For the past decade, Amazon.com (NASDAQ:AMZN) has been one of the market's best growth stories, and investors have done exceedingly well as a consequence with shares jumping from $40 to a high of $408. While Amazon has dramatically grown revenue thanks to market share gains at the expense of brick and mortar retailers, Amazon has been unable to generate consistent profits due to low gross margins and high R&D and cap-ex spending in an effort to develop new products and better logistics. The lack of profits has been a major reason why value investors have hated the stock for years. After all, the stock will not earn money this year but trades north of $320, and it appears the market is getting tired of the lack of profits now that revenue growth is also slowing with shares down over 10% on Thursday after earnings. With weakening momentum and challenged profitability, I expect shares to continue trading lower. I expect Amazon to hit $200 before $400.
In its second quarter, Amazon lost $0.27 on revenue of $19.34 billion compared to expectations for $0.15 on sales of $19.36 billion (all financial and operating data available here). Revenue growth was a solid 23%, and investors might expect some of this growth to flow through to the bottom line. Unfortunately, the reverse happened with a 2013 operating gain of $79 million turning into a $15 million loss this year. This loss came despite a favorable move in currencies that increased income by $31 million. Thanks to the weak operating loss, Amazon reported a net loss of $126 million, which compares unfavorably to a net loss of $7 million last year. Even with dramatic growth, Amazon has proven itself incapable of generating sizable and consistent profits.
Now, I respect management's focus on building a long-term business rather than trying to goose near-term profits, but there is a middle ground between investing and earning some money for shareholders. After all, while Amazon is still a high-growth company, it is not exactly a start-up as it will generate over $85 billion in revenue this year. Unfortunately, it sells products like the Kindle for a loss while logistics costs are eating much of its 30% gross margins. Amazon should consider increasing its expense discipline or slightly raising prices to boost margins. Investors pay for profits not for revenue, and right now, Amazon isn't generating any.
Over the past year, free cash flow stands at a paltry $1.04 billion, giving shares a 150x free cash flow multiple. Revenue growth was in line with last quarter's, though I expect a deceleration below 20% in the second half of the year. Media revenue was up a less robust 10% year over year as the tablet market slows and Netflix (NASDAQ:NFLX) proves to be a tough competitor thanks to beloved original content like House of Cards. Many investors also focus on its "Other" business line, which is where Amazon houses its cloud and web service business.
While we tend to think of AMZN as a retailer, bulls see tremendous growth in this business as enterprises gravitate towards the cloud and storage becomes more important. Year-over-year growth was 38%, which suggests Amazon was a market share loser as companies like Microsoft (NASDAQ:MSFT) have reported triple digit growth. This growth rate was also a deceleration from the first quarter's 60% growth. In fact, we saw a 3% sequential decline. In other words, Web Services may not be the profit center bulls were counting on. This is because the space has become very crowded very quickly leading to almost weekly price cuts that slash margins and slow top-line growth. This business may not have the upside we previously hoped for. Another sequential decline in the third quarter would be extremely concerning.
Speaking of the third quarter, Amazon's guidance was stunningly poor, which is a major driver of the 10% decline after-hours. Amazon expects revenue to increase by 15-26% to $19.7-$21.5 billion while analysts were looking for $20.8 billion. The slowdown at Web Services and Media explain why its revenue midpoint is a bit short of consensus. However, the real surprise was Amazon's prediction of a $410-$810 million operating loss. This compares to a mere $25 million loss lost year. Amazon is almost certain to lose over $1.00 per share next quarter and will likely be closer to a loss of $1.50. I was looking for closer to break-even in the quarter, so this guidance was quite jarring. With slowing growth, ever increasing spending, and margin pressure in cloud services, it is hard to see Amazon generate earnings of at least $3.00 per share until 2016 at the very earliest.
For years, Amazon shares were able to shrug off the lack of earnings power because of its accelerating revenue growth. Now, revenue growth is slowing down and will fall below 20% by the end of the year with a full-year growth rate closer to 15% in 2015. With momentum starting to turn against the name, fundamentals will play a greater and greater role. I do not believe investors should purchase a $300 stock with no immediate-term profitability or well-communicated path to high profits. With at most $3 in 2016 earnings power, Amazon would be worth about $50 at the most. Now, I am not predicting shares will drop that far; instead, this illustrates how expensive the stock is at current levels. Investors should not be tempted to buy AMZN because it will not earn money for the foreseeable future. After this quarter, I expect AMZN to fall to $200 before it ever returns to $400. I would still be a seller.
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