3 Can’t Turn All of These Frogs Into Princes

It's nearly impossible to count the number of articles that suggest that (NASDAQ: AMZN  ) will disrupt industry after industry, and much of that opinion is based on pricing. There are many who believe that Amazon can enter almost any industry and lose money to take market share. However, market share doesn't pay the bills, and there are several trends that suggest Amazon may be spreading itself too thin.

Where it all started
Although Amazon's most ardent supporters have a hard time believing it, the law of large numbers does apply to Amazon. Competitors like Target (NYSE: TGT  ) in the general merchandise space and Best Buy (NYSE: BBY  ) in the electronics business are affected by industry trends because of their large size.

It's true that Amazon is stealing sales from some of these physical retailers, but like it or not, even Amazon's most bullish analysts are expecting 22% annual revenue growth this year and top-line growth to slow further to 20% in 2015. Considering Amazon was posting annual revenue growth of 29% at the end of 2012, investors need to understand that slowing growth is Amazon's future.

In fact, the trend of slowing growth in two of Amazon's core businesses is undeniable. The company's merchandise sales growth last quarter was the second slowest in the last year. The company is facing increased online sales focus from its peers.

Target knows that site-to-store and online sales have to be a core focus going forward. Though Best Buy has challenges in overall sales, the company's online sales are improving. In the last quarter, Best Buy grew online sales by 29%, which followed a more-than-20% annual increase in the prior quarter.

Two of Amazon's biggest businesses are slowing down. If investors were frustrated with last quarter's results, the future looks like more of the same.

Is the fire going out?
Amazon offers multiple versions of its Kindle Fire and Kindle tablets, and the theory for a while has been that Amazon can sell these devices at a loss and make up the losses from increased digital sales in the future. The problem is that Amazon's digital media sales are growing more slowly than in the last year.

What's even more disconcerting, Amazon has done everything but give the Kindle Fire lineup away, and yet the tablet isn't keeping up with the industry. Even with increased specs, cheap prices, and in some cases payment plans, Amazon's annual tablet growth came in at 22% last year. By comparison, the overall tablet market grew by 68%, and companies like Samsung, ASUS, and Lenovo all posted growth of at least 75%.

Amazon may not want to admit it, but Target's decision to not carry the Kindle lineup didn't help its cause. Best Buy carries the Kindle, but between Apple, Microsoft, and Samsung each setting up their own dedicated spaces in Best Buy, Amazon is being squeezed.

Draining away
Though many have faith in Amazon to produce huge profits at some point down the road, this hope could turn out to be a mirage. The company not only reported a decline in operating income this last quarter, but the company's core free cash flow plummeted from the prior quarter. Six months ago, Amazon produced more than $300 million in free cash flow. This quarter, core free cash flow dropped to just $20,000.

When a company generates nearly $20 billion in sales in a quarter, investors should expect more than $20,000 in core free cash flow. Target has troubles with sales, but in the last three months, the company generated more than $400 million in free cash flow. Best Buy also has challenges, but its more-than-$180 million in free cash flow isn't one of them.

Amazon investors may want to look at the company's balance sheet to determine if they are worried. In the last year, the company's net cash balance dropped from more than $9 billion to about $5.5 billion. With a 41% decline in net cash in one year, clearly Amazon is draining its cash hoard.

The bottom line
Amazon and bullish investors might believe the company can succeed in any new business it decides to enter. However, there are signs that the company is running into problems trying to meet investors' expectations. Sometimes when a company tries to turn too many frogs into princes, all that happens is opportunities hop away.

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  • Report this Comment On May 28, 2014, at 4:36 PM, Seanickson wrote:

    I think amazon investors can be happy with 20% sales growth. The company trades at 1.75 times sales so ideally it can achieve walmart/target type margins and settle into a p/s valuation of 0.5 times sales once its growth phase is over. Online competition is fierce though, certainly wouldnt surprise me if online margins remain somewhat lower.

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Chad Henage

Chad is a self professed tech nerd and has been investing for over 20 years. He follows nearly everything in the technology and consumer goods sectors, and is a huge fan of the Peter Lynch investing style. He has over 1,000 published articles about stocks and investing. You can follow Chad on Twitter at @chadscards1274.

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