What Could Hold Back Amazon?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The previous quarterly financial reports of Amazon.com (NASDAQ: AMZN) didn't impede the progress of the company's stock during recent weeks. The company showed growth in revenues but a drop in profitability. The last quarter of the year should entail a sharp rise in revenues (due to seasonality) but will it rise much higher than in the same quarter in 2011? What are the main factors that could impede the progress of Amazon? Let's further examine these issues.

Amazon’s Profitability Remains Low

According to the third quarter financial reports of Amazon, the operating profitability has further declined to reach -0.2%. This low profit margin is ubiquitous in the retail sales sector: other leading retailers such as Best Buy (NYSE: BBY) and Barnes & Noble (NYSE: BKS) also have a very low profit margin. Moreover, for both of these companies the operating profitability has declined in the third quarter even though each company is competing with Amazon in different sectors (Best Buy in electronics and Barnes & Noble in books).  The last few months of the year (mainly November and December) will have higher sales mainly due to the holiday season, but this won't necessarily leads to higher profit margins as I will show herein.

The chart below shows that except for Barnes & Noble the operating profitability of Amazon and Best Buy in the last quarter of 2011 wasn’t the highest compared to other quarters.     

<img src="/media/images/user_12845/amazon-operating-profitability-and-others-dec-2012_large.jpg" />

The revenues of Amazon, on the other hand, have hiked in the third quarter by 27% (quarter-over-quarter) compared to the parallel quarter in 2011. One of the factors that pulled down Amazon's sales in the recent quarter was the unfavorable changes in foreign exchange that caused, according to the company, a drop of nearly 7% in its international segment sales year-over-year. The recent developments in the foreign exchange markets might curb the growth in revenues in the last quarter of the year. Moreover, this could also pull down the company's profitability even further.

In the electronics segment, the release of the  iPad mini by Apple (NASDAQ: AAPL) at a retail price of $329 is another factor that could cut into Amazon's sales and profitability in the last quarter of 2012, as it competes head-on with Amazon’s Kindle Fire in the tablet market. As I have pointed out in the past, the iPad mini serves as a type of “price discrimination” product so that Apple could augment its market share in the tablet market for the $250-$350 price range.

Let's turn to the retail market and examine how this market has progressed in recent months.  

Retail Sales Only Slightly Rose

According to the recent U.S retail sales report (pdf format), sales have slightly increased in November by 0.3%. In the previous report, retail sales edged down by 0.3%. A closer look at the data reveals a rise in Electronics & appliance stores by 2.5% compared to October but a 1% drop compared to November 2011. Further, sales in “Sporting goods, hobby, book & music stores” increased by 0.5% during last month and by 7.1% compared to the same month last year. These two sectors are close to Amazon's businesses. During the past 11 months sales in Electronics & appliance stores declined by 0.8% compared to the same time-frame last year, while sales in “Sporting goods, hobby, book music” increased by 6.5%.

This report suggests sales, in business sectors related to Amazon, have only slightly increased in recent months. This may imply low growth in Amazon's sales in recent months, which will reflect in the company's revenues for the fourth quarter.

Finally, let's examine the company's progress with respect to the market.

NASDAQ and Amazon

The chart below shows that during the year (UTD) the company has outperformed the NASDAQ. Moreover the publication of the company’s third quarter financial report didn't impede the progress of the stock.  

<img src="/media/images/user_12845/amazon-snp500-dec-2012_large.jpg" />

Moreover, the current expectations regarding the future growth of the company are still high: the current forward P/E (one year) of Amazon is 141.59 (according to yahoo finance); in comparison, eBay (NASDAQ: EBAY) has a forward P/E (one year) of 18.38 (according to yahoo finance). This finding suggests the market expects Amazon to continue to rise.

Amazon, much like other related companies such as eBay, doesn't offer a dividend. This might help Amazon's stock, because the Bush tax cuts might expire at the beginning of 2013. The tax cuts have included a low 15% tax on dividends. At the beginning of the year, the tax on dividends will rise to a rate as high as 43%. Since Amazon's stock is characterized by high growth and since the company's doesn't pay dividends, this could lead to a higher demand for this company's stock.

I think Amazon's growth in revenues might continue, but certain factors that I have listed above are likely to slow down the company's progress. In any case, the company's profit margin is likely to remain low and might even further dwindle.


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liorc has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, and Best Buy. Motley Fool newsletter services recommend Apple, Amazon.com, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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