Why Amazon Is Undervalued
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
According to an August 2011 IDC study on the worldwide new media market model, the global eCommerce market is worth $673 billion. That is simply an astounding number and Amazon.com (NASDAQ: AMZN) is perfectly positioned to take a large chunk of that market, capitalizing on this secular trend. Any doubts over AMZN’s growth trajectory were squashed on Friday. Shares jumped over 15.8% after an extremely solid quarter.
The acceleration in sold unit growth coupled with better-than-expected gross margin impressed the market and us. Paid units grew by 49% y-o-y and gross margin came in at 24.0%, driven by Amazon Web Services (AWS) and higher third party (3P) unit mix contributing 39% of total paid units. We identify additional positives in active customer accounts increasing by ~9 million q-o-q to 173 million and US media growth where AMZN benefits from media purchases from its Kindle Fire. Furthermore, the company has been active in the share repurchase space; in Q1 AMAZN repurchased 5.3 million shares amounting to $960 million, up from the $277 million the company spent in Q4 2011.
A source of potential margin compression is the significant capex outlays to build out AWS infrastructure. Management indicated plans to spend $800 million to $900 million next quarter, which is appropriate given its plans to build out 13 fulfillment centers. We would not be surprised if AMZN increases that number as the company decides to spend more on AWS growth. This investment focus may result in lower operating margins, but should boost long term profitability.
We also like fellow eCommerce competitor eBay (NASDAQ: EBAY), which posted similarly solid Q1 results. We are very excited for the opportunity in mobile payments for Paypal, granted this is a longer-term investment thesis. Management guided to $7 billion in total payment volume (TPV) this year for mobile and $8 billion of gross merchandise volume (GMV), both exceeding analyst expectations. The fundamentals are intact with double digit annual revenue growth at PayPal over the next 5 years; revenue payments were up 32% y-o-y.
However, from a valuation perspective we view AMZN as having more potential upside. A competitor we like a lot less is Overstock (NASDAQ: OSTK), a small cap eCommerce player that we believe poses a negligible threat to AMZN. The company has struggled, missing Q1 revenue estimates. It was only able to turn profitable to the tune of $2.7 million by cutting $8.5 million in headcount in January. OSTK has not successfully increased the number of unique customers (1.7 million) and new customers have increased at very low rates—3% y-o-y. Just as in 2011, we anticipate OSTK to lag behind eCommerce peers in terms of growth.
Apple’s (NASDAQ: AAPL) strong tablet sales remain a threat to AMZN’s product expansion in digital distribution. In its most recent quarter, AAPL reported iPad sales of 11.8 million units, which was overshadowed by booming iPhone sales in China but in-line with analyst estimates. The expectation is that iPad sales will see very robust growth in the next few months, which will be reflected in AAPL’s next quarter. Since we view one of the core drivers of growth to be Kindle/e-book sales, the iPad remains a significant threat to this part of our thesis on AMZN. With that said, AMZN will be able to realize growth from other opportunities including taking eCommerce market share and tackling the retail market, in which eCommerce penetration is still relatively low. If bankruptcies in the retail world persist, AMZN should benefit from increased consumer activity online.
With the stock trading at approximately 1.2x 2013E forward sales (average multiple of 1.5x over the past 4 years), we think there is still room for upside. The next generation Kindle tablet launch, potential for margin expansion, and eCommerce growth will propel AMZN’s stock this year. International growth, branding, and a continuing focus on selection and price should help AMZN hit organic growth in the high twenties. We also think that the market has not given eBooks a fair shot, meaning that the shift to digital is actually an opportunity and not a headwind for AMZN. We share the bullish sentiment of billionaire Chase Coleman (see Chase Coleman’s picks), John Griffin, Patrick McCormack, and Philippe Laffont.
Fool blogger Meena Krishnamsetty does not own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Apple and Amazon.com. Motley Fool newsletter services recommend Amazon.com, Apple, and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.