by Marc Bastow | April 30, 2013 8:30 am
I’m never quite sure what to make of Amazon (NASDAQ:AMZN[1]). At times, it seems like a ground-breaking tech stock with unlimited upside. Other times, it looks like an ahead-of-its-time retailer whose time might not be running out, but whose bottom line keeps pointing toward some kind of shareholder reckoning.
I’ve previously come out on the side of the former[2], but amid something of a plateau following an incredible five-year run, the stock seems increasingly troubled. In fact, it’s that loss, and its recent trends, that have me a bit worried.
You see, I still think Amazon can be great, but I also believe last week’s pullback on news of an earnings disappointment is just the start of a more intermediate-term downturn.
Net Income Continues to Fall: Since peaking in 2010 with a profit of $1.1 billion, earnings then fell to $632 million in 2011, and Amazon took a $39 million loss in 2012. Yet, over those past few years, the stock price has gone in the polar opposite direction, and I’m sorry, but that’s troubling.
AMZN also set a poor pace with its Q1 2013 earnings, which came in at $82 million, down 37% from last year. What’s just as troubling is management’s forward guidance for the second quarter of 2013, which has operating income coming in somewhere between a $340 million loss and $10 million profit compared to a $107 million profit last year.
Management’s annual report discussion on continued deterioration in net income included increases across the board in SG&A, fulfillment, marketing, technology and content costs … essentially every line item associated with cost is on the rise year over year. Sure, revenues have surged 80% from 2010 to 2012, but so have operating costs — by a percentage point more, no less.
Thus, analyst estimates for EPS of $1.50 in 2013 and $3.55 in 2014 seem like a tall order; we won’t see those unless either sales growth goes through the roof or expense levels are more tightly managed.
Cash Flow Gets Tighter: AMZN boasts 46 facilities spanning 37 million square feet in North America alone, and plan to open another eight (over 8 million square feet) in the next 22 months. Tie in Amazon’s 48 foreign operations, and you have quite a heavy investment in property, plants and equipment. Ramping up said operation has cost AMZN plenty, with capex bounding from $979 million in 2010 to $3.8 billion in 2012.
The system is wholly necessary to Amazon’s strategy, considering it wants to provide universal same-day delivery for its goods as soon as possible. Still, that capex growth paired with shrinking margins is squeezing cash flow. By AMZN’s own reckoning, free cash flow (which they compute to include cash on hand) dropped from $2.5 billion in 2010 to $295 million in 2012. Take out the cash component, and that free cash flow turns negative in two of thee past three years.
Again, Amazon’s quarterly results feed the same concerns: Expenses year-over-year increased from $386 million to $670 million, and free cash flow was down 85% to $117 million. AMZN has access to fairly cheap money, sure, but it’s a troubling trend in any case.
The Competition Heats Up: Amazon is given credit for crushing the life out of Best Buy (NYSE:BBY[3]) and other specialty retailers, but there’s still the matter of other e-tailers, as well as big-box retailers Walmart (NYSE:WMT[4]) and Target (NYSE:TGT[5]).
For instance, Walmart is jumping to match Amazon on the same-day delivery front, rolling out the option[6] in five test cities. It’s also going to offer lockers to store your purchases[7] lest you have to wait in line to check out.
Both Target and Walmart can match any discounts offered through Amazon with little thought to the consequence, and Target already offers a price-match on any online product from competitors.
The tablet/e-reader space isn’t any prettier. Amazon’s Kindle line has to go toe-to-toe with tablets from Apple (NASDAQ:AAPL[8]), Samsung (PINK:SSNLF[9]) and Microsoft (NASDAQ:MSFT[10]), among a host of smaller players, and Barnes & Noble’ (NYSE:BKS[11]) Nook is still kicking around as an inexpensive e-reader options.
Amazon’s pricing strategy revolves around CEO Jeff Bezos’ notion that the price of the product isn’t important since the company will make money on selling the content: books, movies, you name it. Bezos views it as the incremental growth engine. Again: I love the concept, but selling tablets at cost still is a nightmare on options. So if you believe in Amazon, you have to believe the model will prove itself in the long-term.
These Guys Are Good: Amazon knows how to innovate.
Amazon’s premium service, Prime, is a hit, with an estimated 10 million subscribers today (at $79 per year) headed toward an estimated 25 million by 2017[12]. These people spend money, too — about twice as much per customer as non-members. The big question is what those customers provide in the way of margins. As AMZN continues to perfect its delivery system through the extensive fulfillment center model, pressure on margins should be reduced.
Meanwhile, the Kindle might not be the best of the tablet bunch, but it’s a quality product that has caught on. Amazon’s most recent purchase of book-recommendation site Goodreads — and its 16 million users, 530 million books and 68,000 authors — is just another salvo in the race for eyes to buy electronic media. Amazon’s reach on the book side is growing, with Bowker Market Research’s latest figures showing Amazon at a 27% share of all unit book sales at the end of September 2012, up 6 percentage points year-over-year.
Amazon’s reach in the cloud also continues to expand in its sixth year. Amazon Web Service’ revenue rose 64% year-over-year to $750 million, and it’s clearly becoming one of the key names in the field.
Amazon is working to “right-size” its revenue and expense levels, and is clearly struggling to do so. Top-line growth is just ahead of expense growth, and the past several years (and latest quarterly results) show little change in this pattern.
I truly believe Amazon is a great company with enormous long-term potential, and investors should keep it on their radar (I’ll be doing the same).
But for now, I think some bloom has come off the rose, and AMZN shareholders’ reaction — a nearly 8% loss since that report — shows they’re losing some of their long-held patience.
That means better prices could present themselves in the months ahead.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he is long AAPL and MSFT.
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