Is Amazon.com (NASDAQ:AMZN) a uniquely strong business or a dangerously speculative bet? Depending on whom you ask, you'll get very different answers to that question.
When Amazon announced this week that it was shopping for $3 billion in new debt, it marked the company's first visit to the bond market in 15 years. However, it also invited the credit rating agencies to chime in about its prospects.
Maybe they could clear something up for us. Amazon is trading at a sky-high valuation. The company's P/E ratio isn't even worth calculating. (Google Finance lists a multiple of about 3,250.) But Amazon is clearly succeeding in online retail and expanding that dominance to new markets that boast lots of potential. Are we looking at a strong investment, or a speculative bet? Even the debt rating agencies can't decide.
A strong business
Standard & Poor's weighed in on the bull side, rating Amazon's bonds at AA. That's just two notches below the pristine ranking of U.S. federal debt. The rating corresponds to a "very strong capacity to meet financial commitments." S&P sees minimal risk ahead for the web retailer, saying that Amazon's strengths "far more than offset"the gambles it is taking. Those risks include a rapid growth strategy, large technology bets, and declining margins.
Amazon is in good company with this rating. S&P has bestowed AA status on such profit powerhouses as Google (NASDAQ:GOOGL) and IBM (NYSE:IBM). The gorilla of search has no problem paying the bills, as it last reported a hefty $16 billion in cash on its books. Ditto for IBM, with its $12 billion in cash and $16 billion in profits last year.
A risky bet
But the Moody's rating service wasn't nearly as optimistic about Amazon's business. That credit agency slapped the e-retailer's debt with a Baa1 rating, well below its highest AAA rank. That rating signifies an investment with "moderate credit risk" that could have "speculative characteristics." It's the same ranking Moody's gave to much smaller Stanley Black & Decker (NYSE:SWK), which recently logged a debt-to-equity ratio of 60%.
In its report on Amazon, Moody's highlighted the e-retailer's "weak" and declining earnings, saying:
Moody's is concerned that Amazon.com's EBIT margin will be limited by competitive factors, an increase in its net shipping costs, and its pricing strategy. Moody's is also concerned that profitability may be affected as Amazon.com expands the number of devices it develops internally and expands it web services business .
But that wasn't all. Moody's also warned that a downgrade would be in the cards if Amazon can't manage to reverse the negative trend in earnings and cash flow.
About that cash, just how badly does Amazon need the $3 billion? Instead of filling any particular need, the company could just be taking advantage of ultra-low interest rates. Google and other cash-rich companies have done the same lately. November corporate debt sales set a record by clocking in at over $100 billion, after all .
But Amazon's commitments do seem to be piling up. The company broke all kinds of real estate records when it promised $1.16 billionto purchase its headquarters outright.
And Amazon's operating costs have been on a tear lately. They jumped last quarter, continuing their poor trend of growing faster than revenues. The company's ramped-up spending on streaming video content is a prime example of the cost of such an ambitious growth strategy. Amazon looks to be spending at least $1 billion a year just in its challenge against Netflix.
Foolish bottom line
Those capital outlays make Amazon's $3 billion in cash on the books seem a little tight. Particularly when its annual free cash flow has declined to $2 billion, from $3 billion in 2009.
That's why I come down on the bearish side of this argument. Its revenues are massive, and so Amazon should have no trouble servicing the debt it floated this week. But the retailer's broader spending trends suggest that the quarterly loss Amazon booked in Q3 is typical of what investors can expect for a while. And without stronger earnings, 1.9 times sales is too much to pay for Amazon.
Have an opinion on Amazon? Sound off about it in the comments section below.
Fool contributor Demitrios Kalogeropoulos has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Google, and IBM. Motley Fool newsletter services recommend Amazon.com, Google, and IBM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.