By Nawazish Mirza
Amazon (NASDAQ:AMZN) enjoys a strong retail standing globally through its focus on selection, price, and convenience for its continuously expanding consumer base. As a result, the company's sales, albeit seasonal, have been increasing steadily. In 2011, Amazon experienced a 41% growth in revenues and an 11% increase in operating cash flow.
Although margins came under pressure owing to a great deal of competition in the industry, we feel that Amazon is a buy given its financial and technological flexibility, which allows it to cope with the competition in retail and nontraditional segments. We also await stronger fundamentals going forward, stemming from Amazon's entry into map and navigation services by the acquisition of UpNext -- a territory occupied by Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG).
Key Thesis Points
1. Amazon is the largest online retailer, dominating the retail industry through its diversified services to consumers, sellers, enterprises, and content creators. In its product portfolio, electronic products contribute the most to the top line. Amazon continuously focuses on this segment, which contributed to the decline of Best Buy (NYSE:BBY). Amazon is facing competition from physical retailers like Wal-Mart (NYSE:WMT) and web portals and shopping websites like eBay (NASDAQ:EBAY). However, we feel that Amazon has an edge over these retailers thanks to the quality, speed, convenience, and pricing offered by Amazon.
2. Turnover increased by 41% in 2011 owing to increases in both North American and international revenues. The increase in sales is a consequence of competitive pricing, increased product offering (mainly in electronics), and shipping offers (notably to international customers). Amazon did not transfer increased shipping costs to its customers that put some pressures on its margins, resulting in a decline of net margin to 1.3% in 2011. However, we expect that with competitive offerings aiming to achieve volume growth in sales, the impact of shipping costs will be mitigated. Furthermore, operational efficiencies emanating from inventory management, coupled with strong bargaining profile on the supply side, we do not see any material threat to the core profitability of Amazon.
3. The competition profile for Amazon is changing in its enterprise section, where it hosts thousands of businesses. Google's proposed "Google Compute Engine" is expected to provide enterprise services at a lower price than Amazon. This could erode margins; however, with Amazon's focus on customer penetration and retention on retail side by increasing marketing efforts, the company is likely to absorb any price shock in its enterprise segment.
4. The recent strategic move of entering the map and navigation business by acquisition of UpNext will enable users to load maps on the Amazon's Kindle Fire tablet. This native mapping capabilities for Amazon will give a new shape to its tablet segment, and we expect more robust cash flows emanating from Kindle Fire supporting overall financial performance. Going forward, we expect Amazon to capitalize on this acquisition with an eye on the possibility of a smartphone launch.
5. Amazon maintains strong profile compared to its peers. Amazon dominates substantially with a market cap of $103.3 billion compared to $53.2 billion for eBay and $995 million for Barnes and Noble (NYSE:BKS). Amazon is trading at a significantly high P/E ratio of 188, while eBay's share price is trailing at 16.2 times earnings, representing investors' strong expectations about Amazon. We expect Amazon's earnings to double and its P/E ratio to drop below 90 over the next 12 months. Based on expected sizable profits, stable cash flows, revenues, and geographical diversification -- coupled with financial and operational flexibility -- Amazon stands out as a long-term investment over its peers.