Amazon.com (AMZN 0.11%) posted its first quarterly loss in nine years on Thursday, and the stock was crushed in after-hours trading. The aura around Amazon was beginning to feel very similar to Netflix (NFLX 0.40%) and Green Mountain Coffee Roasters (GMCR +0.00%) before their fall -- or so I thought.
Come Friday morning, Amazon's stock moved higher, even after disappointing results across the board. Jeff Bezos must have managed to hypnotize his company's shareholders, because I just don't get it. I've been short Amazon for a while, and I still don't see how the market keeps pushing the stock higher given these terrible results.
Amazon lays a quarterly egg
I've been going against grain of the market and our Motley Fool newsletters for some nearly a year now. In January I said it was time to sell the stock and I followed that up with a dive into its insane share price in May and a short call (and trade) in July, not to mention an underperform call by a group of analysts I'm a part of.
All of these calls have been wrong, but after Amazon's third-quarter earnings, I have fundamental momentum behind me. We have two straight quarters of deteriorating results to point to.
Amazon should be driven by two factors: sales growth and net income. And both metrics have fallen over the past year. In the most recent quarter, Amazon posted a massive loss, and even if you take out LivingSocial, the company would have lost $105 million.
| Metric |
Q4 2011 |
Q1 2012 |
Q2 2012 |
Q3 2012 |
|---|---|---|---|---|
|
Sales Growth |
33.6% |
33.8% |
29.5% |
26.9% |
|
Net Income |
$177 million |
$130 million |
$7 million |
($274 million) |
Source: company earnings releases.
So why didn't the stock drop on Friday like it did in after-hours trading? I think Amazon still has an invincible aura around it, and investors will explain away the bad results by looking to tomorrow.
Somehow, Amazon has gotten investors to believe that it will make up for losses now by growing into the future. Here's why I don't believe that will be the case.
Cloud computing is the future
Maybe the cloud is the future, and maybe Amazon will dominate it someday. But right now, Amazon Web Services, or AWS, accounts for a measly 4.7% of sales and grew at 59.2% last quarter. At that pace, it will be years before AWS is a significant portion of Amazon's business. By then you can be sure that Microsoft (MSFT 3.90%), Cisco (CSCO 1.35%), Hewlett-Packard (HPQ 1.47%), and a multitude of others will come after this business, and Amazon will have to fight in another low-margin business.
Amazon is just investing for the future
This is the classic argument for Amazon. The company is investing now so that it can make a profit in the future. There are a few problems with this argument, in my eyes.
First, this is the kind of argument a start-up makes, not a $103 billion company with $67 billion in sales over the past year.
Second, Amazon doesn't explain when the payoff will come and how large will it be. Is this investment going to pay off when Amazon reaches $200 billion in sales? What about $300 billion? What will margins be in the future? The highest net margin Amazon has ever posted is 3.7%, so if the company tripled sales, it could generate a $7.4 billion profit, which would make the stock about as expensive as Wal-Mart (WMT +1.61%) and Target (TGT 0.26%) today. Remember, that's if sales triple, and if margins reach their historical high, and if the stock goes nowhere in the meantime. I don't like that many "ifs" in my investments.
Finally, what is this magical potion Amazon is investing in? If you're pointing to server farms or distribution centers, I don't see it in a size that would justify quarterly losses. In the third quarter, Amazon spent $716 million on fixed assets, about 35% higher than last year. That's enough to keep up with growth, and that's about it. The real reason for this quarter's loss is growing fulfillment, technology, and stock grant costs. Investing in the future has little to do with this quarter's loss.
Improving operating margins?
Bloomberg reported that the stock was up yesterday on better-than-expected operating margins. The article, linked here, cites an analyst who says, "The Seattle-based retailer is getting better at managing margins, and investors are betting that higher spending now will result in higher sales down the road, said Colin Sebastian, an analyst at Robert W. Baird & Co."
I had to read that statement again and double-check the numbers. He said "better at managing margins," didn't he? Am I looking at different earnings numbers from what Baird gets? The past four quarters show deteriorating operating margins.
| Metric |
Q4 2011 |
Q1 2012 |
Q2 2012 |
Q3 2012 |
|---|---|---|---|---|
|
Operating Margin |
3.7% |
3.3% |
2% |
0.7% |
Source: Company earnings releases.
If fact, the trailing-12-month operating margin peaked in the second quarter of 2011 at 4.9% and has fallen ever since, finally reaching 2.5% this quarter .
Sebastian also says that Amazon "exceeded their operating profit expectations now for the fourth consecutive quarter." What should we expect next quarter? Negative-2% operating margins? Would investors cheer that, too?
The Kindle will dominate the world
My other favorite argument is the one that says Kindle will rule the world. Watch out, Apple (AAPL +0.15%) and your overpriced iPads!
The problem is that Amazon has never made any money on Kindles. Sure, Bezos says Amazon will make up the profit on the back end with e-book sales, but I say "prove it." Show us the numbers.
According to some fancy calculations I did last month, I think it would be a stretch for Amazon to make even a 10% margin on the Kindle. Apple, by comparison, has investors worried with "just" a 40% gross margin.
Amazon may sell a lot of Kindles, but it certainly isn't making a lot of money on them, if any at all.
Other tidbits you should know
Looking through Amazon's report shows some other interesting tidbits.
- Fulfillment costs rose 34.7% in the quarter versus 26.9% sales growth. Amazon Prime (of which I am a frequent user) can probably be blamed for this.
- Over the past year, Amazon has destroyed $204 million in shareholder value as judged by shareholder equity.
- Amazon is increasingly using restricted stock grants to compensate employees. In the past nine months, the company has granted 6.6 million shares of stock worth $1.5 billion, which is 47% more than last year. These grants cost $597 million on the income statement, which is 50% higher than last year. To put the impact into perspective, the number of shares outstanding has been fairly constant since the end of 2010, but over that time Amazon has spent $1.2 billion to repurchase stock -- the direct result of stock grants.
Everyone's been hypnotized
I know that I'm going against conventional wisdom here, but I just don't see how everyone still loves Amazon's stock with these numbers. Sales growth is slowing, margins are falling, losses are growing, and to top it off, management is giving away the company. These should be red flags for any company, much less a company with a P/E ratio of 290!!
But still I lose my bet against the company, and bullish Fools are proven correct. Fellow Fool Joe Magyer went into painstaking detail to make the bullish case for Amazon in our premium report. So far he's been right, and that still leaves me scratching my head. Find out why Joe thinks I'll continue to be wrong and Amazon will return to profitability by clicking here.
If only someone somewhere on the market could use his megaphone to make a short case in Amazon. Where's David Einhorn when I need him?
