Amazon: Sacrificing Margin for Sales

Amazon (AMZN) experienced healthy top line growth of 41% for its second quarter, but in the process, trimmed its gross profit margin 40 basis points from 24.3% to 23.9%. Its cost of goods sold spiked 42% from $2.185 billion to $3.096 billion, which is alarming, since this cost component increase shouldn't be higher than revenue growth. Management seems to be focused on slashing prices in order to protect market share. It's a dangerous to get involved with price wars, as once you embark on this course of action, it is hard to reverse.

Risky proposition: Management has poured a boatload of money into the development of Kindle, yet surprisingly has been very secretive about how much this product will contribute to the bottom line. This Mighty Book seller needs to provide more transparency on this project to ease investor concern. The kindle is a big gamble, as either this venture will strike out or hit a grand slam.

Second quarter results exposed: The company saw its earnings increase 95% from 18 cents to 37 cents. The quarter was beefed up by a substantial 25% decrease in its income tax rate from 29.7% to 22.1%. This saved the company approximately $16 million or 4 cents to its bottom line, however its loss of gross profit margin of 40 basis points actually cancels out the income tax gain. The company's other cost components such as Fulfillment, Marketing, Technology and G&A were all significantly higher, but flat as a percentage of sales, yet these charges could soon accelerate, as AMZN has announced the planned openings of new fulfillment centers.

Sequential drop in earnings: Third quarter consensus estimates are 26 cents on sales of $4.33 billion. This estimate equates to a staggering 30% drop in earnings from AMZN's second quarter results of 37 cents, despite an expected revenue increase of $266 million to $4.33 billion from $4.06 billion. The company seems to be going in the wrong direction, and margin erosion appears to be the major culprit.

Forward PE Multiples too rich: The shares are still selling at expensive forward multiples despite AMZN's recent price meltdown. The stock is selling at a mind-boggling, 52 times 2008 estimates of $1.56 and 38 times 2009 earnings estimates of $2.12 per share.

Insiders are dumping: In the last six months, AMZN insiders have sold 2.3 million shares of stock without making a single purchase. The two single largest shareholders are CEO Jeff Bezos with a 30% stake, and Legg Mason's approximate 8% position. These two holders could create havoc to the market if they decide, or worse yet, are forced to sell. That many potential shares hitting the market on the supply side would be hard to absorb.

Reduced consumer spending: Let's face it, the slowdown in the economy is hurting consumer confidence and in the process, reducing discretionary income. The consumer still needs to buy food, gas and shelter, but the purchase of books and gadgets, can, and will be put off. This slowdown in spending could have a very negative impact on AMZN's bottom line.

International Sales and currency exchange: AMZN generates substantial international sales, and has enjoyed and additional bounce from this segment due to the weak US dollar. The company had generated additional income in the currency exchange process and now that the US dollar has rallied, this procedure now works against it, as the company receives less dollars rather than more dollars in the conversion process.

Bottom line: The shares present more risk than return at this juncture. Use last week's 10% rally from  Wednesday's lows as a selling or shorting opportunity. The prospect of a miss on third quarter earnings is plausible, and that type of event would certainly spark a new 52 week low.

Disclosure: Short AMZN.

Comments

[kozakkk667:]

To repeat what I posted on the yahoo board on 19-sep08 in light of a reuters news item:
"Hedge funds seen switching short exposure to retail"
biz.yahoo.com/rb/08091...

"My thinking: as we get closer to the 22-oct earnings announcement, with all the consumer headwinds and now opportunistic hedgies looking for fresh targets, companies like AMZN will end up in their cross-hairs as there are hardly any others in the retail space with as lofty valuation and expectation."

However, insiders & insitutions together hold 99% of the float (24% + 76%). So only with the same intitutional holders co-operating (with the exception perhaps of Bill Miller!) with the shorting hedgies (instead of fighting them), we have a good shot at a swoosh down ...

2008 Sep 22 01:44 PM

[BSO:]

Good article, I agree w/your comments. One thing you do not appear to be aware of is that a large portion of their Q2 earnings were due to a one time gain from a non cash sale of a European DVD unit. Back this one time gain out of operating income and they actually came in below expectations.

2008 Sep 22 02:09 PM

[BSO:]

good article. one thing you are not factoring in is that a good portion of their Q2 earnings were from a one time gain on a non cash sale of a European DVD unit. Back this one time gain out of operating income and they actually missed expectations.

2008 Sep 22 02:11 PM

[Mark Krieger:]

great point about the Euro DVD sales..I completely forget about that ..sorry about that

2008 Sep 22 02:19 PM

[Louie Junior:]

Good Analysis -- although I doubt the dollar's rally will continue in light of the trillion dollar taxpayer bailout.

2008 Sep 23 08:48 AM

[LBC:]

Dollar rally will continue for some time -- Europe has as much exposure to this bad debt as we do -- they just haven't come clean about it yet.

2008 Sep 23 04:16 PM