Amazon Set To Foray Into Online Travel

  • Amazon is expected to launch an online travel portal focused on hotel bookings for boutique hotels.
  • The online travel industry enjoys higher profitability as compared to e-commerce, which could positively impact Amazon earnings, if executed effectively.
  • The reducing operational efficiencies and slowing topline has shifted focus to earnings growth. Failure to deliver on this metric could lead to further corrections in stock price.

Amazon (AMZN) has historically made huge losses, a direct result of chasing revenue growth over profitability. The focus has always been on customers, leading to rock bottom prices on most of their services. A recent attempt to move away from the philosophy of low prices was the launch of Fire phone, which we all now know was a total failure. Following the failure of Fire phone and the huge write-offs that followed, can Amazon find profitability and success with its latest venture of Amazon travel?

Skift reported last week that the initial launch of Amazon travel will feature a limited collection of boutique hotels within driving distance from the cities of New York, Los Angeles and Seattle. The report also stated that the service is expected to go live around the New Year. Although there hasn’t been any confirmation from Amazon, we look at the possibility of Amazon’s potential entry into online travel in a greater detail.

Amazon revenue and profit trends over the last decade

Amazon has been notorious for its lack of profitability for over a decade. The company has been aggressively spending on sustaining its rapid topline growth, which has seen the company revenues grow from $6.9 billion in 2004 to $ 74.5 billion in 2013. On the other hand, Amazon’s operating income has grown from $432 million to $745 million over the same period. While the revenue has grown at an average annual rate of 30%, the operating income has only grown by 6% every year from 2004 to 2013.

Amazon revenue and profitability trends

Amazon’s falling efficiency and faltering operating model

In an earlier article on Amazon’s high PE ratio, we had pointed out the following:

  • Amazon’s reinvestment is generating lower incremental sales over the years, raising questions on the strategy of reinvesting more to drive topline growth.
  • Amazon’s payables to cost of goods sold ratio has hit a plateau and has declined over the last three years, which will add downward pressure to Amazon’s cash flows.
  • Amazon’s inventory turnover ratio has consistently declined over the last decade, implying decreasing operating efficiency.

The lower incremental growth on reinvestment and falling operating efficiency with topline growth, has seen investors value earnings growth over top line growth. Amazon had taken various steps like raise in the Amazon Prime membership fees and the pricing of the Amazon Fire Phone. The amazon fire phone was a disaster, with Amazon blaming the high price of the Fire phone for its disappointing sales performance. Amazon took a $170 million charge on the Fire phone in the most recent Q3 2014. We think that the attempts to move away from a loss leader strategy are encouraging and the focus on earnings growth is good, though none of these moves have had material impacts on the firm’s bottom line yet.

Can Amazon travel help drive Amazon’s bottomline?

Online travel agents (OTA) have historically had earnings before interest, tax, depreciation and amortization (EBITDA) margins higher than the wafer thin margins of online e-commerce industry.

EBITDA margins

2010

2011

2012

2013

Amazon

4.1%

1.8%

1.1%

1.0%

Priceline

27.0%

33.3%

35.9%

37.3%

Priceline, the largest OTA has EBITDA margins nearing 40%, while Amazon has EBITDA margins in the 1% to 5% range, over the last few years. Hence, the entry into the OTA sector is justified and could help Amazon’s bottomline, if executed effectively.

Moreover, apart from the higher profit margins of the online travel industry, Amazon will also be able to use its base of registered and active customers to cross sell travel products from its e-commerce platform and hotel bookings from its travel service. Amazon’s knowledge of shoppers gives it a unique strength, which can be used to effectively target and cross sell products.

Amazon valuation

Amazon has historically traded at premium valuations. Investors valued the company for its high growth, which supported and fueled the stock price in spite of sky high valuations through the last decade. However, recent quarters have seen the company’s topline growth slowing down, which has resulted in a constant pressure to focus on earnings growth. Earnings misses in recent quarters led to significant pullbacks in Amazon stock price. The stock is down 16% in the year to date compared to 12% rise in S&P 500 and 15% gains in NASDAQ composite.

AMZN stockchart
Source: Amazon stock price Vs Nasdaq, S&P data by amigobulls.com

Amazon stock continues to trade at exorbitant valuations, even post the recent correction in price. The stock trades at a price to sales multiple of 1.8, which is very expensive given the firm’s nearly non-existent bottomline, reducing incremental sales returns from reinvestment and reducing operational efficiencies. We re-iterate our negative long term outlook on the stock, as reflected in our Amazon stock analysis.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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