Amazon: Room to Grow

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 |  About: Amazon.com, Inc. (AMZN), Includes: AAPL, DISH
by: Elliott Gue

The dot-com implosion of the late 1990s spooked many seasoned investors from plowing money into online retailers. But for every Pets.com that sold more hype than product -- in fact, the ill-starred company never turned a quarterly profit -- there are a number of successful businesses that survived the meltdown and have changed the face of retailing forever.

In the first quarter, U.S. households spent more than $46 billion at online retailers -- up tenfold since the end of 1999. Whereas overall consumer expenditures stagnated when the country first emerged from the Great Recession, e-commerce recovered quickly and hit a record high in the third quarter of 2009.

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Budget-conscious consumers still find that shopping online yields better deals and selection than those available in local brick-and-mortar stores.

As I wrote just last month in an article on U.S. Consumer Spending, the rise of popular Internet retailers such as Amazon.com (NASDAQ:AMZN) was a major factor in the demise of bookseller Borders Group. A similar fate befell video rental giant Blockbuster, which Dish Network Corp (NASDAQ:DISH) recently purchased in a bankruptcy auction.

Top online retailers will continue to win market share from their offline counterparts in coming years.

Retail Retold

Founded in 1995 as an online bookseller, Amazon.com has taken full advantage of its first-mover advantage to grow into a global force. Sixteen years later, the firm boasts retail operations that serve the U.S., U.K., Germany, France, Japan, Canada and China.

The company’s trailing 12-month revenue exceeds $40 billion, or almost $1 out of every $10 spent globally on e-commerce. Amazon.com boasted 144 million active users at the end of the second quarter.

Digital and hard-copy media such as books, music and movies still account for roughly 40 percent of Amazon.com’s revenue, but the firm has expanded its selection and offers a wide variety of merchandise, including clothing, electronics and even groceries. Sales in these non-media categories continue to grow apace and have become an important part of the online retailer’s business.

Amazon.com’s brand recognition and reputation for service has made it an industry leader, but investors shouldn’t overlook the company’s extensive network of distribution centers. This logistics system enables the e-tailer to stock such a wide range of products and ensure their timely delivery to its end-markets. The company built 13 fulfillment centers in 2010 and plans to add another 15 in 2011, bringing the total to between 65 and 70 distribution facilities.

The firm also rakes in money by providing third-parties with access to

its logistics, online payment and transaction processing infrastructure. Retailers of all sizes can sell items directly on Amazon.com’s website, one of the highest-profile domains on the Internet. Those with their own websites can contract with the online giant to handle fulfillment, billing, shipping and other logistics. For the firm’s two million third-party sellers, this arrangement guarantees fast and reliable distribution.

In the second quarter, revenue from third-party retailers accounted for 36 percent of all merchandise sold on Amazon.com. The e-tailer takes its cut of each sale through a fixed revenue-sharing agreement, a per-unit fee or some combination of the two.

Finally, Amazon.com’s web services (AWS) division allows companies to outsource certain information technology functions to the company -- a version of cloud-based computing. Second-quarter revenue from AWS and the firm’s third-party fulfillment operation grew by more than 85 percent from year-ago levels.

The company’s overall sales surged 51 percent in the second quarter to $9.9 billion (44 percent excluding favorable currency adjustments) -- the fastest pace of revenue growth in a decade. This trend should continue in coming quarters, with digital books and Amazon.com’s third-party services once again leading the way.

The firm’s Kindle e-reader allows consumers to purchase and download digital books and other textual material for immediate consumption. Although Amazon.com’s e-reader and e-book business faces a handful of competitors -- including Apple’s (NASDAQ:AAPL) iPad and iBooks -- sales of Kindles and digital matter accelerated in the second quarter. IPad owners can also download an application that allows them to read all of their Kindle books on the popular tablet.

Not only are ever-greater numbers of consumers embracing the digital book, but the wireless distribution model also ensures superior profitability.

Bearish commentators often cite the company’s declining profit margins as a sign of weakness. But Amazon.com’s management has never waffled on its plan to invest heavily in its infrastructure and back-office operations to support long-term earnings growth. Instead of grousing about margins, investors should regard these capital expenditures as a down payment on future prosperity.

Trading at almost 60 times analysts’ consensus estimate of 2012 earnings, the stock isn’t cheap. But as I told InvestingDaily.com readers in "No Recession Looming: Buy Stocks into the Summer Shakeout," the recent market sell-off has given investors the opportunity to buy stocks at valuations they could only dream of a few months ago. Furthermore, the company’s extraordinary growth prospects support the current price tag and should continue to command a premium in an otherwise weak economic environment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.