Why Amazon Needs To Improve Operating Margins

| About: Amazon.com, Inc. (AMZN)

Amazon (NASDAQ:AMZN) has been in and out of news (mostly in) for the last one month or so - record holiday season sales, swelling cash, purchase of a text-to-speech technology company and quarterly earnings released on January 29, 2013. The focus, however, has been on earnings and margins. While margins in the North American division were improving, those of the International division were falling.

The Company

Amazon is an online retailer of books, movies, music and games along with electronics, toys, apparel, sports, tools, groceries and general home and garden items. The company focuses on price, selection and convenience. It has four sets of customers - consumers, sellers, enterprises and content creators - and enables them to sell on its websites, on their branded websites and to fulfill orders through it. Also, the company produces and sells Kindle devices and derives revenue from its marketing and promotional services such as online advertising and co-branded credit cards. Last year, in June 2012, Amazon acquired publication rights for more than 3,000 backlist titles from Avalon Books.

Recently, in January 2013, the company acquired IVONA Software, a technology company that specializes in developing text-to-speech software. While the acquisition is apparently considered to be a measure for improving audio of e-books for people using Kindle, it is also likely to give credence to rumors that the online retailer is moving closer to producing a smartphone of its own and give competition to Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG).


Amazon has organized its business into two segments: North America and International and reports segment-wise information in its annual results.

It is clear from the chart below that whereas net sales increased by almost 33% in quarter ended September 30, 2012 as compared to the same quarter in prior year. The figures for nine months also reflect a similar increase (34.76%). The problem, however, is of growth, particularly in the International segment, which is apparently dropping at a faster rate than that of North American segment.

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Another problem with the International segment is presented by fall in margins. According to a research firm, Tiburon Research Group, margins for the International division continue to fall, while those of the North America are improving slowly. The following chart says it all.

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Source: Retailgeeks.com


The following table shows Amazon's quarterly earnings per share for the last four fiscal quarters prior to the quarter ended December 2012, results for which were declared yesterday, January 29, 2013.

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For the quarter ending December 2012, some analysts had forecast an EPS of as high as $0.8, while some others saw a negative EPS of $0.38. The consensus forecast was $0.29.

Stock Price

What is interesting is that AMZN traded at its 52-week high before declaration of results for the fourth quarter despite the fact that it reported a net loss of $274 million in the quarter ended September 29, 2012 as against a profit of $7 million in the quarter ended June 29, 2012 and $130 million in the quarter before that. What is even more interesting is that it was also expected to report a loss for the fourth quarter.

Most of it was due to:

  1. A report in the Guardian that Amazon's cash pile and investments had increased to anything between $7 and $9 billion.
  2. Both EBay (NASDAQ:EBAY) and Overstock (NASDAQ:OSTK) reporting solid results.

Overstock is an online retailer that offers discount brand name, non-brand name and closed merchandise. With a market cap of $333.19 million, it is much smaller than Amazon. OSTK reported revenue of $342 million in the fourth quarter, which reflected a 9%-plus YOY growth rate and an EPS of $0.37, an increase of more than 100% over the same quarter prior year. Gross margin was up by 170 basis points to 17.9%

With a market cap of $72.02 billion, EBay is much bigger but not as big as AMZN (market cap:$117.93 billion). The company reported an EPS of $0.64 for the fourth quarter ended December 2012, 4.92% more than what was forecast by analysts.

Fiscal Quarter Ended December 2012

It was expected that Amazon too will come up with great revenue figures, which it did. Revenue at $21.27 billion in the fourth quarter 2012 rose by 22% as compared to the same quarter prior year. However, profit for the quarter was down to $97 million from $177 million in the same quarter prior year, a fall of 45%. EPS, which was $0.38 in December 2011, came down to $0.21 per share in December 2012.

The encouraging aspect of the fourth quarter results, however, was the improvement in operating margins, which rose to 1.9%. This was 0.4% up from the same quarter in 2011. The breakup of the two divisions was not easily available but if the overall increase on operating margin is any indication, improvement in International division, if any, would be insignificant.

The increase in operating margin is probably explains why the stock is still trading close to its all-time high - after having lost 5.6% on January 29, 2013, the stock regained 7% in after-hours trading session.


Investors may find 1.9% operation margin to be too small but that is price that AMZN must pay now to grab a bigger market share in the coming years. A bigger matter of concern is that at more than 150 times its next year's expected earnings, the stock is highly overvalued. With a relative strength indicator above 70, the stock is either overbought or is in a lasting uptrend, both indicating that a correction may come at any time.

On the other side, Amazon is a growth stock - analysts expect it to grow at a healthy annual rate of 28.64%. A lot depends upon Amazon's efforts for improving its operating margins in both divisions, particularly International division.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.