It's All About the Revenues at Amazon
The online retailer is unique: The stock rises when the company reports weaker earnings. How that's possible and why the shares can fly still higher.
Amazon.com is a religion stock: either you are a believer, or you are not.
This has been true ever since the Internet gold-rush days of the late '90s. How else can one explain a 3.9% surge in shares after quarterly earnings fell 8% despite a 51% jump in revenue―the highest gain in 10 years? Amazon (ticker: AMZN) last week reported earnings of $191 million, or 41 cents a share, versus $207 million, or 45 cents a share, a year earlier. That beat analysts' consensus estimates of 35 cents, which were cut three months ago after management warned of shrinking margins. Revenue surged to $9.91 billion from $6.57 billion last year. Revenue from electronics, such as Kindle e-readers, and general merchandise soared 69% to $5.89 billion. Sales of books, CDs, DVDs and other media jumped 27% to $3.66 billion.
Jeff Bezos: Sam Walton to a new generation of consumers.
Generally, such a disconnect between revenue and earnings would spook investors, but Amazon's stock―and its flock―is sales driven. Back in the original tech bubble, Jeff Bezos' upstart would spend freely with little detailed explanation and ask investors to sit tight. We were skeptical about the stock for years but wrote positively about it in early 2009 ("The World's Best Retailer," March 30, 2009), when the shares were trading at just 70 and annual revenue was about $20 billion. We see no reason to change course. Amazon has compiled a 14-year track record of investing aggressively in technology, distribution and real estate at the expense of margins, only to reap stellar revenues in return.
Amazon's stock performance points to "investors who believe in the revenue story and are willing to be patient regarding the company's heavy investments," says Faye Landes, a retailing analyst with Stamford, Conn.-based Consumer Edge Research. Landes is still bullish on Amazon shares despite their trading at an unthinkable 107 times 2011 earnings estimates (see chart below). She has an Outperform rating and a 250 target, about 12% above Friday's levels. Amazon shares are up 24% for the year.
Growth Stock
Amazon shares have been on a tear for three years, as its big investments in areas like distribution, Kindle and cloud computing continue to pay off.
| Recent Price | $223.90 |
| Revenue '10 (bil) | $34.20 |
| Revenue '11E (bil) | 48.01 |
| Capital Expenditure '10 (bil) | $0.98 |
| Capital Expediture '11E (bil) | $1.15 |
| EPS '11E | $2.09 |
| EPS '12E | $3.33 |
| P/E '11E | 107.3 |
| P/E '12E | 67.3 |
| E=Estimate | |
| Source: Thomson Reuters |
Citigroup Internet analyst Mark Mahaney is even more optimistic. "They are showing great growth and investing like they expect great growth," says Mahaney, who rates the stock Buy and revised his 12-month target last week to 280 from 240 despite cutting his 2011 earnings-per-share estimates to $1.97 from $2.36.
Thomas Szkutak, Amazon's chief financial officer, warned investors to expect accelerated investment and lower profits during the third quarter despite projected sales growth of as much as 47% to $11.1 billion. He estimated operating income of $20 million to $170 million, a rather cavernous gap representing a range of declines of 93% to 37%.
Where is the money going? Mostly to the company's tech-intensive fulfillment and distribution centers. Before last week, Amazon planned on nine new warehouses for 2011, but now it has increased that number to "more than 15." Some of those are international markets, such as Australia. Amazon also continues to invest in its Kindle e-reader franchise and is rumored to be working on the launch of a tablet device. On top of that, Amazon keeps building massive data centers to support its industry-leading cloud-services unit, Amazon Web Services.
WHILE PAST PERFORMANCE isn't predictive, CFO Szkutak contends that previous heavy investments have produced high returns. "We need both fulfillment capacity and infrastructure capacity. It is a high-quality problem," the CFO told investors. It's "something that we've done before," he said, and have worked to perfect since the company was formed in the mid-1990s.
Landes, a veteran Amazon watcher, understands the connection between distribution expansion and revenue growth, explaining the forces behind the recent sales surge in a punk economy. Amazon remains a low-price leader and is increasing its share of consumers' spending across a broad range of categories beyond books and electronics, to products such as groceries and personal-care. Landes credits the Prime membership program, which facilitates inexpensive overnight shipping, as a key contributor.
The Bottom Line
Amazon shares could jump by 10% to 25% if it can continue to turn its substantial capital outlays into rapid growth in its traditional retailing, Kindle and cloud-computing businesses.
To own Amazon shares, investors not only need to weigh the risks of capital expense devoted to e-commerce distribution but understand the magnitude of the company's commitment to its cloud-computing business, which is likely to require hundreds of millions of dollars in data-center construction. The company doesn't break out revenue from Amazon Web Services, but analysts estimate them between $700 million and $1 billion. "You should expect that we continue to invest in that business because of the high-growth nature of it. It is growing very fast," says Szkutak. "That's a great big space to be investing in."
Shareholders also have to bear in mind that states are still fighting to secure more taxes due on Amazon goods. Amazon recently cut ties to thousands of California affiliates after that state imposed an Internet-sales tax.
Perhaps the most pragmatic way to view Amazon is to compare it with Sam Walton's Wal-Mart Stores (WMT) in the 1990s, says Morgan Stanley Internet analyst Scott Devitt. In 1991, Wal-Mart posted an amazing 35% increase in revenues, to about $44 billion. In 2011, Amazon.com could rack up a 43% rise in revenue to $49 billion. "Amazon.com is the Wal-Mart of our era, but it's better," because its storeless business model could lead to higher long-term economic returns, he says. Amazon shareholders just need to keep the faith.
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