Amazon Share Valuation and Target Price
I have seen discussions about Amazon (AMZN) and its share price so many times, I think it's about time to perform a valuation on its share price and a view of important financial metrics.
This comes at a great time, since Amazon reports earnings on Thursday, July 26.
Get To Know Amazon
Amazon is one of the leaders in the Internet retail industry, and being so, there are some things that the company expects about the future that might raise some red flags to stockholders.
Taken from Amazon's 10-K:
We expect a disproportionate amount of our net sales to occur during our fourth quarter. If we do not stock or restock popular products in sufficient amounts such that we fail to meet customer demand, it could significantly affect our revenue and our future growth. If we overstock products, we may be required to take significant inventory markdowns or write-offs, which could reduce profitability.
So it's mostly a Christmas-time type of upside surprise for Amazon's top and bottom line.
You can see from the reported earnings below how seasonal its earnings are.
Amazon also states that it aims to focus on sustained long-term growth, and:
To increase sales of products and services, we focus on improving all aspects of the customer experience, including lowering prices, improving availability, offering faster delivery and performance times, increasing selection, increasing product categories and service offerings, expanding product information, improving ease of use, improving reliability, and earning customer trust.
Lowering prices will not be good news for Amazon's already beaten-down margins (as you will read later) -- red flag right here.
The implications of the following statement are not to be understated:
Our variable costs include product and content costs, payment processing and related transaction costs, picking, packaging, and preparing orders for shipment, transportation, customer service support, and a portion of our marketing costs.
Our fixed costs include the costs necessary to run our technology infrastructure and AWS; to build, enhance, and add features to our websites, our Kindle devices, and digital offerings; and to build and optimize our fulfillment centers.
Variable costs generally change directly with sales volume, while fixed costs generally increase depending on the timing of capacity needs, geographic expansion, category expansion, and other factors. To decrease our variable costs on a per unit basis and enable us to lower prices for customers, we seek to increase our direct sourcing, increase discounts available to us from suppliers, and reduce defects in our processes.
To minimize growth in fixed costs, we seek to improve process efficiencies and maintain a lean culture.
You will see why it is so important for Amazon to get its act on track and become very effective in its use of resources, or its stock price will suffer.
Taken from Amazon's Income Statement in its 10-K, Excel format:
(click images to enlarge)
Amazon's COGS are huge, and we will now see just how its revenues compare to its costs.
Sales By Region And Segment
The growing popularity of Internet retail sales is undeniable, especially for electronics, which represents almost 60% of Amazon's revenue. As people tend to shop more frequently online -- with more confidence to give out their credit card information, along with the expectation that their product will be delivered on time instead of them having to go out and buy it -- sales are expected to continue to grow for the likes of Amazon and its competitors.
Amazon has its cash and cash equivalents distributed in the following fashion (Source: Amazon's 10-K):
The total investments, cash equivalents and marketable securities add up to $5,997 million dollars.
Amazon takes the motto "you need to spend money to make money" very seriously. That's a good thing, because the company needs to do just that if it wants to improve its razor-thin margins and thrive in the Internet retail industry. Again, from its 10-K:
We expect spending in technology and content will increase over time as we add computer scientists, software engineers, and merchandising employees. We seek to efficiently invest in several areas of technology and content, including seller platforms, digital initiatives, and expansion of new and existing physical and digital product categories, as well as in technology infrastructure to enhance the customer experience, improve our process efficiencies, and support AWS.
As you will see below, Amazon truly does get most of its cash flow from cash, cash equivalents and marketable securities.
The company's net income for 2009 was $902 million, $1,152 million for 2010 and $631 million for 2011.
Now compare this to its cash coming from operating activities:
Year Ended December 31,
2011 2010 2009
Cash provided by (used in):
Operating activities . . . . . . . . . . . . . . .. . . $ 3,903 $ 3,495 $ 3,293
Investing activities . . . . . . . . . . . . . . . . . .(1,930) (3,360) (2,337)
Financing activities . . . . . . . . . . . . . . . . . .. (482) 181 (280)
According to Amazon:
Our principal sources of liquidity are cash flows generated from operations and our cash, cash equivalents, and marketable securities balances, which, at fair value, were $9.6 billion, $8.8 billion, and $6.4 billion, at December 31, 2011, 2010, and 2009.
Amazon has beaten estimates for three out of the last 7 quarters, as shown in the chart below.
This is after the earnings were lowered from almost $1 to around $0.07 EPS.
Analysts lower earnings estimates, especially when their estimate is too high and companies miss earnings, giving plenty of room for those companies to beat the consensus EPS and revenue forecasts.
Analysts usually do this so the stock price of their beloved companies do not suffer. I, however, am not pressured by anyone and try to be as objective as possible when analyzing companies and their stock.
This analyst revisions occurred every quarter last year , and in December, the company reported $0.28 EPS, beating by 300%. Amazing! (Not).
Quarterly Earnings Surprise History
Fiscal Quarter End
Earnings Per Share
For 2011, Amazon's EPS was $1.34, and the consensus for 2012 is for its EPS to come in at $1.21.
The following chart describes the EPS surprise Amazon has given (up or down) for the last 4 quarters.
The expected earnings growth for Amazon is -10.05% for 2012, and the company is expected to report EPS of $0.01 on Thursday. This is not very good news for shareholders.
The chart below shows the expected earnings growth for the future, provided by Zacks Investment Research.
Currently Amazon has a Price/Earnings ratio of over 184. The industry has a P/E ratio of 23.7.
Of 33 analysts who follow the stock, 21 have a "Strong Buy" rating on Amazon, 2 have a "Buy" rating and 10 have a "Hold" rating. There are no "Underperform" or "Sell" ratings. From a contrarian point of view, this is very bearish for the stock price, as practically everybody who wants to get into this stock is already in.
Amazon's cash flows are a bit tricky, because they have very small Net Income, and the Net Cash Flow from Operations is about 3-6 times bigger.
The main account to keep a close eye on is Liabilities, as Amazon receives cash from its customers in 22 days (as of 2011), and the company takes a long time to pay its suppliers (144 days as of 2011), thus resulting in "free" financing from its suppliers, much like wholesale stores like Wal-Mart (WMT) do.
Net Income Adjustments
Net Cash Flow Operating
Other Investing Activities
Net Cash Flows Investing
Cash Flows-Financing Activities
Sale and Purchase of Stock
Net Cash Flows Financing
Effect of Exchange Rate
Net Cash Flow
Return On Equity, Assets, Capital Structure And Liquidity
ROE (last 3 year average)
ROA (last 3 year average)
Ratio and Acid-Test
1.17 (0.84 Acid-Test)
Amazon's Return on Equity has been decent. Its Return on Assets is very low because of its tiny profit margins. The Capital Structure is no trouble, as the liabilities the company owes are interest-free, so it looks decent in this department. It is understandable that Amazon scored less than 1 in the Acid-Test given its huge Current Liabilities.
Margins (4 year average)
Cost of Sales/Sales
Amazon's margins are razor-sharp, and any increase derived from its expansion plans might lower them even more. The 2.9% net margin is a 4-year average; its margin for 2011 was an embarrassingly low 1.3%
Piotroski's F_Score & Economic Profit
Score: 5 out of 9
Amazon scored average in the Piotroski's scorecard. Its weak points are its decreasing ROA; Liquidity (as measured by the Current Ratio); the Equity Offering, as Amazon increased its share count; and of course, the margin, decreasing from 3.4% to 1.3%.
Investors are currently paying $2.06 for every dollar Amazon sells -- not very lofty in this area, but considering its margins, still pretty high.
Return On Invested Capital
Projecting the "Business as Usual" scenario, these are the ROIC results that I expect Amazon to have for the near future. Its Return on Invested Capital is expected to be between 13% to 30% above its Cost of Capital. This, of course, is good news for investors, but is still not enough to justify its current lofty share price.
Breaking down the pre-tax ROIC to derive an integrated perspective on the company's performance, we can see how it is not surprising that Amazon earns its ROIC mostly from its high Capital Turnover, coming in at 16.9. And being a retailer, its operating margins come in paper-thin at 1.79%. The EBITDA divided by its Invested Capital results in a pre-tax ROIC of 30.4%.
DCF Valuation and Price Targets
Using the EBITDAx7 valuation formula, we can see that the company would need to have EBITDA of around $15 billion for its shares to be valued at $226.17. It currently has $0.86 billion in EBITDA, and the projected EBITDA is only of roughly $7.5 billion by 2016. Talk about overvaluation.
Next up, we have the Graham Formula, which is still widely used by value investors to get solid companies at rock-bottom prices. The $10.56 valuation is not a typo, considering the $1.21 EPS Amazon had for 2011, the company would need to report around $26 EPS to be valued at $226 per share.
The expected EPS for 2012 is $2.57. Almost there!
I used 3 scenarios for the DCF analysis:
- The "Business as usual" scenario: Amazon's sales decrease only 4% in 2012, and subsequently increase to 45% in 2013, 30% in 2014 through 2016, and 15% to perpetuity.
Its margins improve from 22.4% in 2011 to around 24% and 22% to perpetuity.
Its SG&A costs decrease from 20.6% in 2011 to 19% in 2012 through 2016 and stay at 20% to perpetuity.
The investing to sales ratio remains at 4% (down from an average 8% in the past four years) as its expansion plans continue, in order to support its higher sales. Efficiency improves, as we saw in the margin area.
- The "Positive outlook" scenario: Amazon excels at expanding and there is no financial crisis of any kind, its sales are not impacted at all by either competition or a slowing economy, and its sales decrease by 4% in 2012, and then improve to 45% in 2013, 30% from 2014 through 2016 and stay at 15% to perpetuity. Notice this is the same as the "business as usual" in the sale increases area, but the margins will be greatly improved.
Its gross margins improve from 22.4% in 2011 to 23% in 2012 and 2013, and then are improved to 24% from 2014 until 2016, and then remain at 23% to perpetuity.
The SG&A costs stay below the 20% line, hovering between 18% and going to 20% to perpetuity.
The main difference is that the seemingly low margin changes are huge and very difficult to pull off, but in this scenario, Amazon dominates the Internet retail sector and its competitors fall prey to the wolves.
- The "negative outlook" scenario: Amazon's sales decrease by 4% in 2012, and then increase by 30% in 2013, 25% in 2014 and 2015, 20% in 2016 and 15% to perpetuity, held back by a slowing economy and increased competition. Its gross margin stays at 22.4% to perpetuity and its SG&A costs hover between 21% in 2012 and fall to 18% by 2015, remaining at 20% to perpetuity.
The investing to sales ratio stays at 4% as well.
For this company, the margins played a huge role in the valuation, as every decimal was a strong hit on its share price. I even used a 9% WACC instead of the 10.3% Standard & Poor's typically used to come up with a higher valuation. This was not enough.
Giving the "Business as usual" a 50% chance of playing out, and the other 2 scenarios a 25% chance of playing out, the target price for December 2012 is $164.88. I expect Amazon's shares to fall 27.1% from here until December of this year.
The 12-month price target range, according to analysts who follow this stock, is between $210 and $285, with $250 being the consensus target price.
Standard & Poor's has a $240 12-month price target for Amazon, based on a DCF analysis with a 10.3% WACC and a 4% terminal growth rate.
Next up is the weekly chart for Amazon. As you can see, it has hit pretty strong resistance around the $240 area in the past, and the expected EPS for this and next year is no help.
The graph is pretty neutral, giving no indication of either bullish or bearish technicals, there are no oversold or overbought readings yet, but if the Chipotle disaster is any indication, Amazon will be the next brick to fall.
I will be giving trade ideas in my next article, as Amazon reports earnings this Thursday, as I mentioned above.