Earnings Preview And Investment Thesis

Apr.26.12 | About:, Inc. (AMZN)

What do you make of a stock that is trading at a price to earnings ratio of 140x (forward p/e is 75x), has an EV/EBITDA of 50x and has a 1000% premium to its book value? Well, many will wonder if it's a growth stock and if such valuations are justified. Let's throw in another important piece of information: the street is already expecting top line for (NASDAQ:AMZN) to grow by 30% and 28% in the years 2012 and 2013. The 5 year earnings growth rate, average of sell side analysts, stands at 27%; the historical annual growth for the past 5 years has been 12%. This gives us a very high price earnings to growth ratio of near 6x.

Amazon's stock is already pricing in the high growth expectations and is still overvalued from a value investor's perspective. There is neither any good news from the dividend investing front. The stock doesn't pay any dividends; its expected free cash flow yield for 2012 is a mere 0.5% which is a decline from 2011's 2.5% and the current return on equity of 8.5% is expected to decline to 2% in 2012. The net margin for Amazon is on the decline too, and will only be 30bps for this year. The EBITDA margin is 2.6%.

The only positive from the balance sheet perspective is the cash rich situation of Amazon. The total cash is in north of $9.5bn whereas the debt is only $1.8bn. This gives a net debt to equity ratio of -35%. The management can use this cash for strategic acquisitions going forward.

On top of that, there is a severe competitive threat arising from Apple's (NASDAQ:AAPL) iPad and iPhone models taking the market away from Kindle, the e-book reader. From a long term perspective one should keep an eye on the e-commerce adoption rates.

From the 26 analysts that cover the stock, only 1 has sell/underperform rating.

The Business Model

Amazon is the world's largest online retailer. It also provides virtual technology infrastructure, known as cloud computing. Amazon's third major division manufactures the Kindle e-reader.

The agency pricing model vs. principal pricing model: The agency pricing model for e-books doesn't favor Amazon. In this business model the gross margins for Amazon are pre-determined as they have to sell at a fixed price. Whereas, in the principal pricing model Amazon works on a "cost-plus basis" helping it gain market share.

Amazon's plan was to flood the market with cheap e-books, keeping margins very low in this segment, and make money by selling Kindle. The problem aroused as Apple's iPad became a success. Apple started selling e-books at $12.99-14.99 vs. Amazon's price of $9.99. Apple charged 30% commission from the publisher and allowed them to charge higher prices. This new model was profitable for Apple and the publishers. However, this new agency pricing model was a threat to Amazon's business model. This resulted in consumers paying higher prices too. For the same reason, DOJ filed an antitrust lawsuit against Apple and the publishers. The reason, of course, was fixation of prices by Apple and the publishers. This is a threat to Amazon's low "e-book pricing model."

So far, this lawsuit is proving to be in favor of Amazon as three of the five publishers accused have decided to switch back to Amazon's pricing model. This will be a key catalyst going forward. If all publishers move back to Amazon's pricing model, the company will be able to regain its lost market share.

Earnings preview:

After the E-Bay's (NASDAQ:EBAY) earnings beat there has been a lot of anticipation on the Amazon front. Historically, Amazon has been a pretty volatile stock on earnings announcements. Its last earnings report for 4Q2011 was not taken positively by the market. Though they were able to beat the consensus earnings estimate, however the stock was down 7.7% the next day. The stock performance on the earnings announcement for 3rd quarter 2011 was even worse. They missed the EPS expectations and the stock was down 12.6% the next day.

Below one can see the stock performance of Amazon after reporting earnings. In last 9 instances, the stock has been down 66% of the times after reporting earnings. On average it has been down more than 2%. More worrisome part is the stock's inability to recover in the following days. In one week's time after announcing the earnings, on average the stock has traded down 2.8%.

Announcement Date Period Reported EPS Estimated EPS % Beat % Change 1Day % Change 3Days % Change 1 Week
01/31/2012 Q4 11 0.38 0.163 133.13% -7.70% -3.48% -5.27%
10/25/2011 Q3 11 0.14 0.243 -42.39% -12.66% -4.33% -6.62%
07/26/2011 Q2 11 0.41 0.341 20.23% 3.89% 3.89% -1.16%
04/26/2011 Q1 11 0.44 0.606 -27.39% 7.86% 7.41% 8.86%
01/27/2011 Q4 10 0.91 0.882 3.17% -7.22% -6.69% -5.82%
10/21/2010 Q3 10 0.51 0.478 6.69% 2.52% 3.02% 1.13%
07/22/2010 Q2 10 0.45 0.536 -16.04% -1.00% -2.45% -2.67%
04/22/2010 Q1 10 0.66 0.608 8.55% -4.30% -5.38% -5.57%
01/28/2010 Q4 09 0.85 0.723 17.57% -0.49% -6.28% -8.01%
Click to enlarge


Guidance: Management has guided 1Q2012 revenue to be up 22%-36% i.e. $12-$13.4bn.

Street Expectations: $12.86bn


Street expectations: $0.08. Range: $0.16-$0.25

Important will be to watch the management's guidance for the 2Q2012. The street expectations are for $12.83bn. If the mid-point of the guidance number is above these street expectations the stock can trade higher. The other catalyst for the stock will be an update on the release of new tablet models. Any positive talk by the management on the margins front will be the key driver for the stock.

The stock has been underperforming last few months and is down almost 20% for the last 6 months. An earnings beat coupled with better than expected guidance can be a catalyst for Amazon's shares to trade higher. A miss will be disastrous for the stock and I expect building up of short positions in that case.

Conference call is at 5.00 p.m. eastern time.

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