Amazon Suffering From A Lack Of Focus

Investopedia Advisor submits: Don’t get me wrong. Amazon’s (AMZN) chief exec, Jeff Bezos has done a terrific job at building out the website, expanding its product offerings, and making the company a household name. But its second quarter earnings (released last week) just plain stink. And given the company’s current cost structure, and management’s near term earnings-related guidance, I can’t help but think that the shares have more downside then upside, at least for the next six months.

Here is what I am seeing:

The Big Picture
First off, from a 10,000 foot view, just look at Amazon. They sell seemingly everything. In some ways that’s a good thing, because it means it will appeal to a wider audience. But in many ways it’s a bad thing because it means that they don’t have a real specialty where they can focus and build out a niche.

Amazon used to be known for just books. Then it was books, and toys. Now they are almost an online Walmart (WMT).

Again, it’s a good thing for consumers, but a bad thing for a company that needs to limit its spending and sell higher margin, non-commodity related items.

Operating Expenses Pinch
This is kind of an extension of what I was saying above, but take a look at Amazon’s second quarter operating expenses. In the quarter, they totaled $462 million, or about 21.6% of sales, whereas in the same period last year, they totaled $346 million, or about 19.7% of sales.

Now it’s not the total dollar figure of operating expenses I’m concerned about, it’s the percentage increase. In my mind, Amazon isn’t some new fangled company that should need to be doling out huge dollars for technology and promotions at this point. If it really had a solid niche and a competitive advantage, it should be at a point where it can hang back a bit on technology and promotions spending and just let the profits run. But unfortunately, it can’t. In order to drive sales, and compete with the likes of its bricks and mortar counterparts, Borders (BGP) and Barnes and Noble (BKS), management is spending a fortune on promotions (both coupon-based and free shipping). This is not a great sign, again, because in my mind, Amazon is a household name that should ideally, at this point, have more leverage, and not have to discount merchandise or promote like a discount retailer in order to garner customers.

Lack Of Insider Enthusiasm
Bezos and his crew want us to believe that Amazon is well-positioned for the long term and that the company’s investments have set it up to reap big profits down the line. But if that is the case, why hasn’t management put its money where its mouth is? Rather, over the last six months, insiders have sold off more then 270,000 shares (mostly option-related).

If Amazon, which is trading near the lower end of its 52-week trading range, (actually, near a three-year low) were such a bargain, wouldn’t you think senior officers would be buying en masse?

Guidance Lowered
Management said, in conjunction with the earnings announcement, that it expects operating income in fiscal 2006 to be between $310 and $440 million. That’s down about $85 million from previous guidance, and would be flat to down from last year. Aren't internet-based companies supposed to enjoy better leverage and higher margins? Plus isn’t the second half of the year usually great for retailers?

Put another way, heading into the second half of the year, the guidance reduction is not a good omen.

Competition Picking Up
Look around, Borders and Barnes and Noble are popping up all over the place with their comfy chairs and Starbucks (SBUX) coffee inside their stores. Plus the Barnes and Noble website is looking darn good these days! And don’t forget about Yahoo’s (YHOO) online shopping stores, or Wal-Mart and Target’s (TGT) stores and sites. Whereas once Amazon had an online lock on many of the businesses it was in, it now has to compete against a host of other deep-pocketed companies. Some of which I think (Wal Mart and Target specifically) have a lot more staying power then Amazon.

New Business Opportunities May Take Years To Materialize
I am not blaming Amazon for its strategy. If I were a senior member of the management team, I would probably be trying to enter new, profitable ventures as well. But the grocery business? Recently the company began its foray into groceries, which is typically a low-margin business to begin with. And although the company is selling a host of brand-named goods, and items that will satisfy growing trends (like its organic food line), I think this will take years to materialize.

Don’t get me wrong. With the company offering consumers a $10 rebate on anything they spend over $49, they are likely to garner some customers. But over the long haul, they will need to promote this business, and I think it will take years to develop as a major profit generator.

As an aside, I question why they are going into this business in the first place. The grocery business is notoriously competitive. And if you have to give away big coupons and throw in free shipping just to get business, I don’t understand how, as a company, you are going to make any money for the long term. I guess that remains to be seen.

Oh, and by the way, check out the grocery section of the site. I don’t think the deals are that good. Certainly they aren’t competitive with the big name discounters, whose stores I will already be in to do other shopping.

In short, Amazon has built itself into a pretty formidable online retailer. It offers a huge array of quality products that it delivers in good condition, and on a timely basis. I have ordered things from Amazon, but as an investment I just can’t consider it a bargain at this time. I’d rather wait for a big sell-off, perhaps near year-end as funds dump the shares for a tax loss, or if the company ratchets down future numbers because of increased expenses, or a slower than expected Christmas season.

Again, the bargain hunter in me, wants to buy Amazon on the hunch that sooner or later the company will get its act together and the shares will move higher. But the realist in me thinks that this stock is more likely to go to $20, before it goes to $30.

AMZN 1-year chart:

By Glenn Curtis, Contributor - Investopedia Advisor

At the time of release Glenn Curtis did not own any shares in any of the companies mentioned in this article.