When I saw Amazon's (NASDAQ:AMZN) first quarter earnings, the first thing I looked for was the company's margins. This is because the margins have always been the company's most troubling metrics over the years. The company almost never had trouble with growing its revenues, but it always struggled with increasing its margins. The problem seems to have become even worse in the first quarter of 2012.
A year ago in the same quarter, the company's worldwide operating margin was 3.3%. This is pretty low to begin with, but it got even worse this year at 1.5%. If we look at the twelve trailing months (TTM), the margins fell from 3.6% to 1.4% over the last year. In North America, operating margin fell from 4.8% to 3.5%, outside of North America, it fell from 5.6% to 2.3%. This is alarming as the company's expenses are increasing faster than its income.
Running a low-margin business is always risky as it takes only a small amount of change in the macro economy for a company to swing from profits to loss. If a company's expenses keep increasing, its revenue will have to increase at a faster rate just to keep the company profitable, and this can be quite difficult for many companies. On a positive note, the company's gross margin's are improving.
In the last few years, Amazon made a lot of investments and spent a lot of money. If everything goes as planned, in the next few years, all these investments will start paying off and the company's margins will increase significantly. The same thing happened last decade where Amazon spent a lot of cash for investments and those investments paid off a few years later. It looks like Amazon is in a cycle where the company invests heavily for a few years and enjoys return on these investment for the next few years.
As many brick-mortar retailers such as Best Buy (NYSE:BBY) are struggling to survive, Amazon still has the upper hand. Currently there is a tough competition, resulting in pricing pressures, however once some of the competition gets out of the way, Amazon might get more flexibility in its pricing. The company delivers more products (e.g., e-books, stream movies, downloadable software, electronic music) electronically than ever, and this will also help the company's margins in the long term. Currently one of the biggest margin-eaters for the company is the costs associated with mailing products to customers.
In conclusion, while Amazon's current margins are dangerously low, there is plenty of room for improvement and Amazon will have better days ahead. As for Amazon's valuation, at the moment I would suggest this stock to only those with long term horizons (7-10 years). In the short term, the company is too difficult to predict.
Disclosure: I am long AMZN.