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Amazon.com (NASDAQ:AMZN) has a reputation of being a consumer-friendly company. But the same cannot be said of the way the company looks at investors in terms of paying dividends. The company has never paid any dividend, and it doesn't seem that this trend will change any time soon. Hence, this stock should be avoided by investors who look out for regular income in the form of dividend. The only way investors can generate returns out of the stock is by means of capital appreciation. Let's look at how the company's stock has performed in the past.

AMZN Chart

The stock has yielded a return of almost 532% during the period 2009 to 2012. That's a magnificent holding period return for the investors. This is despite the fact that the company's operating profit has declined since 2010. Going forward, the concern that I have about Amazon.com is its inability to convert the top line growth into a stronger bottom line result. This is the reason which makes me believe that the stock will see some consolidation at the levels of $300. The table below shows how inefficient the company has been in converting its sales into profits.

Particulars

2012

2011

2010

2009

2008

Net Sales

61,093

48,077

34,204

24,509

19,166

Income from Operations

676

862

1,406

1,129

842

Net Income

(39)

631

1,152

902

645

Basic earnings per share

(0.09)

1.39

3

2.08

1.52

Amounts in USD million.

Source: Company's 10-K Filings.

While the company has been able to more than triple its net sales during the 2008-2012 period, that hasn't reflected in the bottom line. The confidence shown by the investors in this stock, which has resulted in a robust stock price appreciation, is surprising. One probable reason of this can be that since the company cannot be valued on the earnings basis (because of negative earnings), the investors have valued it on the basis of its growing sales. If the company is valued on the basis of its trailing twelve months P/S multiple, the company's stock is worth around $341, which is the consensus target price for 2013.

Consensus estimated sales for 2013 = $74,385 mn.

Equity shares outstanding = 453 mn.

Sales per share = $164

P/S (NYSE:TTM) = 2.08.

Therefore, target price = 164*2.08

= $341.

Currently, the stock is trading at $316, so there is an upside potential of almost $25, by the end of 2013.

However, from here on, I believe that the company's stock will only move up if the company takes appropriate steps to convert its revenue growth into higher profitability. For this, the company has to undertake initiatives to reduce its operating cost.

This is how Amazon classifies its operating costs.

Nature of cost

2012

2011

2010

Cost of Sales

45,971

37,288

26,561

Fulfillment

6,419

4,576

2,898

Marketing

2,408

1,630

1,029

Technology & Content

896

658

470

Other operating exp.

159

154

106

Total

60,417

47,215

32,798

Amounts in USD million.

Source: Company's Filings.

Operating expense as a percentage of total net sales in 2010 was 96% which increased to 98% in 2011 and remained at the same level in 2012. This year it is expected to remain at the same level, and there are no signs of it being reduced in 2014 as well.

Since transportation cost forms almost five percent of the total operating expense of the company, let's look at how it fares as we move forward.

Addressing the 2Q conference call Mr. Szkutak, Amazon's SVP & CFO, said that he expects the company's transportation cost to continue to increase to the extent the customers accept and use shipping offers at an increasing rate. Also, as the company's product mix shifts towards the electronics and other general merchandise segment, and the company increasingly uses expensive shipping methods, the shipping cost of the company will increase which will further add pressure to the total operating cost. Here is an extract of the company's shipping cost in the last three years.

Particulars

2012

2011

2010

Shipping revenue

2,280

1,552

1,193

Outbound shipping cost

5,134

3,989

2,579

Net shipping cost

2,854

2,437

1,386

Amounts in USD million.

The company's net shipping cost has increased in the same proportion as the increase in revenue and this year also I expect the shipping cost to increase further.

Summary

I strongly feel that the company's management should take steps to control operating expenses. From a valuation standpoint, the stock at the current level shows an upside potential of $25 (if valued on a sales per share basis). However, I would recommend investors to exercise some caution before taking up any position in the stock, as its stock price can be very sensitive to any further reduction in earnings estimates.

Source: Will Amazon.com Be Able To Improve Its Profit Margin?