Currently trading at a price-to-earnings multiple over 1,400, it is no secret that Amazon.com (AMZN) stock is not cheap: yet as I do with any overpriced stock, I try to see if that valuation is valid. Now, some "value" investors may find it appalling to pay up for expensive stocks; however, with the emergence of the efficient market hypothesis and the evolution of time; I find it increasingly difficult to find undervalued stocks that still have a dependable future business. I am not saying you should go out and buy all the high flying story stocks you hear about on CNBC: but I am saying that some of those high flyers will continue to fly, eventually growing into the potential priced into their respective stock.
AMZN is one of those stocks I expect to continue rising. The consistent execution along with the successful growth tactics employed by CEO Jeff Bezos has demanded attention from both the e-commerce and the traditional retail industry. As online and mobile platforms continue to gain popularity amongst consumers, I believe Amazon.com is very well positioned to gain market share, and capitalize on growth opportunities. The company gets ready to release earnings after the close Thursday; and there is a very good chance that results will surprise analyst expectations, underpinning the stock price. However, along with 2013 Q4 earnings estimates that appear to be a bit inflated, other headwinds are present which could hurt the stock immediately following the earnings release. I will outline those headwinds along with my potential trade strategy going into tomorrow's earnings release below.
2013 Q3 Highlights
Below is a table of key financial metrics I pulled from last quarter's press release.
2013 Q3 Highlights
Y/Y % Change
$(41M) from $(274M)
Operating Cash Flow
Free Cash Flow
Total Operating Expenses
Technology & Content Expense
While the company did increase top-line sales by 24% year-over-year (Y/Y), none of that growth managed to reach the bottom line, which finished the quarter with a net loss of $(41M). Free cash flow suffered dramatically with over $1.4B in outflows occurring via the purchase of corporate office space and property in Seattle. Total operating expenses also increased proportionally with the increase in sales: offsetting profit potential. Operating expenses were lead by significant increases in technology and content expenses along with fulfillment center expenses. Although bottom-line earnings have been missing for the company, it's well documented that CEO Jeff Bezos consistently chooses growth over earnings. The company increased its operating cash flow by 48% Y/Y last quarter, however, expansionary growth takes priority to bottom line growth for Bezos, which explains the company operating at a net loss. It should be noted, however, that last quarter's loss of $(41M) is far less than the loss the company took in Q3 of 2012, which was $(274M).
In a press release last week, Starbucks (SBUX) CEO Howard Schultz stated, "holiday 2013 was the first in which many traditional brick and mortar retailers experienced in-store foot traffic give way to online shopping in a major way." He continued to state that Starbucks was positioned "as one of the very few consumer brands with a national and global footprint to benefit from the seismic shift underway." Best Buy (BBY) also echoed this notion as it saw holiday same store sales decrease 0.9% Y/Y but holiday online sales increase a whopping 23.5%. Further, online retailer eBay (EBAY) recently reported 2013 Q4 revenue that was up 13% Y/Y, EPS that was up 14% Y/Y and enabled commerce volume that was up a hefty 22% Y/Y. The online consumer evolution is undoubtedly underway as these companies have demonstrated; and if Starbucks, the coffeehouse chain, can "benefit from the seismic shift underway," I believe Amazon.com (the world's largest online retailer) can surely prosper.
Let us not forget either two of the prime reasons consumers look to online retailers: convenience and price. From a convenience perspective, it is easy to see the benefit of e-commerce and from a price perspective, the elimination of various fixed costs enables online retailers such Amazon to offer attractive prices relative to those of brick and mortar stores.
Safety and weather concerns are also notable factors to consider when evaluating the potential shift retail shoppers may be undergoing. Companies have noted unfavorable weather conditions in a handful of recent earnings calls, however, contrary to the traditional retailer, Amazon.com serves as a viable, substitute retailer for many of the goods and products consumers could not purchase from traditional brick and mortars due to weather. Turning to safety, increased mall shootings during the last part of 2013 are likely to have discouraged some consumers from shopping at malls and regular shopping areas: another factor that would benefit online retailers such as Amazon.
Last quarter the company highlighted various company developments that would be influential in its future progress. The company continues to develop and innovate its Kindle tablet: introducing a new version last quarter, which was lighter, included new features and also contained an enhanced camera. While the price point of this tablet is attractive, my positive view of the company does not rely much on Kindle sales performance as it competes with the likes of Apple's iPad: a product I find more likely to win the tablet battle. Moving on, the company green lighted the production of six new pilots for kids and 3 more to be written by award winning writers for its Prime Instant Video business. While competitors in this space such as Netflix (NFLX) may be a bit more solidified, this business enjoyed a successful first round of pilots last April and may be able to gain share. It will be interesting to monitor new developments the company may report regarding Amazon's Prime Instant Video.
Amazon Art, a marketplace that gives customers access to over 40,000 works of art from over 150,000 galleries, was also launched during the last quarter. Initially, my reaction to this business was negative: believing affluent art investors see the gallery setting as a social outing. However, due to the company's track record of execution, I will be interested to see how this new business has held up since its launch and a positive update will not surprise me.
Lastly, Amazon Web Services, the company's cloud computing platform, gained momentum in the public sector over the last quarter increasing its customer base to over 2,400 educational institutions and 600 government agencies. The company has also been engaged in new projects with customers such as the Federal Drug Administration and I expect this success to continue.
Below is a table of valuation ratios for Amazon.com and relative competitors.
There is no technique to see Amazon's valuation as anything but expensive, however that being said, I do indeed believe the company's growth prospects are greater than those of its competitors. While companies such as Netflix also operate with high plow back ratios, Amazon's price-to-cash flow (P/CF) multiple is far less than that of Netflix. The company also operates with a noticeably lower enterprise value-to-EBITDA multiple than that of Netflix: implying that Amazon generates a higher amount of overall cash flow relative to the current enterprise value of the total company. While companies such as Best Buy or Barnes & Noble Inc. (BKS) may appear to have better valuation multiples, these companies have uncertain revenue and earnings stories as they have both struggled to grow and sustain top-line and bottom-line growth over recent quarters.
My negative trepidations regarding the stock stem primarily from Wall Street and its sentiment regarding the company. As the stock has enjoyed a crescendo like rise over the past few years, the street has consistently been alright with the company's lack of profits. The company has continued to grow, and I wonder if and when the street will begin looking for bottom-line profits instead of consistent re-investments in the business? In addition, fulfillment costs increased over 34% last quarter. I understand increasing expenses will be unavoidable with expansion; however, similar to my first concern, I will be paying close attention to investor sentiment regarding growing expenses.
Moving forward, new initiatives such as the further development of Prime Instant Video and Amazon Art still need to prove themselves. Hiccups in those initiatives could lead to hiccups in the stock's price action following earnings. Lastly, I fear analyst estimates may be a bit on the heavy side. Last quarter the company guided for Q4 revenues to fall somewhere between $23.5B and $26.5B, however current estimates are looking for revenues of $26.07B: much closer to the high of the range management provided last quarter.
As global turmoil has brought down the entire market landscape over the past month, bright spots will be found amongst earnings and Amazon very well has the potential to be one of those spots. With the market trading sloppily as I mentioned, I am not looking to increase any equity exposure; however, a defined risk bet on this name into earnings is something I am interested in.
At the open Thursday, I'm looking to buy the weekly January 390 calls for about $11.70 and to sell the weekly 400 calls for about $7.70: giving me a net debit of $4.00 per option in my account. My return to risk ratio is 2.5/1 as I am risking $4.00 for a maximum gain of $10.00 per option. These options expire on Friday and thus this trade is a very short term speculative one. I will be out of the trade regardless of what occurs post-earnings by Friday Morning. If earnings come in solid, as I suspect they will, I'm looking for at least a 4% move higher which would break the stock back above the $400 level it reached in December.