Amazon.com: Bezos Seriously Testing Investors' Patience And Trust After Guiding For A Big Loss

Jul.25.14 | About: Amazon.com, Inc. (AMZN)

Summary

Amazon.com posts second-quarter results, which are more or less in line with expectations.

The shocker is the guidance for a large loss in the third quarter, which could result in a full-year loss.

Bezos is seriously testing investors' patience, who are becoming frustrated with no improvements on the bottom line and the lack of transparency.

Investors in Amazon.com (NASDAQ:AMZN) were not pleased with the company's results, or better said, the outlook for increased losses for the third quarter.

The lack of transparency regarding the payoff of its initiatives is resulting in frustration among investors, who until now, have blindly followed Amazon.com CEO's truly long-term strategy. Bezos is perfectly happy to sacrifice earnings or even post manageable losses in his quest for dominance and future growth. This patience is now facing a serious test.

Second-Quarter Highlights

Amazon.com posted second-quarter sales of $19.34 billion, a 23% increase from last year. For a change, foreign currency moves actually added a percent to reported sales numbers. Sales were in line with consensus estimates from the financial community.

The company posted a $127 million loss, compared to a much more modest $7 million loss as reported last year. This resulted in a loss of $0.27 per share, a bit higher than the analyst forecast for a loss of $0.15 per share.

Looking Into The Results

Reported growth was once again driven by North America. Sales in this region grew by 26.4% to $12.00 billion. The company's operating earnings for the geographic segment were up, but much less than reported sales growth. Reported operating earnings of $438 million resulted in operating margins of 3.7%.

International sales rose by 18.2% to $7.34 billion, yet the overseas operations posted a $34 million operating loss, which compares to break-even results last year.

Total product sales, which remains Amazon's largest business, rose by 19.6% to $15.25 billion. More rapid growth was posted by the service sales, which rose by 38.5% to $4.09 billion. Included in this segment are some of Amazon.com's new and most promising future businesses, yet the company does not release any breakdown of sales of certain offerings and products.

Combined operating earnings of $404 million resulted in overall operating margins of just 2.1% of sales. Note that Amazon.com still has to charge some other items from these earnings to end up at the bottom of the income statement. This includes taxes and $391 million in stock-based compensation, resulting in a net loss of $126 million for the quarter.

Again A Disappointing/Conservative Outlook?

For the current third quarter, Amazon expects sales to come in between $19.7 and $21.5 billion, which implies a 15%-26% increase from last year.

The shocker is the operating loss forecast, with Amazon anticipating losses to range between $410 and $810 million, compared to a $25 million operating loss reported last year. According to consensus estimates, analysts are expecting sales of $20.83 billion and losses of $0.07 per share. The midpoint of the operating loss guidance, at $610 million, implies an operating loss of around $1.30 per share, much worse than anticipated.

Amazon.com is traditionally a bit cautious in its guidance. Reported second-quarter sales of $19.34 billion came in comfortably ahead of the midpoint of the $18.1-$19.8 billion guidance given at the first quarter. The reported operating loss of $15 million compared favorably to guidance for losses between $455 and $55 million.

The Market's Valuation Of Amazon

By the end of the quarter, Amazon.com held a total of $8.0 billion in cash, equivalents and short-term investments. Total debt of $3.1 billion does result in a net cash position of roughly $5 billion.

On a trailing basis, Amazon.com has now posted sales of almost $82 billion, on which it posted earnings of a paltry $200 million.

Factoring in the 10% drop in after-hours trading, Amazon.com's equity is valued at about $150 billion and operating assets at some $145 billion. This values operating assets at some 1.8 times trailing sales and a non-meaningful earnings multiple.

Focused On Growth, Not Earnings

Over the past decade, Jeff Bezos has guided Amazon.com to focus on spectacular growth, with revenues roughly ten-folding from less than $7 billion in 2004 to a trailing basis of $82 billion. Combined with just 10% dilution over this time period, this, of course, has been very impressive.

This has fueled the share price, which has almost kept track with revenue growth over this time period. Yet, the problem is the lack of earnings, especially since 2011. While many criticize that Amazon.com lacks profitability, the company did manage to post earnings of more than $1.1 billion in 2010. Given the reported $34 billion in sales, this resulted in net after-tax profit margins of 3% for that year.

After posting a tiny loss in 2012, Amazon's profits have not been meaningful in recent years, as the company could post losses again this year. This is, of course, the result from a myriad of investments which the company is making, such as Kindle, the Fire Phone, Web Services, a superior shipping experience, as well as many other initiatives.

This results in increased scrutiny by investors, who are clearly growing impatient with the lack of earnings, but are negatively surprised by the huge forecasted loss in operating earnings for the upcoming quarter.

Final Takeaway

Investors reacted in a strongly negative way to the earnings report. Of course, revenues and losses were "better" than the company's own guidance, but the real disappointment was related to the guidance for the current quarter.

The guidance for operating losses of $410 to $810 million is very big, as analysts were anticipating losses in the tens of millions. Not just investors, analysts are disappointed as well. Bank of America analyst Justin Post wonders whether the company "has gone too far with its multiple strategic investments."

Note that Amazon.com has traditionally managed to exceed even the optimistic or high end of this range, and the company will most likely post a big loss in the hundreds of millions for the quarter. This should perhaps result in a full-year break-even result or even a loss.

When things are not going so well, the lack of transparency might actually be a drawback. For years, investors have tolerated the absolute lack of information regarding financial information about some of its categories, such as Prime, the Fire Phone, Kindle, Amazon Web Services, which is facing a price war, testing with grocery delivery, improved distribution capabilities, and many other items. As an illustration of the cost of these services, Amazon.com will spend about $100 million in content for its Prime Instant Video services.

The key question remains what Amazon.com's "real" or sustainable operating margins can and will be if these "overinvestments" stop. This will be largely the deciding factor in what will be the eventual valuation of the firm. In that light, either a long-term short or long position remains a risk, in my eyes.

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