Amazon: Operating Leverage May Drive Gains

Jan.22.07 | About: Amazon.com, Inc. (AMZN)

Scott Devitt, the Internet analyst at Stifel Nicolaus, this morning boosted his rating on Amazon.com (NASDAQ:AMZN) to Buy from Hold, setting a price target on the stock of $44. “We believe Amazon is entering an operating leverage cycle and that the company’s shares perform quite well such environments,” Devitt wrote in a note this morning. “We believe the downside risk to the shares to be the lower $30 and the potential upside into the mid-$50s, or the midpoint of the last two leverage cycles. We would be buyers of the shares here and aggressive buyers of the shares if the stock were weak following [fourth quarter] results.

Devitt lists a number of potential 2007 and 2008 catalysts for Amazon shares:

  • Slower technology and content spending.
  • Slower headcount additions.
  • More selection.
  • More retail categories.
  • More services.
  • More international expansion.
  • More fixed cost scale driven by improving revenue growth trends.
  • Lower logistics costs due to lower energy prices.
  • Less sales and marketing spend as a percentage of GMV (gross merchandise value.).

“At its core, Amazon is a technology company that happens to focus on the retail vertical,” he writes. “Amazon offers a more capital efficient, centralized alternative to the traditional retail method of ‘growth by the addition of store footage.’ In fact, both Amazon and eBay (NASDAQ:EBAY) trade for material discounts to Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) in a free cash flow basis…We are unaware of any other $13 billion retail business growing organically (think same store sales) at 26% with an ROIC [return on invested capital] north of 20%, capex/CFO [cash flow from operations] of 25%, and a forward FCF [free cash flow] yield of 4%…In our view, this business is misunderstood, is unique, is well-positioned, is solely focused on its customers (consumers, sellers and developers) and is undervalued.”

Amazon today is up 73 cents, at $37.75.