Amazon (AMZN) reported third quarter results that showed a loss for the first time in four years. Revenue was $13.8 billion, a little less than $13.9 billion that analysts expected. Amazon lost 60 cents per share in the quarter, much of it due to the loss on its investment in the daily deal site, Living Social. Analysts believe the third quarter is a mere preamble to the fourth quarter, and Wall Street expects a significant revenue boost for Amazon. I believe that Amazon's fortunes will improve, and that investors should not shy away from its stock. Here's why.
I believe Amazon's recently unveiled set of its best selling Kindle Fire tablets, which include larger screens, will compete more directly with Apple's (AAPL) iPad line. The Kindle Fire HD comes in a 7 inch and 8.9 inch version and will have two WiFi channels for faster transfer. Amazon is dropping the price of its 7-inch fire model to $159, down from $199 for its original model. "We have built the best tablet at any price," says Amazon CEO Jeff Bezos. Wall Street also expects a resurgence from Amazon, powered by its Kindle tablets and associated downloads.
The Kindle Fire has been Amazon's top-selling product since launch, capturing 77% of tablet sales in the US in the months since it went on sale. Apart from grabbing a chunk of the lower end of the tablet market, it proved demand for a pocket-sized slate exists, forcing Apple to unveil a smaller tablet in order to protect its market share. Though the Kindle Fire pressured Amazon's margins, it gave the company potentially millions of new high-spending customers. Amazon sold more than six million Kindles in a week last December 2011, which prompts analysts to believe it can replicate the same success next month with the new Kindle tablet lineup.
Since Apple has launched smaller, cheaper tablets to intensify the fight between it and Amazon, the latter has considered launching a mobile device that could compete with another of Apple's product, the iPhone. Amazon is partnering with film distributor, Epix, which boasts recent blockbusters including The Avenger, The Hunger Games, and Thor among its titles. Amazon is entering the streaming business with a very competitive attitude and deeper pockets than rivals such as Netflix (NFLX), and its Epix deal will enable it add 3,000 titles to its Prime streaming service. Amazon believes it can win the war in the sector because it has plenty of experience undercutting the competition by offering lower prices.
Amazon however has problems. Kindle Fire tablet, its best selling product, is threatened by Nexus 7 from Google (GOOG) and the less expensive version of the iPad from Apple. Microsoft (MSFT) is throwing itself into the arena of the tablet computer war between Amazon, Google and Apple leading to the Christmas season. The software giant has just unveiled its first tablet dubbed Surface. Though Amazon's Kindle Fire is a best seller, it was only able to break even, according to HIS iSupplies estimates, while Google said its Nexus 7 is being sold at cost. Despite the challenges all software giants will be vying to get their device on the shopping list as from now on.
Though Amazon is a dominant e-commerce company and has achieved the difficult task of growing faster than the overall industry, its operating margins have been about 2% or less for the year. "Amazon has the lowest operating margin and the highest valuation in the technology company coverage," says Collin Gillis of BCG Partners. "the company is not likely to achieve material leverage off its revenue growth as cost associated with investments into its digital platform builds." Amazon's razor-thin margins have the downside of being very unforgiving. Analysts believe they may be responsible for the losses in its third quarter report.
In direct response to Amazon's successful third party merchant marketplace, Barnes & Noble (BKS) is looking to provide some competition, adding more than a million new products to its online marketplace at B.N.com. The products include cooking utensils, digital cameras and even baby strollers. The rivalry between Amazon and Barnes & Noble was intensified recently, with both companies selling their own digital reading device. Though Amazon boosts a market cap of $105 billion, compared to just $620 million for Barnes & Noble, it doesn't guarantee it will win the war.
Despite its problems, I believe that Amazon will achieve significant revenue in the fourth quarter. New warehouses are coming, speeding delivery of physical goods to customers that will encourage them to stock more. Amazon can best be compared to Apple, Barnes & Noble and Microsoft. Its price-to-sales ratio is 1.84, cheaper than Apple at 3.5. Amazon is more expensive to Banes & Noble at 0.14, but it is stronger because it has a bigger market cap more experience at undercutting rivals.
Amazon has an unattractive price-to-earnings ration at 2,766.93, compared to Apple at just 13.06. It also compares unfavorably to the industry average at 18.94. However, Amazon is expecting significant revenue with Kindle Fire in the next month or two, making its stock attractive in the short term. One should note the nature of Amazon's business is that of a discount retailer that limits margins. So the company is not likely to gain much leverage , as costs associated with investment will inevitably build up. Given all this, I believe Amazon is a short-term investment and that investors should only expose a small percentage of their portfolio to it.