On Air Now

Listen

Listen Live Now » 98.5 FM Battle Creek, Michigan

Weather

Current Conditions(Battle Creek,MI 49017)

More Weather »
70° Feels Like: 70°
Wind: WSW 10 mph Past 24 hrs - Precip: 0”
Current Radar for Zip

Tonight

Scattered Thunderstorms 68°

Tomorrow

AM Clouds/PM Sun 81°

Mon Night

Clear 66°

Alerts

Growth concerns dog Amazon as it shores up digital beachhead

A worker carries packages for shipment at the Amazon warehouse in Leipzig, December 3, 2008. REUTERS/Fabrizio Bensch
A worker carries packages for shipment at the Amazon warehouse in Leipzig, December 3, 2008. REUTERS/Fabrizio Bensch

By Alistair Barr and Ben Berkowitz

SAN FRANCISCO/NEW YORK (Reuters) - Amazon.com Inc's stock sank 6 percent on Friday as a poor financial outlook revived concerns about whether the company can sustain its torrid pace of expansion while profitability improves.

The world's largest Internet retailer on Thursday reported its highest gross profit margins in a decade as years of spending on high-margin businesses, from digital media to cloud services, began to pay off. But slower revenue growth and a disappointing outlook for this quarter exacerbated uncertainty about the its business beyond the United States.

Amazon faces a sluggish European economy and has had inconsistent success breaking into emerging markets such as China, where competition from the likes of Alibaba is intense.

Year-over-year unit growth, which measures the number of items Amazon sells, was 30 percent in the first quarter, down from 49 percent in the first quarter of 2012.

As growth concerns worsen, the company will have trouble justifying its triple-digit price-earnings multiple. Analysts at J.P. Morgan, Credit Suisse and Pacific Crest Securities on Friday lowered their price targets on Amazon shares, citing the top-line deceleration.

"As unit growth decelerates, does Amazon stop being a growth stock and start becoming growth-at-a-reasonable price?" said one analyst, who requested anonymity. "Margins are coming up but they are still pretty low, so there's not much support for an earnings multiple valuation."

The analyst did not want to be identified because these concerns are based on a worst-case scenario for Amazon.

"That's not my base case but that's the concern," the analyst added. "The stock could be stuck between $250 and $280."

FUNDAMENTAL SHIFT

Longer-term, investors are keeping a close eye on a fundamental shift in its business.

The Internet retail giant that once specialized in moving books and other physical items quickly is increasingly trying to do the same in the digital world, where profit margins are higher, partly because e-books, music and video files and are transmitted electronically at high speed.

It has diversified aggressively into other revenue streams like digital content, advertising and the Amazon Web Services cloud computing business. Lately, it has even branched into creating original video content.

Throw in a fast-expanding third-party merchant business, where Amazon books a cut of sales from seller listings on its website, and the long-term margin outlook looks solid.

"Over the long term it does help margins," said Ben Schachter, an analyst at Macquarie. "You don't have to put these things on a truck and ship them."

ROOM TO MOVE

In the first quarter, net shipping costs stood at 4.7 percent of sales, down from 5.1 percent a year earlier.

"What we're seeing is that Amazon is really getting leverage from shipping costs. AWS is becoming a big part of their mix. They are also benefiting from a greater mix of advertising revenues. We'll continue to see that improve," said Victor Anthony, an analyst at Topeka Capital Markets.

But its brick-and-mortar rivals are catching on, in many cases borrowing pages from Amazon's pioneering e-commerce play-book.

"Amazon's now growing at about 2x eCommerce, compared to 3x a year ago," Doug Anmuth, an analyst at J.P. Morgan, wrote in a note to investors following the company's results.

Retailers are losing less market share to Amazon than they used to as they increase selection online, price-match more aggressively, and work to combat showrooming, Anmuth argued.

Shares of Best Buy Co and HH Gregg Inc, electronic retailers that have been particularly hard hit by Amazon competition, have doubled so far this year.

Amazon shares are up 1.5 percent this year, while Wal-Mart Stores Inc and Target Corp are up about 16 percent and 20 percent, respectively.

Despite declines, Amazon shares still trade at about 100 times 2013 estimated earnings and 75 times 2014 forecast profit.

Even on a more-forgiving valuation method, Amazon shares are expensive. The stock trades at about 20 times earnings, before interest, tax, depreciation and amortization, or EBITDA. Google Inc trades at about 10 times EBITDA and eBay Inc trades at 11 to 12 times EBITDA.

Amazon will need to pump out higher earnings in the future to support such valuations, especially if growth rates continue to slide, analysts said.

The company's gross profit margin hit a better-than-expected 26.6 percent in the first quarter, up from 24 percent a year earlier.

Still, one major source of recent profit growth, Amazon's online marketplace for third-party sellers, known as 3P, stalled in early 2013.

First-quarter 3P unit growth was 33 percent, down from a 40 percent growth rate in the first quarter of 2012, according to Ken Sena, an analyst at Evercore Partners.

Amazon's retail business, known as 1P, buys products at bulk prices and sells them at higher prices, collecting the difference as profit and recording the sale price as revenue.

In a 3P transaction, Amazon books commissions from third-party sales on its marketplace as revenue. That revenue is almost all profit, so as the 3P business has grown, Amazon's gross profit margins have expanded.

The slowdown in 3P growth during the first quarter "has some concerned that the gross margin leverage story may be nearing its end," Sena said.

Amazon shares were down 6.3 percent at $257.36 on Friday afternoon on the Nasdaq, off an earlier low at $252.81.

(Writing by Ben Berkowitz; editing by Edwin Chan, Lisa Shumaker and Matthew Lewis)

Comments