Kindle: The Life of the Party

Includes: AMZN, BKS
by: Andrew Corn

I have been out of (NasdaqGS: AMZN) for most of 2010 until earlier this month (10/20/10). The optimal time to have gotten in was early September as the stock has outpaced the technology, consumer discretionary, as well as the S&P 500 indexes. We were a little late to the party. As the world’s largest on-line retailer, this stock is a challenge to categorize, tech or discretionary? That also makes it harder to analyze.

I place it in its own hybrid sector as I do Apple (NASDAQ:AAPL). Both stocks are viewed in our shop as much tech as they are consumer discretionary even though they are very different firms structurally. I get concerned about AMZN’s margins which can be sliced razor thin in a competitive world of inventory, discounts, returns and shipping. But it also sells the Kindle. The kindle has been around long enough to have reached a mass media status. One can purchase unlimited consumables for years to come after its purchase. Electronic book prices have basically settled at around the same price as paper versions, and are of course far more profitable.

Looking at operating margins on a trailing 12 month basis smoothes out some of the seasonality of the business and it stands at 5.03%. Although the company is now far more than books, analysts like to compare the firm to Barnes and Noble (NYSE:BKS), which actually has negative margins. The firm sports a Return on Equity also on a trailing 12 month basis of an impressive 23.88%. Add in a 41.2% quarterly year over year revenue increase and solid cash flow and one can see why the firm gets assigned its lofty Price to Earnings ratio.

I read on Bloomberg a bunch of statistics estimating the number of the newest version of the Kindle sold, further confirming the tablet and less expensive eReader marketplaces. Since Amazon released its newest version it has reported that Kindle sales are faster than previously discussed (AMZN does not provide exact numbers, just “guidance”). The piece goes on to illustrate one fascinating number. Of the top 1,000 most popular books sold on Amazon, they sell faster on the Kindle. That is good news for the shareholders of another purveyor of razors and blades that gets to charge for both.

Looking at the last five years, with the exception of 2008, the stock has done well in Q4, through the holiday season. Will there be a Christmas this year for holders of AZMN? Management may have low balled, oops, I mean provided conservative guidance as consumer spending picks up and AMZN gains a larger share of a growing pie. We all want a happy New Year and holiday season.

We will be watching closely and the firm may squeeze out slightly improved margins as it adds capacity in its warehouses for the anticipated increase in business (beyond books). All of the versions of the Kindle may ultimately be the life of the party as downloads do not require warehouses, handling, shipping and provide far stronger margins than flat panels and grills. A surprise margin increase, now that would be a reason to party.

Disclosure: Mr. Corn is Chief Investment Officer of E5A Funds LLC. Through various equity strategies under his supervision he is currently long AMZN and AAPL.