Amazon: Guidance Miracle Is Not in the Cards

Amazon (AMZN) has rallied almost 50% from its 52 week lows, so expectations for the fourth quarter appear to be quite high. Management’s hype that they had the best Xmas season ever could backfire, because it could be setting them up for disappointment. The company would have been much better served by keeping a lower profile in an effort to under promise so it could over deliver. AMZN shareholders are hoping that the company meets estimates and maintains guidance, but doing so is a very tall order.

Fourth quarter estimates: Wall street is looking for AMZN to produce earnings of 39 cents on sales of $6.44 billion and chances are this should be met or slightly beat. The key, however, is all about guidance. If AMZN guides lower or fails to guide at all due to the current economic chaos, the stock would certainly plummet. Holding the shares into earnings is very risky, because the shares offer about $20 of downside versus $5 of upside. This represents a very poor risk reward ratio of .25, meaning the holder is willing to risk $20 in order to make $5, not a good wager at all.

Buy the rumor-sell the news: Most of the smart money has already gone long and will be looking for any good news as an opportunity to sell into strength. The stock is headed for a fall either way, as its rich multiple must come back to earth.

Guidance: Wall Street will be focusing much more on first quarter guidance than fourth quarter results, as Wall Street’s passion is all about the future, not the past. I expect AMZN to guide down on its first quarter expectations of revenues of $4.57 billion and earnings of 31 cents to somewhere in the vicinity of $4.45 billion and 26 cents. I think a ratcheting down of expectations is inevitable, but how much of these lowered expectations has already been factored into the share price? Probably not enough.

Gross profit margin compression: AMZN produced a 23.4% gross profit margin in its third quarter. Heavy discounting and promotions will result in a scalping, and a 100 basis point decrease to 22.4% for the fourth quarter is likely. The company’s fulfillment costs of 9.2%, Technology of 6.1%, Marketing of 2.5% and General and Administrative of 1.7%, all have been trending higher and should eat into AMZN’s bottom line. Other factors which could pressure earnings are: a stronger dollar, a higher income tax rate, and lower interest income on cash and marketable securities. AMZN has seen its cash hoard decline 35% in the last year from $3.1 billion to $2.3 billion and interest rates have fallen considerably.

More share dilution: There has been a 2.6% increase in outstanding shares from 425 million to 436 million within the last year. This will have a negative impact on earnings because they will have to be allocated through a larger number. Another potential area for concern: Will AMZN also announce an employee option re-pricing plan, just as GOOG did when it fleeced $500 million from its shareholders to do so?

Bottom line: AMZN will probably beat estimates, but that won’t be enough to keep the share price from imploding because guidance will ultimately be on the soft side. I would cover any short position in the mid thirties.

Disclosure: Short AMZN.

Comments

[soonerxii:]

Back when AMZN was 35 bucks a share in 07 I shorted it based on similar reasoning, and that sob went triple digit on me. I'll be a put buyer in amazon eventually, but not right now.

Jan 30 09:55 AM

[seattleite:]

Are you one of the shorts who is covering today and pushing up AMZN share prices. You must be. I commented on one of your previous articles that your basis for shorting AMZN is weak, but...well....good luck covering..

Jan 30 03:01 PM

[Alan Young:]

I'm glad I didn't read this before the earnings came out. I"m happily shorting at 59-- let's see how long a P/E of 40 lasts in this market.

Jan 31 01:46 PM

[Mark Krieger:]

I admit I was wrong....and have been severley punished for it...about a $10K loss so far..and no I have not covered yet.I guess I am a glutton for punishment. The problem with this company is the company's new PE after the 20% runup is nearly 40 times estimated 2009 earnings of $1.49---that is a very rich valuation versus GOOG, CSCO, MSFT INTC or RIMM or AAPL. The bar has been raised even higher for AMZN--a dangerous proposition. The company's gross profit margin declined an additional 50 basis points from 20.6% to 20.1% and its first Q guidance was sketchy to sat the least..the range was big enough to drive a semi through--with revenues in the range of $4.5 B to $4.92 billion and earnings of between $125 million and $210 million. If you look at 4th q results vs 4th Q guidance-- AMZN came in 30% from the top of its range on both revenues and earnings--if they achieve this same result again in the 4th Q, they will record revenues of $4.8 billion and earnings of $175 million.--the funny thing about 4th Q guidance was the company still came in within its guidance range, albiet near the top of it.--yet the stock exploded--look for a dose of profit taking to hit once reality starts to set this Monday.

Jan 31 03:16 PM