Brian Bolan, research analyst at Jackson Securities, sent a note to clients following Amazon's (AMZN) latest earnings report in which he maintained his "BUY" recommendation.
Amazon offers the “Earth’s biggest selection” of items via the world wide web through its flagship site of Amazon.com as well as Joyo.com, Shopbop.com and Endless.com. The company once known for its books has become the de facto internet retailer and has expanded to provide ecommerce services as well as other unique internet properties.
Valuation and Recommendation
Execution continues to produce solid results as Amazon goes two for two so far in 2007. Strong gross margin expansion and the possibility of further margin growth in the back half of the year leads us to believe that the market will reward the stock with a higher multiple. We continue our Buy rating of shares of Amazon.com.
Amazon.com reported earnings of $0.18 per share or $0.19 per share when backing out stock based compensation. This beat the Wall Street consensus and our estimate of $0.16 per share. Revenues of $2.886B were 2% higher than our estimate of $2.830.
Gross Margin increased 50 basis points from a very strong first quarter level of 23.8% to finish at 24.3%. Gross margins benefited from termination of a less favorable contract with TRU that affected year ago gross margins by about 90 basis points.
The Top Line
Sales in the quarter were higher than year ago levels by 35%, but down from a very strong first quarter by about 4%. Beating our high end estimate by 2% was a strong showing for the company.
The Media segment of the company saw an increase of revenue by 27% or 25% when foreign exchange is backed out. Revenue for this segment came in at $1.833B, about 3% ahead of our estimate of $1.781B. The media segment was the primary driver of out performance from our estimates.
The EGM (Electronic and General Merchandise) segment had sale of $970M, up 55% from the year ago period and just slightly ahead of our estimate of $967M.
Other, which includes the developer services, had revenue of $83M, ahead of our estimate of $81.7M. We expect this line item to grow significantly throughout the later half of 2008.
Gross profit grew 38% to $701M. Gross margin increased 49 basis points to 24.3% primarily due to the wind down and termination last year of a contract with TRU which negatively impacted overall gross margin in Q2 2006 by approximately 90 basis points and North America gross margin by approximately 170 basis points. This is offset partially by product mix.
We note that fulfillment declined only 1% from the previous quarter while sales were down by 4%. This means that while fewer dollar sales came in, it cost more to ship them to end users. We were expecting a better result from this line item, but seeing as it is our first full quarter covering the company we will let this one slide.
We also saw a dollar expansion in the Technology and Content line item. It has been noted that the company will be spending more in this area, but we were slightly surprised to see as much as we did. Coming in 15% above our estimate was some what surprising, but based on previous comments by management, the spending was more or less in line with historical levels.
The Bottom Line
Net income of $78M was filly 16% higher than we had estimated, and resulted in a 2.7% net margin, better than our estimate by 30 basis points. Net margin in the year ago period was a mere 1%, while the first quarter of 2007 had a strong 3.7% net margin. We believe that there is room for the net margin to increase in the third and fourth quarters of 2007 as well as throughout 2008.
Shares and the Buy Back
For purposes of determining earnings per share, Amazon ended the quarter with 423M shares outstanding. This was a 3M increase from the previous quarter even as the company has been authorized to repurchase $500M worth of stock. With the recent price appreciation in the stock, we believe that management may be on the sidelines for some time before committing more capital to share repurchases.
Key Takeaway from the
This quarter was a very solid performance for Amazon.com. Beating the top line number is always a good thing, but for a large scale retailer to significantly outperform in the gross profit line is a big positive. We further believe that margins will continue to expand along with valuation multiples for the stock. Continued execution by the company will only result in further expansion of multiples.
We believe that Amazon is likely to produce a string of raised quarters as the Internet continues to pace the market in 2007. The leadership that search provided in the beginning of the year has been taken over by the strong E-commerce performance of Amazon.com.
For the third quarter of 2007, the company has guided to a sales range between $3B and $3.175B. Our estimate has called for $2.934B in the third quarter. We anticipate that we will be raising our estimates for revenue and earnings in the coming weeks when we published an updated earnings model.
For the year, management guided to revenue of between $13.8B and $14.3B compared to our estimate of $13.9B. We expect our revised model to be published in the coming weeks and we believe it is likely that our estimates will be at the top or even above the guided range.
What do we do after a company the size of Amazon has back to back solid quarters that showed excellent execution and still holds the promise of continued margin expansion? We review our target price. At the current time, we are not going to move the target price, just review it and will wait until we publish our updated model. At that time, we believe there is a strong likelihood of an increased target price.
For more on Amazon's latest quarter, see the company's Q2 2007 Earnings Call Transcript.