Seeking Alpha
Profile| Send Message|
( followers)  

Since our earlier article in which we discussed our bullish stance on Amazon.com, Inc. (NASDAQ:AMZN), the stock is up 12%. We think it is an ideal time to realize gains, as Amazon is going to see large investments in fulfillment centers and technology (mobile devices and apps) hurt its bottom line in the coming quarters. The returns from these investments will benefit the company over the long run. The current net profit margin stands at 0.6% (trailing twelve months), down from the 5-year average of 2.72%. Moreover, there have been some insider sales in the last month. Investors should now wait for a better entry point.

Below is the news that has led to stock price appreciation over the last month:

  • The news that the Kindle Fire tablets have sold out drove the price to $250. The Kindle Fire currently has 20% of the market share for tablets. This news also fueled speculations of a newer version of the tablet being launched soon.
  • A deal with Nokia OVI to use Nokia's feature for maps on the new Kindle Fire - which is expected to be unveiled this week.
  • There is also news of Amazon introducing a larger Kindle tablet to compete with the iPad, just as Apple Inc. (NASDAQ:AAPL) is introducing a smaller version of the iPad. This could be a catalyst for future price appreciation.
  • Amazon expanded its licensing agreement with NBC Universal Cable & New Media Distribution to beef up its Amazon Prime Instant Video offerings. This deal follows others with MGM and Warner Bros (Time Warner Inc.: TWX). This is bad news for Netflix, Inc. (NASDAQ:NFLX), which charges higher for the same unlimited streaming service.

Amazon has no long-term debt, and has cash in hand of $4.97 billion; the company has operating cash flows of $3.22 billion. This is good for the investments (13 fulfillment centers in 2012) that Amazon wants to make to give its customers a same-day delivery option. The company keeps engaging in share issues and buybacks. The third quarter guidance included an operating loss of -$350 million and -$50 million.

The Competition

From a competitor's point of view, Amazon is the beneficiary of Best Buy Co. (NYSE:BBY) losing its market share in electronics retail. Amazon Prime and LoveFilm compete with Netflix. LoveFilm's unlimited streaming costs £4.99/month, as compared to Netflix charging $7.99/month. Amazon continues to sign new deals, as the ones mentioned above, which will make it more competitive as compared to Netflix. The company has a 20% market share in online retail sales. Same-day delivery, which Amazon is pushing for, will undoubtedly have an impact on other brick-and-mortar retailers. Customer service and the return policy are other competitive advantages of Amazon, apart from its prices. For more details regarding Amazon's competition, read our article.

The company now faces competition from eBay Inc. (NASDAQ:EBAY), which has 100 million shoppers, and where retailers like RadioShack Corporation (NYSE:RSH) and Barnes & Noble Inc (NYSE:BKS) have set up storefronts to target new customers online. eBay is also testing 'same day delivery' (eBay Now) with large retailers like Target Corporation (NYSE:TGT) and Nordstrom Inc. (NYSE:JWN).

Valuation:

Based on a forward P/S multiple of 1.3x, and 2014 revenues of $80.53 billion (450 shares outstanding), the price comes out to be $233.

The put/call open interest ratio has risen to 1.24 over the last month from about 0.9, showing that investors have become more bearish as the price has appreciated.

Amazon is a high risk investment because of its high multiple relative to its earnings. Any short term fall in revenues or gross margin can have a significant impact on the share price. However, over the long run, Amazon is set to continue to benefit from the consumer shift from offline to online. Also new products like smartphones and tablets can help in driving sales of other digital products. The recent news of the sold out Kindle Fire tablet bodes well for content sales.

Since the price has crossed our target price, the third quarter guidance is negative, and insiders have been selling and exercising their options recently (6 insider sales compared to 1 buy in the last month), we think it is the right time to realize gains. Over the long run, we will be bullish once there is a price correction, and the building of fulfillment centers starts paying off in terms of lower shipping costs (larger margins) and faster delivery. Fulfillment centers take time to reach their full operational efficiency and scale. The games and apps foray might be another source of good news if the company takes the right steps.

Source: Amazon: Sell To Book Profits, Alongside Insiders