Amazon's Recent Earnings: Nothing More Than a "Modest Beat & Raise" Quarter

Caris & Company analyst Tim Boyd addresses clients on Amazon.com's (AMZN) recent earnings report (earnings call transcript). His note follows:

Solid Revenue Growth, But Continued Margin Compression & Aggressive Valuation Reinforces Our Negative Bias; Maintain 4*/Below Average

Amazon reported a Modest Beat & Raise September quarter – revenues of $2,307MM and $0.05 in GAAP EPS topped Street expectations for $2,248MM and $0.03, respectively. December quarter guidance for $3,788MM in revenue and $190MM in operating income also came in modestly higher than consensus ($3,679MM and $185MM, respectively).

Revenue growth was impressive. AMZN’s Y/Y revenue growth rate rose to 24% in 3Q06, a nice acceleration from the 22% rate seen last quarter, but...

...a 14% run-up in the shares during aftermarket trading? OK, AMZN beat Q3 estimates and gave healthy top- line guidance – but were the numbers 14% better than expected? In contrast, GOOG shares traded up less than 10% after reporting what we view as a much stronger quarter. We find it very difficult to justify this disparity. AMZN’s current valuation is nearly twice as high as EBAY’s (arguably its #1 e- commerce competitor) and considerably higher than GOOG (clearly the cream of the Large Cap Internet crop). In our view, AMZN is a stock that continues to live on borrowed time, and unless the company can begin to drive a meaningful portion of that impressive top-line growth through to the bottom line it will become increasingly difficult to justify the inflated share price.

Another all-time low in AMZN’s operating margin. The pro forma operating margin fell 60 bps sequentially and 280 bps Y/Y to 3.1%, yet another all-time low. Although we do believe that 3Q06 will mark the trough quarter in terms of operating leverage, it is important to remember that not long ago AMZN boasted operating margins as high as 8%. The aggressive valuation boasted by the stock seems to imply that these margins will quickly rise back towards this 8% level – an unlikely scenario, in our view. We believe that the market continues to underestimate (a) AMZN’s reliance on free shipping to drive top-line growth and (b) the amount of op-ex spending (especially on the Marketing line) that will be required for AMZN to maintain its competitive advantages in the space.

Full-year 2006 revenue guidance up 3.5%, operating income guidance down 14% relative to the beginning of the year. In other words, management is guiding to an even worse operating leverage picture than it did last quarter. Yes, this guidance implies a 10 bps Y/Y expansion in operating margins, but it’s a little hard to get excited about that when revenue growth has re-accelerated to 24% Y/Y.

Big rise in inventories warrants a wary eye. Investors should take note of the 61% Y/Y growth in AMZN’s inventory levels during 3Q06. The increased inventory is likely a reflection of greater selection across more categories (toys, grocery, etc.) but it nevertheless results in greater risk, especially if the 4Q06 holiday shopping season turns out to be worse than expected.

Valuation unjustified, in our view. Assuming an opening price of $38.50 (based on aftermarket trading last night), we view the market’s current valuation of AMZN as increasingly difficult to justify, especially relative to peers. To wit, AMZN now trades at 31x our 2008 pro forma EPS estimate while GOOG, EBAY and YHOO trade at 25x, 20x and 19x, respectively.

Large Cap Internet Stocks -- Relative P/E Valuation

We are adjusting our 2006, 2007 and 2008 estimates as follows:

AMZN - Changes to Estimates

We are raising our 12-month target valuation to $30 from $28. $30 is 25x our 2008 pro forma EPS estimate and 11x our 2008 EBITDA-per-share estimate.

click to enlarge

AMZN 1-yr chart: