Amazon.com: Short Term A Guess, But Remaining Long-Term Optimistic

Oct.21.13 | About: Amazon.com, Inc. (AMZN)

Amazon.com (NASDAQ:AMZN) is expected to report its third quarter results later this week. Yet analysts at UBS are already upbeat about the firm's prospects after it gave Amazon.com a big upgrade at the end of last week.

While Amazon.com's stock could go anywhere in the short to medium term, I remain upbeat about the company's long-term prospects, and believe the "shorts" have the most risky position here.

As Amazon.com is completely focused on creating long-term value, the company is perfectly happy to sacrifice years of any earnings in order to achieve its goal. For now shareholders continue to support Bezos in this goal, with shares trading near all time highs.

Upgrade From UBS

Last Friday, analysts at UBS upgraded Amazon.com from "Neutral" to "Buy," while raising the price target from $305 to $385 per share.

The new price target implies that shares have some 24% potential compared to the closing price of last Thursday, before UBS issued the report. After Friday's 6% rally, potential returns have been limited to 17%, according to UBS.

Analyst Eric Sheridan upgraded Amazon on the back of Amazon's strong position in multichannel commerce. Sheridan believes the strong position should be converted into better operating results going forward, which in its turn should result in a good stock performance in the coming 12-18 months.

Sheridan cites three main reasons behind the upgrade. First of all is his expectation for a re-acceleration of revenue growth in the fourth quarter and beyond, as indicated by strong seasonal hiring trends. The globalization of the Kindle ecosystem should be another driver of Amazon's valuation. Sheridan furthermore believes that other analysts are not upbeat enough for the prospects of the advertising business.

Valuation

Amazon.com is scheduled to release its third quarter results on Thursday, the 24th of October. The company ended its second quarter with $7.5 billion in cash, equivalents and marketable securities. Total debt stood at $3.0 billion, for a net cash position of around $4.5 billion.

Revenues for the first six months of the year came in at $26.0 billion, up 18.1% on the year before. Net income nearly halved to merely $75 million in the meantime.

At the time, Amazon.com guided for third quarter revenues of $15.5 to $17.2 billion, up between 12% and 24% on the year before. As such, annual revenues could come in around $72 billion, as earnings should come in around the break-even point.

Trading around $329 per share, the market values Amazon.com at around $150 billion, or its operating assets around $145 billion. This values the operating assets of the firm at 2.0 times annual revenues.

Amazon.com does not pay a dividend at the moment.

Some Historical Perspective

Under command of CEO Jeff Bezos, Amazon.com is becoming a true powerhouse. Shares have roughly ten-folded from levels around $30 in 2006. Note that in 2013 alone, shares have already risen some 30% after shares started the year at $250 per share.

The reason behind these share price gains is continued high revenue growth. Between 2009 and 2013, Amazon.com is expected to nearly triple its annual revenues toward $72 billion. The company posted profits of around a billion per annum in 2009 and the year following, after which profits fell to essentially break-even levels in 2012 and in 2013.

Investment Thesis

Amazon.com's valuation and the continued momentum upwards continues to result in fierce debates between bulls and bears of the stock. Bears point to the lack of GAAP earnings, which can be related to "overinvestments" in distribution efforts, and the subsidizing of new ventures like Kindle and Amazon's cloud business, which most likely run GAAP losses at the moment.

Bulls continue their ride higher, although it remains difficult to attach real credible to numbers to support the long case. Therefore shares could essentially go anywhere in the short term, yet the long-term growth success would arguably make a long-term bearish position much more risky, like it has done over the past years, in my view.

Amazon.com continues to make a lot of money from the actual sales of goods through its own and third-party seller platform. Yet it is the delivery of these goods which is being subsidized through Amazon prime to drive customer service. The company furthermore continues with its ambitions to create a cloud business while creating a formidable ecosystem through its Kindle.

To all the bears out there, Amazon.com has certainly demonstrated it can earn decent profits. Note that it earned around $1 billion in 2009 and 2010, when revenue were $24.5 billion and $34.2 billion, respectively. While incredible growth ever since most certainly has been subsidized to some extent, through Prime shipping for example, it is too easy to say that the company is no longer earning money on its main business.

That being said, operating earnings fell from levels around 5% nearly a decade ago to current levels around 1%. That being said, the North American activities, which are the best performing activities of the firm, generated operating earnings of 4.6% in the second quarter. Also note that if Amazon.com would achieve similar margins as it did in 2009, operating earnings would come in around $3 billion per annum, still not enough to justify a $150 billion price tag.

Back in July of this year, I last took a look at Amazon.com's prospects. Shares were trading around $300 per share in the wake of its second quarter results. I concluded that under command of Bezos, Amazon.com is completely focused on boosting long-term profitability and value of the firm, and that Bezos is perfectly happy to sacrifice years of any earnings to achieve those goals.

I continue to stress that traditional valuation multiples, like price-earnings ratios, are not so much applicable to Amazon.com. The focus on long-term earnings even results in the fact that shares are not even selling off after missing consensus estimates. Note that Amazon.com is not immune to a "miss," it is just that investors focus on revenues over earnings at this point in time.

I will not initiate a position, but will keep a close eye on the stock. While I agree that a violent sell-off of 20%-30% could easily occur, the stock continues to show decent momentum for now. I remain a very long-term optimist about Amazon's prospects. To my opinion, shorts continue to have the most risky position in the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.