Amazon Investors Should Be Frightened of Slowing Revenue Growthhttp://www.fool.com/investing/general/2013/01/31/amazon-investors-should-be-frightened-of-slowing-r.aspx Adam Levine-Weinberg
January 31, 2013
Aragorn: "Are you frightened?"
On Tuesday afternoon, Amazon.com (NASDAQ: AMZN) posted its fourth-quarter earnings report. Revenue of $21.27 billion missed analyst estimates by $1 billion, while EPS of $0.21 missed the consensus estimate of $0.28. However, gross margin of 24% and operating margin of 1.9% beat expectations. This margin expansion did not fall to the bottom line because of higher non-operating expense and a higher tax rate.
Following earnings, Wall Street analysts have focused on Amazon's margin expansion rather than the big top-line miss. Numerous analysts commented to Reuters that they were impressed by the margin growth. In fact, at least 13 analysts raised their price targets for Amazon after the earnings report! However, the fourth-quarter revenue shortfall seriously jeopardizes the investment thesis for Amazon. If growth does not meet expectations, the company's sky-high valuation will eventually contract. In short, investors should be very frightened of slowing revenue growth at Amazon.
Margin expansion: Good but expected
However, Amazon bulls have always expected that margins would recover over time, due to future revenue growth. Amazon's margin outperformance in the fourth quarter has been taken as confirmation that the company's recent margin deterioration was only temporary.
This is certainly reassuring for Amazon shareholders. It is good to see some evidence that Amazon's heavy investments are generating real returns. On the other hand, this was already expected, and fully reflected in Amazon's share price. Amazon reported a small loss for fiscal year 2012; clearly, the company would not be valued at more than $120 billion if investors expected losses to continue for an extended period of time.
Slowing revenue growth is a red flag
Amazon bulls have projected a much stronger growth rate well into the future. Less than a month ago, Scott Devitt of Morgan Stanley predicted that Amazon would record revenue of $166 billion in 2016. This would reflect a compound annual growth rate of 29% over the next four years. This projection requires a reacceleration of revenue growth that is very unrealistic for a company of Amazon's size.
In valuing Amazon's business, faster margin expansion cannot fully offset slower revenue growth. The profit that Amazon can earn today on revenue of $61 billion clearly pales in comparison to the profit that it could earn in 2016 if it were to meet Devitt's prediction for $166 billion in revenue. If Amazon's revenue grows at 20% over the next four years, the company will fall short of Devitt's 2016 revenue target by nearly $40 billion. This lower revenue target significantly decreases Amazon's potential profit in future years.
Explaining the revenue miss
In the past, Amazon has disputed whether collecting sales taxes would damage its business. However, by not collecting sales tax, Amazon has been able to "save" customers as much as 10% compared to retailers with a physical presence, which must charge tax. On big-ticket items, this savings would