Amazon Stock A Short Term Bet?

  • Cyber Monday will be reported as an outstanding success for Amazon. It continues to take market share off brick and mortar retailers.
  • Amazon Prime is being used to sign up repeat customers but I think the offering could be repeated.
  • AWS is growing rapidly, but its being financed through debt, which, in long term brings risks to the table.

Cyber Monday is predicted to be Amazon (NASDAQ:AMZN) biggest day of the year (as reported on Bloomberg today) in terms of sales and it doesn't surprise me. The company's performance in the third quarter of this year was impressive in that active users rose to 294 million and revenue growth came in at 23%. Amazon's growth potential is unquestionable especially when you consider that the global e-commerce industry is predicted to double to $2.5 trillion by 2018.

The underlying e-commerce trend and the infrastructure which Amazon has built up means that Amazon has a leg up over many of its competitors. Competitors such as Walmart (NYSE:WMT) and Macy's (NYSE:M), with their current respective stock price valuations on the floor, compared to Amazon are trying to catch up but are finding out that it is going to be a slow process.

Nevertheless any open minded investor must admit that Amazon's business model can be repeated by a large competitor on an international scale. If the likes of Wal-Mart do gain ground on Amazon, then Amazon's operating margins would come under pressure which would be bearish for the stock. However with a huge quarter to come and no real online threat to its business model in the western world as of yet, Amazon stock should undoubtedly grow from here. Let's explain first my near term bullishness but since I'm not a market timer, my preference is to remain out which we will discuss at the latter end of this article.

Firstly (and this is where you have to admire the company's founder Jeff Bezos), the company has been relentless over the years in pumping back all profits back into the company. This ethos can also be seen on the board as no senior board members receives large compensation - including the CEO. The objective here is plain and simple - relentless domination of the markets in which it operates. Wal-Mart is at a big disadvantage straight off the bat here in that it has to fork out a 3.27%+ yield to its shareholders every year as otherwise the stock would collapse.

Amazon's investors are bred differently and they have been handsomely rewarded over the years especially since 2009. I live in a capital city in Europe and Amazon announced recently that it will be setting up a new Fulfillment center that will need around 1,000 employees. The more fulfillment centers Amazon has, the faster the company can deliver the products.

Volumes will continue to increase but watch the attrition rate of Amazon Prime. This "premium" product is being used to lure buyers in in order to avail of cheaper than standard prices and free shipping. It's a good ploy because even though Amazon is probably taking a hit on some products it sells through prime (to keep market share), it knows you will come back and buy because you have signed up to the premium "annual" service and you (customer) think you are getting a deal every time you buy.

Moreover I wouldn't read too much into margins dropping in the third quarter compared to the second quarter or international operations still being in the red. Historically the third quarter has been the weakest for the tech giant and with Amazon prime beginning to gain traction internationally plus a bumper quarter to come, operating margins could easily hit 6% in the fourth quarter due to added volume and productivity.

Furthermore bulls will say that the robustness of the company's AWS division which now has more than 500,000 customers will keep margins elevated for the the company as it is a division that is growing rapidly. AWS did $4.6 billion in sales in 2014 at a substantially higher operating margin of 14.2%. Bulls are forecasting eventual 20%  margins here and turnover growth rates of 30%+ which would keep numbers elevated in the event of heightened competition in other areas.

Nevertheless in saying all of the above and predicting that Amazon will still rally in the near term, here is why I wouldn't be a long term investor of Amazon. Its cloud division which will continue to grow rapidly but for how long? When you include the main quarterly capex spend of $1 billion along with the company's capital leases ($1.5 billion) (server hardware), you are looking at $2.5 billion in capex every quarter which in my view is not sustainable in the long term.

The problem with the capital leases is that that they have to be rolled over every 3 years as servers usually last only 3 years. Amazon is attracted to AWS because of its margins but significant investment in cloud is only going to bring more debt (which is fine for now). However what would happen if interest rates were to rise aggressively ? Amazon's competitors in cloud have the cash flows to invest in this area to keep up with their capex budgets without taking on significant debt which has to be an advantage long term.

If you look at Amazon's balance sheet for the third quarter, the capital leases are reported in the liabilities section under "Other Long Term Liabilities". This metric has almost doubled in 12 months (going from $4.5 billion in Q3-2014 to $8.5 billion in Q3-2015). Long term debt has also more than doubled in 12 months. Furthermore there is no metric is the asset column that is growing at 100% in 12 months despite cash and cash equivalents which actually fell in Q3 compared to Q2.

Conclusion

To sum up, Amazon stock, in my opinion, will continue to do well but more so in the near term. It is rolling out its successful e-commerce business model through fulfillment centers which will undoubtedly add more value to customers. However the speed of its cloud debt is a risk. If interest rates were to rise, making good on this debt could be a problem long term. Investors have to remember that so much future growth is priced into this stock. That's why in my opinion the long term risk is more to the downside..

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  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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