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Published: July 23, 2010
Whenever a company decides to leave the
stock market and go private, you hear an oft-heard lament: “Wall
Street just wants us to deliver the goods this quarter, and they
could care less about the future.” Thankfully, Amazon.com’s (Nasdaq:
AMZN) Jeff Bezos has never worried too much about that, and
has a history of sacrificing short-term results for long-term
growth. That has led to some grumbling and share price
volatility at times, but you have to admire his company’s
long-term track record. Sales, which some had thought might
plateau when they reached $10 billion in 2006, are likely to
exceed $30 billion this year.
Yet to get to $40 billion or even $50 billion in sales, Amazon
needs to keep spending now to build new avenues to growth. But
in the myopic world of Wall Street, rising expenses are a sin.
Shares of Amazon.com are off more than -10% Friday morning after
the company delivered an unexpectedly high rate of spending when
quarterly results were released Thursday night. Pro forma
operating income of $406 million badly trailed the $442
million consensus forecast. Concerns that quarterly profits
might be weaker than forecasts had started to pressure shares
since early May. They have since fallen from around $150 to
around $110, wiping $18 billion in
market value off of the stock.
To be sure, Amazon dropped the ball in terms of communicating
with investors. It simply looks bad when analysts had no clue
that expenses were going to be higher than expected. Then again,
Bezos has an almost cavalier indifference to playing the Wall
Street guidance game. It’s one of the downsides of owning this
stock. And Bezos makes no apologies for more near-term profit
pressures. Heavy spending will likely yield operating income of
just $390 million in the current quarter, nearly $100 million
below Wall Street forecasts. Forward earnings estimates are
being slashed as we speak.
Perhaps lost in the profit kerfuffle is that Amazon.com just
posted a whopping +42% jump in sales at a time when the economy
remains in a funk. Amazon continues to take
market share from online rivals as well as traditional
bricks-and-mortar retailers. Amazon has always taken market
share by undercutting rivals on price. That may hurt near-term
profits, but it sets the stage for a larger sales base that
eventually reaps even greater
economies of scale.
Profits are also being a hit by a decision
to build capacity now to handle future revenue growth. Amazon
will open 13 new distribution centers around the world this
year, while analysts apparently modeled for only a few new
centers. Overall, Amazon.com spent a record $196 million on
capital expenditures in the second quarter, and plans to spend a
whopping $300 million in the current quarter. That’s almost as
much as the company spent in all of 2008 and again in 2009.
Eventually this capex thrust will slow down, at which point
free cash flow should soar.
The key to understanding Amazon is to distinguish gross margins
from operating margins. As noted, operating margins are taking a
hit from heavy spending for the next wave of growth. Yet gross
margins are quite robust. They just hit a record 24.1%, roughly
50 basis points higher than analysts had expected. As sales rise
and better
leverage the
overhead expenses, operating margins should also rise at a
commensurate rate. It may take several years for that to be
fully realized -- hence the near-term weakness in Amazon’s
shares.
Amazon’s decision to keep spending heavily now is based on
expectations that online sales will keep taking market share
from traditional retailers. Online sales currently account for
about 7% of total U.S. retail sales, though Citigroup’s Mark
Mahaney sees that rising to 14% to 15% over the next decade.
Amazon already controls 10% of the online retail segment, and if
history is any guide, that market share could grow another 200
to 300 basis points over the next five years.
Action to Take --> Amazon
could well disappoint during the next few quarters as well. And
analysts will quibble that upcoming profits won’t be that much
higher than year-earlier results, leading to concerns of slowing
growth. They’ll neglect to note that profits should
re-accelerate sharply in 2012 once Amazon’s sales grow into the
company’s new higher cost structure.
Shares always trade at a rich multiple, so don’t wait for this
to move down to deep bargain territory. After today’s sell-off,
shares trade for about 23 times next year’s profits of $4.75 a
share [the generally accepted accounting principles (GAAP)
consensus estimate is slightly below $4, as it accounts for
non-cash stock compensation accounting]. It may take some time,
but as investors start to once again embrace the company’s
robust long-term outlook, shares should eventually power past
the $150 mark seen earlier this spring.
-- David Sterman
Staff Writer
StreetAuthority |
