Amazon (NASDAQ:AMZN) believes in the long term! Demanding one of the richest valuations in retail, Amazon is all about growing revenue and market share in the long term at the cost of profits. Trading at a price to last twelve months earnings ratio of 1389, Amazon's valuation defies all financial logic. It is often argued that Amazon’s valuation cannot be measured by standard valuation metrics. The valuation thus seem to be based upon its intangible powers like its strength in customer service, its popularity in online retail, the excitement around its new product launches every year; totally ignoring the margins each of them is capable of generating. The company believes in investment for tomorrow than profits today. Thus, today we will review Amazon valuation based on its top line, bottom line and its cash flow.
Amazon Revenue and Cash Flow Analysis
Amazon revenues have grown at a compounded annual rate of 31% for the past three years. As the growth story looks phenomenal, Amazon has clearly utilized all its cash flows as capital expenditures to generate higher revenues while sacrificing its margins, as can been seen in the chart below.
The operating cash flows for the company have been growing, followed by a similar growth in capital expenditure resulting in low free cash flows for the company. Amazon generated negative free cash flow of $2.4 billion in the first three quarters of 2013 (measured as Operating cash flow minus capital expenditure).
Amazon identifies itself as a low price retailer. However, Amazon is unable to extract profits by the economies of scale achieved from its vast customer base. Along with low barriers to entry, and high competition Amazon will be unable to push up its margins in the retail segment and will have to come up with new ways to monetize its large network. Currently electronics and other general merchandise segment (E-commerce) contributes 65% of the revenues and grew at 29% on a Y/Y basis in the third quarter of 2013. Kindle’s new Paperwhite e-reader and Kindle Fire tablets have also created a buzz in the media.
Online retail, online video, and cloud will be the primary drivers of growth going forward. While these growth factors are keyed in investor expectations, their margin contribution to Amazon financials remains a concern. Amazon is heavily investing in data centres, causing high depreciation levels and low margins. Media segment grew at 33% in the latest quarter and generates 29% of revenues.
Amazon’s Web services (AWS) generates 6% of revenues but is the fastest growing segment for Amazon at 58% on a Y/Y basis. This segment, although small, is expected to generate high growth numbers.
Amazon 2013 Q4 Results Expectations
Analysts expects fourth quarter 2013 revenue in the range of $23.5 billion to $26.5 billion. Given Amazon’s strong sales in the holiday season, Amazon is likely to achieve the top line expectations. This is expected to fuel another jump in price, irrespective of its bottom line performance. Amazon stock price had jumped following the earnings release in Q3 2013, as Amazon registered 24% Y/Y growth in revenues, despite generating a loss of $41 million.
Amazon Stock Valuation
Amazon is excessively overpriced when compared against its peers on the basis of price to earnings ratio, price to sales ratio as well as price to cash flow ratio. Considering price to cash flow metric for Amazon, as cash flows is where Amazon is expected to be strong, valuation is way over the industry average.
|Price Earning ratio (LTM)||1389.47||24.9||15||29.1|
|Price to Book value||20||3||3.4||14|
|Price to Sales ratio||2.60||4.40||0.50||0.60|
|Price to Operating Cashflow||36.57||14.70||11.20||12.50|
We are cautious as the stock trades at insanely high multiples as compared with its peers. Despite Amazon having strong operating cash flows, the price to cash flow multiple of 36x paints a very risky picture for Amazon, given most of these cash flows are then reinvested into the company as capital expenditures. The company will have to grow at a whopping 25-30% annual growth for next few years to justify these current valuations. However, we find it difficult for Amazon to achieve these growth rates as the company will eventually run out of investments to boost its revenues. Even if it grows to the levels of Walmart in the next few years, valuation levels should return to the similar range as Walmart’s, which is grossly lower than that of Amazon. Without positive net income, Amazon will not be able to return cash in the form of dividends or share buybacks keeping it purely a momentum play. Amazon has never been a favourite at Amigobulls, and our financial analysis for Amazon gives the overall company a rating of 2.3/5.
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