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Amazon.com Just Got Downgraded: 3 Things You Need to Know

By Rich Smith - Mar 22, 2016 at 11:45AM

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This stock brings risks -- and one big opportunity.

Don't look now, but Amazon.com (AMZN 3.15%) just suffered two price target cuts in two days.

The news
Yesterday, as you may have heard, analysts at Oppenheimer slashed $160 off their price target for Amazon stock, warning that Alphabet's (GOOG -0.27%) (GOOGL -0.21%) Google is cutting prices for cloud hosting and predicting Amazon will be forced to cut prices at its own Amazon Web Services (AWS) by 10% in response. Oppenheimer still likes Amazon stock, and rates it outperform -- but warns the company will possibly miss earnings this year as AWS profit margins take a hit.

Now, according to our research here at Motley Fool CAPS, Oppenheimer is only a middling stock analyst, ranking in the bottom half of investors we track globally, and getting many of its stock picks wrong. But just this morning, a new worrisome note was sounded by investment banker Raymond James.

Raymond James removed its strong buy endorsement from Amazon, and cut its price target to $655. That's below Oppenheimer's $660 estimate -- and Raymond James has a much better record of picking winners than does Oppenheimer. (In fact, over the past four years, the majority of its recommendations have beat the market).

Here, then, are three things you need to know about why Raymond James is worried.

Thing No. 1: AWS? Yeah, Oppenheimer was right about that
One so-so analyst warning about Amazon's AWS business is one thing. Two analysts, including a good one, issuing the same warning almost simultaneously, is another. This morning, in a report repeated on TheFly.com, Raymond James warned that Google has been winning business from such cloud-heavy businesses as Spotify and Apple, and that as news of such wins roll in, it will "at least create headline risk for Amazon" -- and at worse, hurt profit margins.

Already, AWS accounts for 7% of the money Amazon makes in a year, and the business has been growing fabulously -- revenues up 69% year over year in the fourth quarter, and operating profits up 161%. Any risk of a slowdown in this profits driver is a factor to be feared.

Thing No. 2: Amazon also sells stuff
Remember books? In addition to cloud storage, Amazon still sells those, too -- and a whole lot of other physical goods. But Raymond James points to rising shipping costs on physical goods as weighing on Amazon's profit margins last quarter, and says these depressed gross margins below what Raymond James had predicted.

Unless shipping costs can be contained, the analyst says margins will show only "gradual" growth going forward.

Thing No. 3: Regardless, Raymond James still likes the stock
And yet, despite all the above, Raymond James still isn't saying to sell Amazon. Rather, it rates the stock an outperform -- just one notch below its earlier strong buy rating. Why?

Well, if you look closely at the numbers, I think you can see why an investor might still be attracted to Amazon.

Consider: While only barely profitable in GAAP terms (its net profit margin is less than 1%), Amazon.com actually does make a lot of money -- free cash flow. It's just that the company tends to invest a lot of that cash in growing its business.

According to data from S&P Global Market Intelligence, last year, Amazon generated positive free cash flow of $7.3 billion. That was 12 times more than its reported net income of $596 million, and it was enough cash profit to give this stock an enterprise value-to-free-cash-flow ratio of just 35.4. Given that most analysts who follow Amazon are still expecting profits growth in excess of 45% annually over the next five years, this suggests that Amazon shares truly are underpriced.

And one more thing...
Did you happen to notice the other Amazon.com news yesterday? According to The Wall Street Journal, Comcast (CMCSA 2.68%) has just hired Amazon to help sell its cable, Internet, and phone services online, on the Amazon website.

That's a huge revenue driver, and news of it broke too recently for either of these analysts to have had much chance to weigh the Comcast deal's effect on Amazon's future revenue and margin growth. But considering how much more a cable package costs than a Kindle book -- I rather expect that the revenue boost will be large.

Bonus points: No shipping costs for Amazon -- because Comcast ships through the Internet's "series of tubes." 


One thing none of the analysts are talking about -- but maybe they should. Image source: Amazon.com.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$2,174.75 (-0.21%) $-4.51
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$109.56 (3.15%) $3.35
Comcast Corporation Stock Quote
Comcast Corporation
CMCSA
$40.29 (2.68%) $1.05
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$2,181.62 (-0.27%) $-5.83

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