Despite disappointing fourth quarter results for Amazon (AMZN), analysts are still bullish on the stock. However, based on my analysis of the fundamentals, multiples, and my DCF model, I find that the firm will be easily outperformed by eBay (EBAY). Despite the seductive growth story, Amazon's multiples conjure up images of stock charts from the dot-com era. This firm is simply not worth the risk.
Amazon trades at a respective 135x and 68.8x past and forward earnings, while its competitor eBay trades at 13.5x and 12.6x past and forward earnings. This is a significant premium that requires dramatic earnings growth to justify. With earnings expected to decline 4.4% in 2012 as the economy subsequently picks up, I believe investors might exit for firms with stronger free cash flow yields.
At the fourth quarter earnings call, Amazon's management addressed a poor close to the year:
"Trailing 12-month operating cash flow increased 12% to $3.9 billion. Trailing 12-month free cash flow decreased 17% to $2.09 billion. Return on invested capital is 22%, down from 34%. Return on invested capital is TTM free cash flow divided by average total assets minus current liabilities, excluding the current portion of long-term debt over 5 quarter ends…
Worldwide revenue grew 35% to $17.43 billion, or 34% excluding the $101 million favorable impact from year-over-year changes in foreign exchange rates. We're grateful to our customers, who continue to take advantage of our low prices, vast selection and shipping offers".
On the plus side, the firm is becoming the brick-and-mortar retailer's worst enemy, with its price checking app and general undercutting of the competition. With 164M active users, the firm still has plenty of room to penetrate and the Kindle Fire has expectations for double-digit top-line momentum. However, fourth quarter results were not only below expectations but also weak on first quarter guidance. Margins are likely to remain constrained in the near-term with greater investments. I expect that a recovery will also reduce the appeal of Amazon's low cost appeal by increasing demand for higher-end retail.
Consensus estimates for Amazon's EPS forecast that it will grow by 4.4% to $1.31 in 2012 and then grow by 105.3% and 86.6% in the following two years. With the firm trading at triple-digit levels, I will leave the reader to make an attempt to extrapolate a justifiable intrinsic value from these (uncertain) projections.
In my view, eBay will similarly face substitute competition from higher-end retail. However, the firm's multiples are reasonable and the earnings streams offer much greater certainty. PayPal has 106M active users and represented nearly two-fifths of eBay's business in 2011. One-fourth of online retail transactions are processed via PayPal, while the segment still has plenty of room for penetration. The GSI acquisition further extends the company's e-commerce base into a greater amount of retailers.
Consensus estimates for eBay's EPS forecast that it will grow by 12.8% to $2.29 in 2012 and then by 15.8% and 14.3% in the following two years. Modeling a CAGR of 14.3% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $38.36, implying 15.3% upside.