Monday, March 10, 2014

What Does the Market See in Amazon?

Amazon: Amazing value with slim earnings
Check the stock price of Amazon.  Soaring, surging the past few years, maintaining a steady climb in the past year (with occasional moments of volatility). (Share-prices hovered around $150-160 back in 2010; they now trade above $365 in 2014.)

Now pull out its financial statements and peek at the company's revenues over the past several years.  Extraordinary, enviable growth.  Revenues in 2010, $34 billion, have more than doubled. They topped $74 billion in 2013.

The company has experienced exceptional growth, as it has pushed itself into multiple products and new services.  It is no longer a mere online book seller, no longer just peddles its electronic reader, the Kindle, and electronic selections.  Under its banner, it sells and delivers just about all merchandise that can be boxed and trucked to the front doors of America (and beyond). In recent years, it has ventured into computing services and unveiled what had been a secret plan to deliver products same day using drones technology, although it may take years for regulators to get comfortable with low-flying vehicles in urban areas. 

Jeffrey Bezos, CEO and founder, is the guiding hand behind all that it does and contemplates doing. For most who watch every step and every hint of a new strategy from the company, Amazon is Bezos. He provides the vision and articulates the strategy--at least to his cohorts, if not comfortably to the media. Amazon is his elaborate apparatus and network by which consumers can log on and shop for every imaginable consumer product.

So take a look at earnings. Uh-oh.  Choppy, erratic, and virtually non-existent until a short time ago. The company lost money in 2012.  While sales will likely pass the $80 billion mark in 2014, profits haven't topped a single billion the past three years. Returns on equity have been less than 8% since 2010, less than 4% last year.

How does the market justify high values and high share prices for a company that can no longer be fairly labeled a hot, emerging enterprise, no longer a company hustling to establish itself and seize a niche? And a company that doesn't pay a dividend. The company is already on its way to being two decades old.

This week, the company has a market value above $170 billion; its tangible book value (after adjustments for balance-sheet intangibles) amounts to about $7 billion.  Go figure.  Some analysts say the market is pricing its shares (now above $350/share for most of 2013) as if company revenues will continue to grow at rates above 15-20%/years and will exceed $400 billion annually before this decade is over.

Some will remind us to take glance at the cash it has amassed on its balance sheet: over $12 billion, resulting from years of operations and years of not paying dividends. The market acknowledges this cash reserve, but that explains a tiny fraction of the total value and it's cash that permits the company to leap to make small acquisitions whenever it wants.

Take a look, too, at the assessments from ratings agencies. They have disparate viewpoints. One agency has rated its debt a AA-, likely comforted by such pole-vaulting sales growth, industry leadership, and a well-understood business model.  Yet another agency has rated it Baa (or BBB) (on the brink of being "junk"), likely befuddled by slim earnings, tight profit margins, occasional stock repurchases, and cash flow buffeted by its success in delaying payments to suppliers.

Often when a company is in its early stages, equity markets overlook the first few years of formation, as it penetrates product markets, establishes a brand, and polishes its infrastructure. Losses in early years are tolerated, as we saw with Facebook, Twitter and other ventures.  Markets look for and expect earnings growth three, five, six years down the line.  But years have gone by, and Amazon's bottom line fluctuates unpredictably from year to year.

Its CEO is not worried a bit. He has told his story often and has convinced shareholders the tale here is not about bottom-line earnings, not free cash flow available for shareholder rewards. His story, he conveys, is about growth, expansion, and a revenue line that doesn't edge upward in small increments. It accelerates. He asks for market patience and gets it.

At least for now, the company appears to be backing up and reaffirming this strategy.  It generates a reasonably amount of cash flow from operations to maintain a growing infrastructure. It has shown it is adept at managing inventory (books, consumer products, housewares, etc.) without having to hold it in its warehouses for lengthy periods, which otherwise requires significant short-term financing.  It has also managed inventory cleverly by not paying suppliers until inventory is already out the door and in the hands of buyers. 

With shrewd ways of managing inventory and cash flows, it generates some cash, holds on to some of it, and reinvests the rest to finance more revenue growth.  In recent years, it has become more comfortable in using debt to support expansion (more warehouses, other new business ventures), but at moderate, test-the-waters levels.  Each year, the cycle repeats:  more revenues, more shrewd inventory management, insignificant pressure on cash flow, a little bit of debt (not much) and more reinvestment in the business and new ventures. Whenever (or if ever) drones become part of the business operation, inventory will be pushed out even more quickly.

Shrewd, careful balance-sheet management while continuing to build the business. That explains one ratings view.  Astounding growth in revenues, but could it endure a sudden substantial decline in revenues, although nobody imagines such a scenario? That explains another ratings view. Yet another view?  Bezos could become distracted by his own personal ventures, including his purchase of the Washington Post media group (a Bezo purchase in 2013 unrelated to Amazon).

While revenues grow consistently at stunning rates, the rest of Amazon's financial condition is an intrigue, an amusing array of situations that don't threaten the company as long as business expands.

What more does the equity market see? A strong vision, marketplace dominance, new products and services, revenues growing 15-20% every year, the ability to keep consumers glued to its web pages, and an understanding that dividends will be sacrificed to permit long-term growth. And yes, the market likes Amazon's knack for remaining nimble, new and innovative, as if it were a start-up.

But earnings returns had better get to 12-15% ROE consistently before the decade runs out and before patience runs out. 

Tracy Williams

See also:

CFN: Now It's Twitter's Turn, 2013
CFN:  Facebook Stock:  What Went Wrong in the Beginning? 2012
CFN: What Happened at JCPenney? 2013
CFN:  Apple With All That Cash, 2013
CFN:  Merger Mania:  Boom Times Ahead? 2013 
CFN:  The Verizon Deal: Big Numbers, Big Debt, 2013

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