Amazon.com (AMZN) reached a new all-time high on Monday, closing at $268.46. The major catalyst was an upgrade to buy at Morgan Stanley (MS), with a $325 price target. Analyst Scott Devitt argued in his accompanying note that Amazon's fulfillment network and other fixed assets will allow it to gain share in e-commerce to remain the global leader. By 2016, Devitt expects Amazon to post sales of $166 billion, up more than $100 billion from expected 2012 sales of approximately $62 billion.
Amazon has posted torrid revenue growth over the past ten years, expanding from less than $4 billion in annual revenue in 2002 to over $60 billion in 2012 (a slightly better than 30% CAGR). Amazon will continue to grow much faster than traditional retailers for the foreseeable future, due to the expansion of e-commerce. However, Devitt's growth estimates are extremely unrealistic. Amazon's recent results have already shown a slowdown in growth. The trend is likely to continue in Q4, as ComScore recently announced that online holiday shopping in the U.S. fell 3% below its initial projections. The slowdown in Amazon's growth rate will continue as a natural consequence of the company's larger size. Amazon has already taken most of the low hanging fruit in the US, while the company has struggled to maintain international growth in the face of strong local competition and, in some markets, economic weakness. The 28% CAGR expected by Devitt over the next four years is therefore extremely unrealistic. Instead, I expect an approximately 20% CAGR, which implies a much lower valuation.
Slowing Sales Growth
In Q3 (the last reported quarter), Amazon posted year-over-year revenue growth of 27%. This was down from 44% growth in the prior year period and was also lower than the growth posted in the first half of 2012. Amazon saw slower growth in all geographies and across its reporting segments. North American revenue growth slowed from 44% to 33%, while international revenue growth dropped from 44% to 20%. Most of the drop in international growth can be attributed to currency fluctuations. Still, holding foreign exchange constant, international revenue growth dropped from 33% to 27%. The "electronics and general merchandise" category, which represents 62% of Amazon's sales, saw growth drop off from 54% in Q3FY11 to 39% in Q3FY12, adjusting for foreign exchange rates. The media segment, which was where Amazon got its start, has already seen sales growth drop off into the mid-teens. (All data from Amazon's Q3 financial results, p. 9)
There are a few key points to draw from this data. First, Amazon's media business has matured, and is only growing at 16%-17% from its current run rate around $20 billion a year. Increasing penetration of Kindle devices may maintain growth in the low-mid teens over the next several years, but is unlikely to drive a return to higher growth rates. The electronics and general merchandise category, being a less mature business for Amazon, can still grow rapidly. Still, this category's growth has dropped from 67% in 2010 to 53% in 2011 and then to 41% through the first three quarters of 2012 (reflecting constant currency). It is unclear at what level growth in this category will stabilize, but the rapid drop-off has shown no signs of abating. High growth here has boosted Amazon's company-wide growth rate over the past few years, but this segment's growth rate is quickly receding toward the company average.
Amazon is facing renewed competition from the likes of Best Buy (BBY) and Target (TGT) in the U.S.; both companies have offered price match programs in recent months to win back customers. Indeed, Target just announced that it will match Amazon's prices year-round. Moreover, Amazon began collecting sales tax in Texas, Pennsylvania, and California all during Q3, which removes one major customer draw. Meanwhile, Amazon doesn't have the same level of brand recognition internationally and has (surprisingly) seen international growth rates drop below domestic growth. All of these factors make it likely that company-wide revenue growth will slow to around 20% annually by 2014 or 2015. At that rate, 2016 revenue will fall short of Morgan Stanley's $166 billion target by as much as $40 billion.
We've Seen This Movie Before
As I have previously argued, Amazon is not the first retail juggernaut we have ever seen. Amazon today is situated similarly to Wal-Mart (WMT) twenty years ago. Wal-Mart posted 35% revenue growth in 1992, but after passing the $80 billion threshold in 1995 only posted one more year of 20% revenue growth (in 2000). The problem was simply that Wal-Mart began to saturate its markets and there were fewer opportunities to open new stores where they could be profitable. If anything, Amazon has fewer growth opportunities today than Wal-Mart circa 1993. Because of the e-commerce model, Amazon already serves most major markets; whereas a physical retailer like Wal-Mart can still grow by adding stores here and there, Amazon needs to generate "organic" revenue growth within markets it already serves. Moreover, Amazon faces a formidable competitor in Wal-Mart; Wal-Mart never faced a retailer of comparable scale and efficiency.
From this perspective, Wall Street's growth estimates for Amazon seem even more implausible, if that is possible. Amazon is no more disruptive today than Wal-Mart was in its time, and faces the additional impediment that competitors like Wal-Mart and Costco (COST) have lower cost structures. Whereas Morgan Stanley expects Amazon to grow its e-commerce share over the few years, it is just as likely that strong physical retailers will invest heavily in overcoming Amazon's first mover advantage. This added competition will hasten Amazon's transition to a moderate growth company by later this decade.
Analysts who point to Amazon's "infrastructure" to justify expectations for 25%-30% revenue growth over the next five years must explain why the multi-year trend towards lower growth in electronics/general merchandise will suddenly stop. Tougher comparables (a natural result of growth) will make growth harder, not easier to achieve. The historical example of Wal-Mart shows that even successful retailers will eventually become too large to maintain 20% growth. Amazon seems to be on pace to hit that point in just a few more years. I continue to see the company as a good short target for 2013, although I would recommend waiting until closer to Q4 earnings before opening a new position.