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Amazon's Fundamentals Continue To Deteriorate

|About: Amazon.com, Inc. (AMZN)

Summary

Amazon fundamentals deteriorated through 2014, underperforming on metrics deemed important by the management.

On the other hand, the stock made marginal gains, continuing its defiance of conventional financial wisdom.

Staying away from Amazon stock is the best way for investors to deal with the Amazon stock bubble.

Amazon's (NASDAQ:AMZN) stock has gained 44% over the last two years and 7% in the last one year. While the stock has significantly underperformed the market indices, we think the gains in Amazon stock price are unjustified when seen in relation to changes in the company's fundamentals. Using the latest available numbers for Amazon for FY 2014, we highlight the deteriorating fundamental trends currently underway at Amazon and why the stock is one hell of a risky bet.

Amazon's topline slows even as expenses outgrow revenue

Amazon topline growth continued to slow in 2014. The topline growth in 2014 came in at 19.5%, 2 percentage points slower than in 2013. As pointed out in our Amazon earnings review Q4 2014, surprisingly the market hasn't taken notice of this or has chosen to ignore this considering that revenue growth was the only metric it cared about only a few quarters ago.

YoY Growth

2013

2014

Revenue growth

21.9%

19.5%

Gross profit

34.0%

29.4%

Research And Development Expense

43.8%

41.3%

Selling General And Admin Expense

31.2%

29.5%

More importantly, Amazon operating expenses continued to outgrow topline growth, questioning the reinvestments as they are generating lower incremental sales. We had pointed this out in our earlier post titled, Amazons high PE ratio and falling free cash flow. Amazon is losing the cost leverage it enjoyed a few years ago and that has been accompanied by higher losses, questioning the firm's ability to generate earnings.

Amazon's terrible profitability just got worse

Amazon profitability continued to slide in 2014, as the company posted a Net Loss of $241 million in 2014, a more than $500 million fall from 2013. Amazon recorded profit margin contractions at the Net as well as operating levels.

YoY change in profit margins

2013

2014

Gross profit margin

2.5%

2.3%

Operating profit margin

-0.1%

-0.8%

Net Income margin

0.4%

-0.6%

Free Cash Flow margin

2.1%

-0.5%

Adjusted Free Cash Flow margin

 

-2.3%

Amazon bulls might argue that the gross profit margin expanded by 2.3 percentage points. However that is a function of the increasing proportion of third party sales in Amazon topline, which Amazon records on a commission basis, leading to inflation of the gross profit margin.

This is an argument which is crushed by Amazon's SEC filings. Quoting from Amazon SEC filings, "We believe that income (loss) from operations is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services." Hence, gross profit margin changes do not provide a clear picture of Amazon's profitability due to the complexity of the products and services sold by the firm.

Amazon SEC filings also state on page 18, "Our financial focus is on long-term, sustainable growth in free cash flow per share." We look at the changes in free cash flow and free cash flow margin in 2014. Amazon's free cash flow margin contracted by 50 basis points in 2014, coming in at a marginal 2.2% in FY 2014.

YoY change in profit margins

2013

2014

Free Cash Flow margin

2.1%

-0.5%

Adjusted Free Cash Flow margin

0.9%

-2.7%

However, Amazon's free cash flow fails to tell the complete picture. Amazon acquires a significantly large amount of capital (Assets) under capital leases, which assumes gigantic proportions when compared alongside the marginal free cash flows. Amazon acquired over $4 billion capital under capital leases in 2014, while generating a free cash flow of $1.95 billion. Adjusting free cash flows for Capital leases and finance lease principal repayments, Amazon free cash flow presents a grim picture. The company reported an adjusted free cash flow margin of -2.5%, essentially losing over $2 billion through 2014.

Amazon cash, debt and interest analysis

Amazon ended the year with a Net Cash position of $9.15 billion, marginally lower than the $9.26 billion at the end of 2013. The total long term debt was $8.27 billion as on December 31, 2014.

 

2013

2014

Cash and cash equivalents

12.45

17.42

Long term debt

3.19

8.27

Net Cash position

9.26

9.15

Amazon's interest coverage ratio has constantly deteriorated over the last 5 years, as seen in the table below.

Source: Amazon 10-K

The company raised $6 billion of debt in 2014 while repaying $500 million of earlier debt. With a 160% increase in debt, and Interest expenses which overshadow operating Income, Amazons mounting debt will continue to pressurize the bottomline in the coming years. Based on the current outstanding long term debt, Amazon interest expense in 2014 will come in closer to $400 million.

Bond Maturity

Rate

Value (in millions)

Interest

Nov-15

0.65%

750

4.42

Nov-17

1.20%

1000

12

Nov-22

2.50%

1250

31.25

Nov-19

2.60%

1000

26

Nov-21

3.30%

1000

33

Nov-24

3.80%

1250

47.5

Nov-34

4.80%

1250

60

Nov-44

4.95%

1500

74.25

Interest due on debt issuance

288.42

Capital lease interest component*

47

Financial lease interest component*

43

Total interest due in 2015

378.42

Source: computed from information given in Amazon 10-K

*Capital lease and financial lease interest components calculated as (repayment including interest - current portion for 2015)

The increasing interest expense will be a further burden to Amazon's bottomline, significantly denting any likelihood of positive Net earnings in 2015.

In effect, Amazon's revenue growth slowed in 2014 while profit margins and free cash flow margin saw big contractions. Amazon continued to burn cash at a rapid rate, financed by over $6 billion in debt through the year, even as Interest expense outgrew the Operating Income. The company underperformed on metrics deemed important by the management, free cash flow as well as operating margin. All in all, 2014 was a disastrous year as far as Amazon fundamentals were concerned and any upward movement in the stock price is a result of pure speculation. However, this is one stock which has defied conventional financial wisdom for over a decade and could continue its insane run for longer than you can stay invested. The bottomline is clear; stay away from this speculative bubble and put your hard earned money at work elsewhere, because all bubbles eventually burst.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The article was written by Virendra Singh - Equity Analyst at amigobulls.com. Amigobulls Mediatech Pvt Ltd is not receiving any compensation for this article (other than from Seeking Alpha). Amigobulls Mediatech & Virendra Singh do not have any business relationship with any of the companies mentioned in the article.