Roll Over Rover? 6 Reasons Why Amazon Is Still Going Higher
John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon.com (NASDAQ: AMZN) reported fourth quarter earnings after the bell on January 29, and the company didn’t disappoint in providing a menagerie of fresh evidence for bulls and bears alike to make their respective cases. Despite the fact that Amazon reported lower-than-expected earnings and revenue for the third consecutive quarter, investors sent the stock higher by more than 9% in the after-hours session. The price action in Amazon continues to frustrate a growing majority who point to the company’s sky-high valuation.
On January 28, I leaned on the side of caution going into Amazon’s earnings release, encouraging readers to either reduce their positions or wait for a better entry-point. Consider the fact that Amazon had been up 12% year-to-date through January 28, compared to only a 6% gain for the S&P 500 index.
As the saying goes, bulls make money, bears make money, and pigs get slaughtered. Aside from this old investing mantra, the truth is no one ever got hurt by taking a profit. This is the most timeless advice one can gather (and hopefully remember) in the investing process.
Let’s briefly highlight my concerns (the “bear argument”) on Amazon heading into fourth quarter results, before discussing why I believe Amazon is still poised to go higher.
Short-Term Bear Case - Potential Disappointment for Q4
The expectations for future revenue and earnings growth were priced into Amazon well before $200 a share. Prospects became even more extreme as the stock reached all-time record highs leading into Q4. I was mostly concerned about a repeat of a Chipotle Mexican Grill scenario from July 2012, when expectations got too high for Chipotle’s second quarter 2012 results. The company disappointed and the stock fell from $403 to $317, a 22% loss overnight. Clearly, this scenario did not transpire in Amazon.com. By the way, Chipotle has upcoming fourth quarter 2012 earnings on Tuesday, February 5.
Long-Term Bear Case - Valuation
The current valuation on Amazon.com compared to Wall Street’s abandoned stepchild Apple also demonstrates the large inconsistency in the typical investor’s mindset. Why have investors been leaving Apple and running for the hills? The main reason is a significant decline in gross margin, plain and simple. If investors applied the same logic to Amazon.com, the stock would be valued at a small fraction of the current market price.
Bull Case - Why is Amazon Still Going Higher?
Despite the above references to the bear case scenario, Wall Street continues to have an overwhelmingly positive bias on Amazon.com. Readers need to recognize that part of becoming a successful investor is learning to be adaptable rather than resistant. Here are six reasons why I believe Amazon.com can continue its march higher:
- The company posted a substantial improvement in gross margin and operating margin during the recent fourth quarter. Consolidated segment operating income (CSOI) rose to $678 million, a 47% year-over-year increase in profits. CSOI margin was 50 basis points higher in the fourth quarter 2012, reaching 3.2% this quarter compared to 2.7% in Q4 2011.
- Revenue growth continued during the quarter and validates the company’s staying power. Net sales rose to $21.27 billion for Q4 2012, a 22% year-over-year increase. Even as the digital word continues to evolve, Amazon.com seems constant and irreplaceable. It’s hard to imagine a day in the future when there isn’t a need to purchase physical goods through an online medium.
- In prior years, Founder & CEO Jeff Bezos attributed the company’s weaker-than-expected profitability to reinvestment for future growth. Amazon’s capital expenditure is now starting to pay off. The company’s CapEx has resulted in the aggressive build-out of new distribution centers across the United States, the acquisition of digital media content, and growth in various international businesses.
- Amazon’s eBooks business is tremendously profitable. eBooks has become a multi-billion dollar category, with a massive 70% growth rate in the last year. The company also has high-margin businesses in the form of Amazon Web Services (AWS) and related cloud computing solutions.
- Following the stronger-than-expected Q4 gross margin, Amazon.com has received analyst upgrades from Credit Suisse, Deutsche Bank, Goldman Sachs, Jefferies, RBC Capital, and Wells Fargo all within the last week. Each firm raised their price target upwards of $330.
- The company has successfully used its Amazon Prime membership program as a loss leader, which encourages customers to overspend. Amazon’s Fulfillment by Amazon (FBA) service is also gaining traction with third-party sellers, who are migrating to Amazon from competing platforms such as eBay.
Random musings following the quarter:
1) Investors often criticize Amazon because the company doesn’t disclose its Kindle tablet sales similar to the way Apple does with iPad / iPad mini. The fact is Amazon’s non-disclosure isn’t an issue, because their goal isn’t to make money on hardware. The popular Kindle Fire and Kindle Paperweight devices are effectively given away for free, at nearly the same price Amazon pays to manufacture them. Money is made through permanent customer acquisition and content sales, which have high gross margin.
2) Can anyone name a legitimate online competitor to Amazon? Wal-Mart is the closest, but a distant second. Furthermore, physical brick-and-mortar retailers such as Best Buy, Sears, and RadioShack are all slipping away. Management teams at each of these companies have stated their plans for net store closings over the next decade. Dollars spent at each of these retailers have to be allocated elsewhere, and Amazon is the most likely bet.
Ancillary Plays for Online Growth
If Amazon.com’s high cost of ownership gives you indigestion, two other e-commerce options can be surprisingly found near 52-week highs. Both of these companies seem to have discovered a niche market and are managing to co-exist with the 800-pound gorilla that is Amazon.com.
While not a complete pure play on e-commerce, HSN (NASDAQ: HSNI) / Home Shopping Network has quietly reached fresh all-time highs in the New Year. The St. Petersburg, Florida company has beat earnings guidance in the last 8 consecutive quarters. On January 17, HSN announced a collaboration with Disney to create exclusive products related to upcoming Disney films Oz the Great and Powerful during the 2013 calendar year. Wall Street sentiment continues to be positive on HSNi, despite the large run-up in share price. Piper Jaffray recently raised its price target to $80 from a previous $64, citing increased confidence related to HSN’s new website interface and redesign. HSNi reports fourth quarter earnings before the market opens on February 23.
Online retailer Overstock.com (NASDAQ: OSTK), which has found a niche market in bed-and-bath goods and home products, has seen its near shares rise 90% in the last 52-weeks. Fun fact: the marketplace currently values Overstock at $312 million, approximately one-fourth of 1 percent of Amazon.com. On an investment basis, CEO Patrick Byrne reported a massive 27.7% stake in his company, a potential sign of increased confidence in the online retailer going forward. Earnings per share at Overstock grew significantly in the last year, as the company benefitted from gross margin expansion and an increase in average order size.
Shipment carriers UPS and FedEx certainly stand to benefit from increased volume of online package shipments. Among the two, I prefer FedEx which is seeing incremental benefit from its restructuring program. Check back at johnmacris.com for a post on UPS and FedEx later this week.
Foolish Bottom Line
Despite the fact that Amazon makes less than half a cent on every dollar in sales, I believe investors can follow the “buy high, sell higher” mantra in Amazon. The marketplace is betting there will never be a sea change away from the world’s largest online retailer. It’s hard to name an extraneous scenario that would fundamentally change the nature of Amazon’s business, other than a concerted effort to implement a nationwide sales tax.
In recent days, I’ve seen a number of analysts go on television and state Amazon could see a mass exodus similar to the scenario we’ve seen in Apple. The sell-off in Apple’s stock was motivated by a firm change in business conditions, related to increased competition from South Korean technology giant Samsung. In contrast to Apple, Amazon doesn’t have a legitimate competitor, in addition to becoming firmly established and ingrained in the mind of the consumer. Revenue at Amazon will continue to grow as the 20-to-30 year old range of consumers becomes older and gains more spending power.
Finally, Amazon was able to deliver a blow in addressing the most valid points of its critics during the quarter. The company’s gross margin improvement was simply higher than anyone expected. Although it’s too early to call an inflection point, increased margin expansion will be vital for success of the stock longer-term. Further improvement is necessary in coming quarters.
As Gene Munster, one of Wall Street’s best technology analysts recently stated, “As long as the dream is there, the stock is going to go up.”
Well said, Mr. Munster. Last I checked, the dream is still alive and well.
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johnmacris has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!