a result, we are raising our FY12 CSOI estimate by 12% to $1.7 billion and our longer term forecasts as well, and believe that our projections are above consensus. Notwithstanding the changing business mix and shifting gross vs. operating margin dynamics, for us, it comes down to profit dollars. If our analysis is correct, we estimate that AMZN’s CSOI will rise from $1.7 billion in 2012 to $3.2 billion and $4.5 billion in 2013 and 2014, respectively.

The stock has been a “stronger performer” this year, he notes — it is up 33%. But it could be “just the beginning of an extended run” he thinks. He takes as significant the company’s share buyback in the first quarter given how rarely Amazon repurchases its stock.

As for valuation, Wang relies on a discounted cash flow model, instead of P/E or price-to-sales.

“We like DCF as it captures our long run expectations for profitability and returns an intrinsic value estimate (as opposed to the somewhat arbitrary nature of relative multiples)."

Conclusion

Amazon has two big themes that I think will make it grow in the future.

In the recent past business platforms got a bad name – they were associated with lock-in. The new business platform is something else. It powers both Amazon and Apple’s success. In the case of Amazon the platform consists of the rules and facilities that organize and manage the commerce engine, its reviewer database and community, the apps community, the Amazon marketplace, the vendors who sell through Amazon, digital rights management, and the writing community that self-publishes to Amazon, as well as its reluctant publishing partners, as well, of course, as its cloud capability.

Like Apple, its platform is closely linked to a device (in this case the Kindle), and is tied into a system that does good digital rights management. For writers the platform is by no means seamless. There are plenty of glitches along the way to getting a book perfectly published on Amazon. But writers are tolerant of that. Amazon is an enabling platform, just like Apple’s App Store. It enables writers and booksellers. It enables people who want to sell to Amazon’s community.

Another essential component is the Amazon ecosystem, made up of merchants, writers, reviewers, publishers, apps developers and the information market of commentators, analysts, journalists and feature writers who get the word out about opportunity on the Amazon platform. Bezos is not as great as Jobs at playing the information market but he is good.

The Amazon ecosystem is made up of tens of thousands of companies whose futures rest on Amazon making the right calls, on Bezos being good. Its main characteristics? All these people need to develop their own capabilities in order to succeed on the Amazon platform. To participate you need to be capable of growing and adapting, and of course competing – all the while putting your trust in Amazon’s ability to make the right moves.

Amazon, as the leader in global online shopping, has most to win as overall e-commerce growth surges. As the Prime membership base expands and current members funnel more household purchasing towards Amazon, sales will accelerate and the profits will follow – Prime provides an accelerant to Amazon's revenues. As Amazon morphs into a media company (Kindle, digital downloads, streaming service, original content) and can deliver more products, which do not incur shipping fees, profit margins should widen and long-term shareholders will greatly benefit. The key here will be whether Amazon can grow their media business faster than the growth of their low-margin core business – time will tell.

Rating: 2.8/5 (13 votes)

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