Drawing the ire of value investors has become very easy lately; all someone has to do is say something remotely positive about Amazon (AMZN 1.52%). For many, the company's enormous P/E of 3,000 is practically offensive, especially when compared to Apple's P/E of 10. In many respects, I agree. Then again, these same investors can never muster up enough conviction to short the stock.
Granted, by every measurable standard the stock is expensive; there's no debate there. Plus, concerns about the company's razor-and-blades model are valid. On the other hand, it's punitive to continue to fight this incredible growth story. Besides, Amazon has been expensive for almost a decade, including gains of more than 250% over the past five years. And if fourth-quarter earnings were any indication, this company has no plans of slowing down.
Numbers were unassuming, but great where it mattered
First, here's the bad news: Amazon posted net income of $97 million, or $0.21 per share on revenue of $21.27 billion. The company missed top-line estimates of $22.26 billion, while falling $0.06 short on consensus earnings per share. And for a company that's heavily criticized for its bottom line, that net income dropped 45% year over year was a major concern.
However, that's a metric for value investors. Growth is what Amazon shareholders are paying for. In that regard, Amazon delivered 22% year over year. This continued its streak that spans six quarters where the company's revenue growth has averaged 30%. For the quarter, unit growth was up 32% year over year.
Likewise, media revenue was up over 13%. It's not outperforming Netflix, but Amazon doesn't need to, at least not now. In the "other" category, there's cloud services, which surged 64%. While this is certainly impressive, I don't think cloud giants salesforce.com and Oracle are running for cover.
Core merchandise revenue was solid, advancing by 28%. All of that notwithstanding, the one impressive aspect about this quarter was Amazon's strong performance in operating margin. Despite the company's strong growth over the years, this has been the one area where Amazon has been unable to gain credibility.
Investors were encouraged that the company is beginning to develop some leverage in that area. Amazon advanced gross margin by 3.5%. The company showed strong efficiency by cutting costs in shipping and focusing on higher-value services. Similarly, pro forma operating income increased 47% while operating income surged 56%. All of which led to a margin improvement of fifty basis points.
Is a new Amazon on the horizon or new investors?
During the announcement, CEO Jeff Bezos said something that I think should resonate with everyone interested in Amazon. He offered: "We're now seeing the transition we've been expecting." This was very brief, yet very telling. As noted, bears have absolutely hated Amazon's business model. The company has focused on building an empire by giving away land.
In other words, today's profits have mattered very little. The company is famous for its aggressive pricing, which includes selling its Kindle Fire at a loss with the hope of recovering that loss from e-book sales and other media. However, that has not happened yet -- not to the extent that the Street would like. Also, that revenue from media advanced only 13% means that it will be a while before Amazon sees the level of profit needed to offset losses incurred from hardware. But are we reading this incorrectly?
On the other hand, that margins are beginning to improve suggests that the company may not have to wait that long after all. Is this the "transition" that Bezos is referring to? And it's worth asking if all those years of declining margin are thing of the past. For that matter, as much as the company has been blamed for this perceived deficiency, it's also been unfair that Amazon has been grouped with Wal-Mart or Target.
I get the retail comparison. But this is a company that has much bigger ambitions than retail. It's not easy to produce 30% growth year over year and maintain retail-level margins. Amazon has been aggressive in its investments for the future, which have adversely affected its margins. While I don't expect the company to suddenly shift gears, this fourth-quarter report just may be the beginning of the margin turnaround story that investors have been waiting patiently for.
Let's establish some perspective
Investors need to meet this company halfway, and not expect an immediate strategy change. The company has proven for a decade that it can deliver the goods to your doorstep and during each conference call. Besides, I don't think changing its business model would serve the company in the long-term, nor would it reward investors for the premium they are paying for the shares today.
There aren't many companies that are capable of doing the things that Amazon is doing. Whether or not the valuation is deserved is a separate subject. But there's no denying that Amazon has been defying gravity for quite some time, and it may be a while before these shares fall down to earth.
