Amazon (AMZN) is reporting earnings on April 25th, and investors are hoping for good news after the company's string of poor results dating back to the second quarter of 2013.
Over its past three quarters, Amazon has missed earnings by an average of 240% -- the percentage number is skewed much higher because the company reported a much wider-than-expected loss in the third quarter of 2012 - 60 cents per share versus an expected loss of 8-cents (i.e. a 650% miss). That doesn't mean the other two quarters were far better for investors - it earned just a penny in the second quarter of 2012 against expectations of 2 cents. Meanwhile, its fourth quarter 2012 earnings were 7 cents below expectations, with the company reporting a profit of 21 cents versus estimates of 28 cents during what is typically its strongest quarter.
To be sure, retail had a tough environment in 2012 - retail sales ex-Autos, as reported by the U.S. Department of Commerce, rose by just 4.6% in 2012 after rising by 7.3% in 2011. It hasn't gotten much better this year - March 2013 year-to-date retail sales were up by just 2.2% -- possibly as a result of the January 2013 tax adjustments and the impact of budget sequesters.
In such a tough environment, it's hard to see Amazon reporting very strong first quarter numbers. Unsurprisingly, equity analysts expect Amazon to register just 9 cents per share of profit in 1Q2013, just under a third of the 28 cents it earned in the same period a year earlier. What's more, the low end of expectations for Amazon is for a loss of 29 cents; that is, at least one analyst is expecting a complete giveback of its profits from a year earlier.
It is therefore no surprise that Amazon's stock has trailed the major indices in 2013: it is up just 3.8% in the year to date, compared with 9% for the S&P 500 and 6.2% for the NASDAQ composite in the same period.
So what's next for the retail giant and should investors consider investing in it? We look at two areas:
1. Growth. After a tough first quarter, Amazon is expected to do far better in the second quarter. Average estimates peg Amazon's second quarter earnings at 22-cents per share, or 2,200% what it earned in the same period last year. For the year, Amazon is forecasted to $1.47 per share - a very strong turnaround from its loss of 9 cents per share in 2012 - driven by an expected 24.1% rise in earnings.
It gets better in 2014, when Amazon is expected to earn $3.55 per share, more than double this year's forecasted earnings. It will do so on revenue growth of 22%. Given the lower growth rate in 2014 compared to that forecasted for 2013, this implies that Amazon's growth will come from wider margins.
Naturally, all these numbers are prospective - analysts will adjust their estimates depending on how closely Amazon's actual performance hews to their forecasts. It does bear pointing out, however, that these numbers already consider that Amazon had a rough time going over the trailing 12 months so it is encouraging that its forward prospects are have not been discounted heavily.
Indeed, Amazon is expected to see earnings growth averaging 37.7% over the next five years - more than triple the 12.1% growth of its industry. It should be noted that this earnings growth figures is skewed higher in Amazon's favor because of base effects; that is, having come from a loss, any positive earnings will have a substantial impact on growth numbers.
That said, Amazon's earnings growth is still impressive, but where will it come from? Amazon is already the largest online retailer and it is unlikely to see its margins climb in this space, particularly as it battles taxes on online sales and sees-off challenges from other online retailers such as Overstock.com (OSTK). In all likelihood, Amazon's growth could come from its mobile and media divisions, specifically its Kindle line of Android-based tablets and Amazon studios.
On the former, Amazon has been discounting its loss-leading Kindle Fire HD tablets aggressively, ostensibly to take advantage of burgeoning tablet demand worldwide that, in turn, should spur the downloading and use of apps, on which Amazon earns higher margins on. As apps become a larger part of its sales mix, these should help Amazon improve its gross margins, which at 25.6% are nearly 10 percentage points lower than its industry peers.
On the latter, Amazon is clearly still in the early stages, but it is evidently taking a page from Netflix (NFLX), which has had success with its original programming and has seen its stock rocket higher in 2013 after being in the doldrums from the middle of 2011.
Amazon is making a big bet on this and other products such as the Kindle and its web services unit. To wit, Amazon's capital spending has grown at an average annual pace of 68% over the past five years - more than triple the rate its peers have invested at and 17x faster than the average S&P 500 company.
2. Valuation. Amazon is hardly cheap - at 77x forward earnings, it is trading at a significant premium of 53% to its industry's 50.3x forward earnings. It is also the second-most expensive company in its industry by earnings growth at 4.7x - only Overstock.com is higher at 7.1x earnings. Needless to say, Amazon is at a considerable premium to the S&P 500 in both these areas.
Interestingly, on a price-to-sales basis, Amazon is trading at a discount to its peers - but this should not be a huge surprise considering Amazon's better-than-industry sales growth of 33.7% compared to its peers' 12.75%. Moreover, because Amazon is an established entity with vast operations, it carries more tangible assets and trades at a discount to its peers on a price-to-tangible book value basis: 21x vs. 21.5x.
All this being said, it would be a considerable stretch to say that Amazon is undervalued.
However, while it is true that Amazon's valuation ratios are high, many of the valuation metrics consider data from the past five years when tablets hadn't yet gone mainstream and when streaming media was the province of Netflix and its rivals (some of which are no longer around). As its capital spending intimates, Amazon believes the paradigm has shifted and it is clearly diversifying into other areas with the intent of capitalizing on their untapped potential in a manner that will allow it to grow its revenues at a faster pace - and where its margins should be better.
Fortunately for Amazon, it can continue to invest in other ventures. Its cash levels are not industry-leading: its current and quick ratios, at 1.1 and 0.8, respectively, are more similar to that of supermarket chains than other online retailers/mail order services - but its debt levels are quite low. At 0.38, its long-term debt-to-equity ratio is less than half that of the typical S&P 500 company (this is more relevant than comparing its debt ratio to its peers because Amazon is a far larger and more valuable entity), which implies that it could take on more debt if it needed to expand its capital spending further.
All things considered, Amazon does show promise going forward, but it is still too early to recommend buying the stock at this time considering its high price and the possibility of a negative earnings surprise given the soft retail environment.
The discounting of its Kindle tablets also gives pause, since Amazon is quite cagey with figures. While this could be a strategy to win market share from Apple (AAPL) and fellow Android device makers such as Samsung (OTC:SSNLF), one has to assume at least half-assume that it is not performing to internal expectations.
In that sense, those looking to enter the stock should wait for a price correction of say 10% before entering a position into Amazon.
Additional disclosure: Black Coral Research is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.