Internet retailer Amazon (AMZN) will release its Q3 2013 earnings on October 24. Evidence suggests that while the company’s growth will exceed that of the overall e-commerce market, it is likely to come down as compared to the third quarter of 2012. The primary reason behind this is Amazon’s growing size and the recent slowdown in the U.S. e-commerce market.
In Q2 2013, Amazon’s revenues jumped 22% globally, with the electronics and general merchandise segment leading the way. Despite this, the company reported a net operating loss and missed consensus estimates, which reflects the pressure on its margins resulting from the rapid expansion. This trend is likely to continue in the third quarter as Amazon remains committed to driving its sales volumes. This strategy could be risky if market dynamics were to change and brick and mortar retailers launch a full-fledged assault on Amazon’s turf. The established retailers such as Wal-Mart (WMT) already have a strong supply chain and are certainly capable of matching Amazon in prices. Our price estimate for Amazon stands at $280, implying a discount of about 15% to the market price.
Amazon expects net sales of between $15.45 billion and $17.15 billion in the third quarter, implying a growth of somewhere between 12% and 24% over Q3 2012.  The operating loss is likely to increase, but the majority of it will result from higher stock based compensation.
We Expect A Slowdown In Q3 Growth, Long-Term Growth Outlook Looks Good
In its Q3 2013 earnings announcement, eBay raised concerns about the slowing e-commerce growth in the U.S. Even a comScore report suggests a slowdown in the growth in the month of August. We believe that some of this can be attributed to the recent standoff within the government and debt ceiling concerns. The macroeconomic situation in the country is still not very sound and Amazon could feel the impact in the near term. However, given that Amazon operates in an industry, which is witnessing explosive growth across the globe, the risk from short-term fluctuations is small. According to eMarketer’s September report, overall e-commerce retail sales in the U.S. are expected to reach $260 billion in 2013, representing close to 16% growth over the last year. This is still a fraction of the country’s total retail sales, which indicates large room for growth. The same market research firm forecasts U.S. online retail sales to grow at a CAGR of 14% over the next few years, surpassing $434 billion by 2017. 
Comparing ChannelAdvisor’s same-store sales (SSS) metric for eBay (EBAY) and its actual results for the third quarter, we conclude that the overall growth stood meaningfully below the SSS.    If the same were to happen for Amazon, its growth could certainly dip below what it was in the second quarter of 2013, and not just below the figure for Q3 2012. The SSS metric tracked by ChannelAdvisor shows a clear sequential decline for Amazon.
Margins Will Continue To Remain Thin
Although Amazon’s diversified product portfolio and growing e-commerce business will support its strong revenue growth, there are factors that suggest there could be margin pressure going forward. The company, which is in the middle of setting up a number of fulfillment centers to roll out same day delivery, is battling growing competition in the cloud/web services front, and is spending heavily toward the development of its content library.
All of these activities are cost-intensive and will negatively impact its already thin margins. In addition to this, big retailers such as Wal-Mart are ramping up their online efforts, which will negatively impact Amazon’s profitability due to higher competition. The company is also expanding internationally and trying its hand at groceries, which tends to be a lower margin business. Amazon is clearly not bothered about doing anything regarding its percentage margins as evident from the management’s statement, as long as lower margins imply higher cash flows.
The retailer’s EBITDA margins declined from close to 9.5% in 2008 to around 6.6% in 2011, followed by a slight rebound in 2012. If this decline continues and the figure shrinks to around 4% by the end of our forecast period rather than 7.5% as we currently project, there could be around 30% downside to our price estimate. We believe this risk is justified given the recent margin declines we have seen in recent years.
Disclosure: No positions.