Amazon.com (NASDAQ: AMZN) has built itself into the leading internet retailer while becoming one of the key players in other areas, primarily tablets and the cloud. The company has and should continue to innovate to drive growth in its businesses.
Management has positioned its core retail business for sales growth and margin expansion which will act as the primary catalyst to drive the shares higher. In addition, the continued success of the Kindle business and its position in the cloud — Amazon Web Services — are additional growth tools.
Amazon is a good buy-and-hold candidate behind these multiple growth drivers, strong management, and positive secular trends (primarily the ongoing shift to online shopping as well as the cloud).
Amazon Prime Can Drive Beats and Act as a Catalyst for the Stock
Amazon Prime became a driver of growth both sooner and to a greater magnitude than expected. It can continue to lead the stock to outperform going forward. While other retailers like eBay (NASDAQ: EBAY) have issued somewhat cautious outlooks based on some softening in consumer demand, Amazon seems cautiously optimistic.
Management stated that it added millions of Prime customers over the past three months and the growth of that service is not showing signs of slowing. Amazon has added about 20% to its customer base and improved revenue per customer of around 5% in 3Q ’13. The latter has steadily improved from a slight decline in revenue per customer in 4Q ’12 behind the benefits of Amazon Prime. This can continue to accelerate behind new customers joining Prime.
Prime customers get free two-day shipping and handling on all orders, regardless of size, unlimited streaming of TV shows and movies, and can borrow a free book per month from the Kindle store. Amazon had to create service centers around the country to deliver on the promise of two-day shipping.
The average monthly revenue from a Prime customer is much higher than non-Prime shoppers, so growth in this base should help accelerate growth in the core shopping business. In addition, third-party vendors push to make sure their merchandise is located in the fulfillment centers so customers get two-day shipping and they get “Prime” branding.
The streaming portion of the service has performed better than expected and the concerns the capex into this business would generate below-average or no returns are gone at this point. Adoption has been smoother and greater than expected and Amazon is now competing directly with Netflix (NASDAQ: NFLX) in this business. Like Netflix, it is adding original content of its own.
Recent Quarter Showed Positive Acceleration in Sales and Gross Profit
Sales in the most recent quarter increased by 24% which was at the top end of the 12 to 24% guidance management provided and ahead of consensus at 21%. Also noteworthy was a slight gross margin beat: 30 BPS versus consensus at 27.4%.
North American sales growth accelerated to 31% for the third consecutive quarter driven by electronics and general merchandise sales. Amazon did post an operating loss of $25 million behind technology and content costs which cause concern from the Street. The sales and gross margin beat though should drive future earnings and were more important to the long-term story.
Management issued 4Q ’13 guidance for revenue growth of 10 to 25% with operating profit ranging from −$500 million to +$500 million. Amazon earned $405 million in 4Q ’12. Importantly, management has as history of setting guidance at a reasonable level and then beating this forecast. Given some macro uncertainty around the consumer, Amazon was likely particularly cautious and can deliver a beat in the 3 to 6% range.
Valuation
Amazon’s stock is expensive according to some, but investors have to pay for growth. With the sales growth forecast far ahead of the retail average, higher potential profitability, and its other businesses — Amazon Web Services, Kindle, and now content streaming — it deserves a leading multiple.
Historically, Amazon has traded at 5-year and 10-year averages of 22.8x and 22.2x NTM/EV EBITDA, respectively. It has an EBITDA margin of around 9%. It should sustain a high multiple given the factors mentioned which should drive the shares higher if it can deliver on growth forecasts. Currently Amazon trades at 23.8x and 17.5x 2014 and 2015 EBITDA, respectively.
Conclusion: Amazon Worth Owning for Core Business, Others Are Gravy
Amazon has changed the way consumers shop, is playing a role in developing the tablet market, and has significant share in the growing cloud market. In addition, it is starting to push into the streaming business and will likely emerge as the key competitor to Netflix. All these other businesses are like gravy on top of growth in the core online shopping business.
With consumers continuing to shift purchases online and the initial success of Amazon Prime, the company can gain share in the increasing online shopping market in North America while also continuing to expand internationally.
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