Amazon's (AMZN) announcement of its 1Q earnings prompted me to consider the intervening events since my article about this company, "Shopper Beware: Buy Anything at Amazon Except Its stock", from Feb. 4, 2013.
Amazon's business is doing extremely well. First quarter 2013 saw big revenues of $16 billion, up 22%. Forays into hotshot areas like cloud storage are gaining traction. The company has an infinite appetite for the consumer's wallet and is creating innovative products engaging customers in all aspects of media, devices, shopping and music.
Despite this bravo performance, Amazon investors are having a less than sanguine go of it. The stock attempted a rally after hours only to get clobbered the next day and sold again the day after. Since the announcement, AMZN is down 25 points, approximately 9%. This is especially depressing considering the S&P 500 hit new highs during this period.
With the business great and the stock not so great, we face a question: what is this company worth today? Amazon is not an easy business to value as it has many components that could carry different multiples of earnings, different growth rates and different gross margins. The company does not help answer the question as they do not detail the numbers by product line. The following information is from Amazon's call transcript:
At a high level, we know that electronics and general merchandise composed 63.8% of sales. "Media" represents 31.6% and "Other", which includes Amazon Cloud, is about 5%. We also know that with a sales run rate of $64 billion, sooner or later the company is going to produce profits. Here we get to the meat of the matter regarding profits: how much is there and when are we going to get it?
Amazon did a good job with gross margins, with cost of goods sold at 73.4% of sales. This compares will Wal-Mart's (WMT) COGS of 75% or Target Corp's (TGT) COGS of 68.9%. We know that TGT and WMT tend to have bottom line Net Income between 3% and 4% of gross sales (see TGT annual report and WMT annual report). I will apply a 4% Net Income assumption to a gross yearly sales figure of $73 billion, a sales number the company might make in 2013. This would deliver $2.9 billion of net income.
In fact the company will not bring in an income number anywhere near this, however, I am looking past the large investments that mask underlying profitability. This would imply underlying earnings per share of $6.20. Now we will assign a multiple, and I will use 35 times earnings. Some might argue for a higher multiple, but we are working with earnings that are not yet in existence, and a thoughtful investor may not want to pay a higher multiple, at least till we actually see the money. That leaves us a price of 217 per share. I think it's quite generous. Investors can do better elsewhere and should avoid this stock for now.
Myriad factors can disrupt this valuation. If we value Amazon at a multiple of sales that resembles Target Corp. or Wal-Mart, we would get a far lower valuation. If we more strongly weight the "media" portion of the business, the valuation could be stretched higher.
Amazon is facing some headwinds: sales softness in Europe, along with brewing labor unrest in Germany. Sales tax law in the USA will reduce Amazon's competitive price advantage. Amazon disclosed 68 days of payables outstanding on the quarter. This means it is a whole lot more fun to be a customer of Amazon's than to wholesale to them. In fact, there are lawsuits outstanding for slow payment brought by third party sellers. Third party sellers make up about one third of unit volume. The lawsuits by themselves are not material, but open the potential for sellers to seek more generous terms from competitors and evidence unhappiness with Amazon's slow paying ways.
Amazon's management is intelligent, aggressive, articulate and extremely driven. Their "head's down" focus on execution and innovation garners admiration from Wall Street and Main Street. The stock is still too high at the current quote. I recommend not purchasing this stock until the price is lower and the path to profitability is better illuminated.