Amazon: High Valuation Hints at Further Downside

Despite Amazon (AMZN) falling more than 60% from its 52 week highs, the shares are still too rich to justify such a lofty valuation. AMZN's forward 2008 PE of 34 is outrageous compared to its competitors' more realistic Price Earnings ratios. For example, eBay (EBAY) sports a multiple of 9, Barnes & Nobles (BKS) PE is 8, while Wal-Mart's (WMT) multiple is the highest of the group at 15.

Horrible fourth quarter guidance

Although AMZN delivered third quarter results that met expectations, admitting its 4th Quarter guidance was miserable is an understatement. Management trimmed its fourth quarter guidance substantially (its largest quarter of the year, due to the holiday season). Previous analyst top line estimates were $7.05 billion, and were trimmed as low as 15% on the low end, as the company issued an overly large sales range forecast of between $ 6-7 billion.

Analysts had also pegged operating earnings of about $400 million and AMZN had to guide this down to a range encompassing $145 million to $305 million. The bottom of the range represents a potential 65% drop from earlier forecasts.

Third quarter analyzed

Even though sales were up more than 30%, AMZN was still unable to increase its gross profit margin of 23.4%, as its cost of goods sold increased 31% from $2.5 billion to $3.62 billion. The shortfall was attributable to the fact that AMZN had to utilize price cut after price cut to attract weary consumers.  AMZN's SG&A costs went the wrong way, rising 32% from $639 million to $845 million, amounting to a 30 basis point increase from 19.50% of sales to 19.80%. The other issue hurting AMZN was the gain in the US dollar, as the company's significant international presence creates problems when foreign currency is ultimately exchanged for the greenback.

Likely bottom

The shares still have significant downside risk. If you allocate a more reasonable PE ratio of 12, such as the average of WMT's and EBay's forward multiples, and multiply it by 2008 earnings estimates of $1.43, the result predicts a share price equivalent to $17.16, approximately 65% lower than today's share price. I don't think the shares could fall this low, but the possibility still exists.  I anticipate $30 as a more reasonable buying opportunity, since the company still appears in a growth mode.

Insiders and supply overhang: Insiders are not nibbling, even at the recent decimated share price, in fact, the last six months have produced insider sales of 2.4 million shares. Legg Mason (LM) still owns over 40 million shares, and it may be forced to sell even more shares due to customer redemptions, further flooding the market. Jeff Bezos's 100 million share stake also represents a significant source of potential supply hitting the market.

Bottom Line

The shares still are subject to increased selling pressure, especially with the recessionary environment that now plagues us. Discretionary items such as books and gadgets are going to drop low on the priority list, as consumers focus only on the essentials. The stock is too expensive when compared with its peers and needs to drop at least 40% before one even contemplates purchase.

Until then, take advantage of its impending further collapse by shorting at will. Stocks seem to always go in both directions in extremes, but panic has a more powerful impact than elation. Although the shares have recently rallied 5% off their lows, it was no more than a dead cat bounce initiated by shorts covering to book profits, as well as retail buyers trying to pick a bottom. The bottom is still nowhere in sight, as the shares continue to make lower lows and lower highs. Being short in this market is the right thing to do, especially if you are lucky enough to hold a short position in AMZN.

Disclosure: Short AMZN.

Comments

[sforce:]

Tim Boyd of American Technology Research said:

"Neutral means Neutral at current prices with a 12-month outlook. Amazon shares should trade lower in the near term, perhaps as low as $30 (15 times our new 2009 pro forma EPS estimate of $1.97), perhaps even lower (beta contingent). Investors who agree with that view should by all means short the stock here and now for short-term gains.

Our new $40 price target is a 12-month target, i.e., we assume that 12 months from now, the market will have sufficient visibility into the state of the economy and the consumer to assign Amazon shares a 20 times multiple. Amazon is a unique and extremely well-managed franchise that is likely to emerge from the current economic malaise much stronger than when it went in. It is the kind of stock that investors will want to own for the long term at the right price.

We would start nibbling and/or covering shorts at $30. With Apple (AAPL), Research in Motion (RIMM) and Google (GOOG) already trading at an average calendar 2009 price/earnings multiple of about 15 times, there is no reason Amazon shouldn't trade there, too, after Wednesday's report."

-- Tim Boyd

online.barrons.com/art...

2008 Oct 26 11:25 AM

[20smoney:]

I'm short Amazon... and long Apple.

read why at 20smoney.com

2008 Oct 26 08:50 PM