Is Amazon Still Amazing?

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One of the main talking points on Wall Street these days is retail giant Amazon’s high valuations. Keeping in mind the saying “Invest into ideas and not stocks”, this article explains the rationale behind investing into Amazon’s future ideas and focuses on its growth over the years, declining profitability in the recent past, challenges and the opportunities lying ahead. It also provides a brief competitor analysis in the current scenario and concludes with a recommendation on the stockin the short and long term.

Amazon.Com (NASDAQ:AMZN) is a global company and the world’s largest online retailer. It has its own product, the immensely popular Kindle series e-book readers and isone of the pioneers to provide cloud computing services.

High Growth, Less Profitability

Amazon has been consistently registering impressive growth over the years with annual sales of $60 billion in 2012. From getting listed on NASDAQ at $18 per share in 1997, the stock has come a long way to $260 at present.On Jan 29, 2013 Amazon.com announced its latest financial results. The revenue of this Seattle based e-commerce company jumped 35% from a year earlier, but the profit dipped 57%. Net income for the quarter stands at $97 million, or $0.21 per share. Despite its weak earnings, the shares on the day of the results rallied by close to 9%, reaching $284.20. There was a rise of 38% in operating expenses year on year. This was indeed a surprise to the investors as the revenue growth was not commensurate with the increase in spending during the holiday quarter.

Amazon has consistently outperformed the NASDAQ Technology Index (NDXT) from the last 3 months but has been declining after the last quarterly results. Return on equity of the stock is -0.49%due to negative annual earnings.

Mr Jeff Bezos, CEO of Amazon had an explanation to this phenomenon. According to him the success of a retail chain company is in its free cash flow and not earnings. The primary reason for the decline in profitability is the investment the company is making towards creating new infrastructure and newer avenues for growth.

Tall Claims, are they all true?

In a way the claims of Mr Bezos are true because Amazon did recently invest heavily on cloud computing technologies and digital content. The cash pile of the company is on a high at $11.45 billion due to its nature of taking receivables quickly and delaying the number of days of payables. Amazon has invested a considerable portion of its assets in infrastructure and building economies of scale.  Another reason of low profitability is the cost of doing business in developing countries. Currently Amazon has operations in 7 countries including India and China. It wants to scale up its low international presence by setting up warehouses and reducing dependency by de-centralising their operations. This fact is validated by thehigh debt to equity ratio of 53.53 which creates a substantial amount of leverage on Amazon’s balance sheet.

Currently Amazon is trading at a 5 year expected price to earnings growth ratio of 4.20which gives a clearer picture of the stock’s future value despite its weak earnings.  But the big question that lies before the investors now is whether Amazon will continue its growth potential in the future despite having such high operating costs. The answer to this question lies in a number of factors that have to be considered before forming any opinion.

The Peer Market

In terms of cloud computing services, Google(NASDAQ:GOOG)has the largest number of users across the globe. The dashboard of tools like Google Apps, Gmail and Google Docs are household names now. Google recently launched its own tablet, Nexus 7 which is giving a stiff competition to Amazon’s Kindle Fire, both being priced at $200.

Amazon is also facing a tough competition from local online retailers in China like Alibaba which has a market share of 76%. Online transactions in China are growing exponentially and Amazon is trying to tap the opportunity by investing heavily in the market. But since its inception for over 8 years now, Amazon has been able to capture just 1% of China’s $196 billion e-commerce market.

Retailers like E-Bay(NASDAQ:EBAY) are providing pressure on Amazon’s bottom line by changing their business model to same day delivery. Wal-Mart(NASDAQ: WLMT) and E-Bay generated more than $1 billion and $500 million in adjusted free cash flow last quarter respectively which suggests that most of the competitors are building up their cash stock pile for a secure future just like Amazon.

The Way Forward for Amazon

Amazon is shifting towards a more third party unit and digital content sales. The revenue generated from web services and advertising has been increasing. Amazon Prime is a great future revenue source, with fast shipping and a streaming video library which is starting to rival Netflix. Amazon is also planning to launch a virtual payment system wherein customers can purchase games, applications and other items on the company’s Kindle tablets using a new product called Amazon coins. According to me it is a promotion tactic to drive traffic towards Amazon’s app store which is not as popular as Apple’s.

The international operations of Amazon have started to deliver results. Also the tablet market is growing strong and Amazon, after incorporating new features in the productshould come close to its rivals, Apple and Samsung in this domain.

The Takeaway

Despite all these issues, Amazon’s fundamentals are really strong, having a superior top management. These are believed to be better than its peers in the industry and are expected to drive the company’s growth in the near future. Mr Bezos’ vision to make Amazon a $1 trillion e-commerce company by 2016 is certainly a thing to look forward to. Amazon is a differentiator incloud computing and other emerging technologies. The current valuations of Amazon are high but it is definitely a stock to look forward to in the future. An investor can hedge his short term risk by writing a put option with exercise price of $200. Looking at all the possible scenarios I would recommend a ‘hold’ strategy in the short term but for a long term investor it is definitely a ‘buy’.

References

  • Nasdaq, Market Watch
  • Yahoo Finance
  • Bloomberg
  • Insidermonkey.com ; seekingaplha.com

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