Amazon Stock Has The Growth Drivers But Will Elevated Growth Continue?

  • Capital leases in the liabilities section of its balance sheet are growing faster than AWS revenue.
  • Interest rates combined with a recession and the now mandatory tax collection make it difficult for Amazon's online sales growth to sustain.
  • By adding value locally, offline retailers still can compete with Amazon despite their higher prices.

Amazon stock price is up 114% year to date despite net income coming in lower ($79 million) than the second quarter of this year ($92 million). In fact net income totals have been in the red twice over the last five quarters which have many Amazon bears convinced that over time this stock will ultimately go lower. However in my opinion value investors place too much importance on price to earnings ratios and EPS growth especially for growth stocks such as Amazon. Do you think an shareholder cares if this company keeps on reporting quarterly losses going forward especially when we see the share price up almost 300% since 2012? What matters on Wall Street is top line growth levels (revenue, gross margin, etc) but more importantly the future drivers of this growth. If you have these two components, the respective stock will keep on rallying irrespective of bottom line figures. Amazon stock has huge growth drivers in areas such as "Amazon Web Services (AWS)" where growth rates are accelerating, "Amazon Prime" which continue to offer big discounts and faster delivery times and "International Expansionary efforts" which are ongoing mainly in Europe and China.

Furthermore Amazon stock is being aided on Wall Street by the growing e-commerce trend which is easy to see in competitor Alibaba (NYSE:BABA) numbers which grew its top line by a huge $770 million last quarter compared to Q3 2014. The growth drivers are certainly there, which is why Amazons stock commands a high premium. Twitter (NYSE:TWTR) (another potential growth stock) doesn't have the perceived growth drivers Amazon has. Despite having the top line growth, Wall Street has taken a bearish stance on this stock due to its sluggish user growth which could turn into an opportunity going forward if Twitter can convince Wall Street that its growth drivers are back. Amazon on the other hand has no such troubles with growth drivers but with expectation. The higher Amazon stock goes, the more risk will definitely enter the equation. Let's discuss some areas where it needs to keep its foot to the floor so its valuation can be justified.
Firstly, probably the biggest growth driver Amazon has in its arsenal at the moment is its web services division which brought in sales of over $2 billion last quarter which was a 78% increase in turnover compared to the same quarter of 12 months prior. This division has now doubled its top line since the first quarter of 2014  (see chart) but the important metric in this division is the segment margin levels, which analysts believe can be pushed to 30% over time
However this growth is coming at a cost. When you look at Amazon's balance sheet, it is evident that its long term debt and "Other long-term liabilities" are growing faster than AWS revenues over the last 12 months (see chart)
Capital leases (server hardware) make up the other long-term liabilities and these need to be rolled over in 3 years which will result in more debt. Rising debt levels may not be hurting Amazon now but they very well could do in the future. Why? Well firstly Amazon's retailing division is the AWS's biggest customer. Any slowdown in its retail division will mean less demand for installation of AWS's infrastructure. Secondly if the FED delivers on its commitment to raise interest four times next year, Amazon's debt over time will become harder to service - especially given the company's appetite for growth channels. CEO Jeff Bezoz has stated that AWS will become a $5 billion business faster that many analysts think, due to its growth curve. However I would also be watching interest rates, debt levels and how Amazon retail grows internationally as these may adversely affect the share price going forward
Speaking of interest rates, it may be risky on Amazon's part to begin leasing a fleet of 767 planes to control its international shipping services at this moment because we still do not know realistically how well online sales will do in a rising interest rate environment. If US retail sales remain sluggish (missed analysts expectations again last month with 0.2% growth), Amazon is going to find it difficult to keep its gross income metric growing at the rate it is growing presently (grew to $8.44 billion last quarter - up from $5.81 billion in Q3-2014) Why? Well it is easier for an online retailer to grow sales when retail sales are robust but when they are not, Amazon needs to steal market share from its competitors in order for it to maintain its growth levels. Watch retail sales numbers. If they start to slide (which rising interest rates could cause), having substantially higher cap-ex commitments don't make that much sense in the near term.
Finally just look at one of Amazon's competitors Costco (NASDAQ:COST) which announced disappointing numbers recently, as a result of which, the stock is now down almost $11 a share from $169 a share on the 8th of December. Costco was selling at a premium to the market and analysts now believe its valuation will come down especially if the dollar strengthens more from here. Amazon prime is an online mirror image of Costco's business model, but the problem with these business models is that they are designed for growth and volume. What about the run of the mill consumer who does not want to do all of their shopping with one of these retailers? Is paying the membership fee then justified? Will face to face customer service slowly be nullified over time? I don't think so, nor does Apple (NASDAQ:AAPL) or Walmart (NYSE:WMT) as they both continue to invest heavily in their people. This is where offline companies may have an advantage over online retailers going forward - their ability to "up-sell" their products because of outstanding customer service. Throw "Local" into the equation and now you have a formula that can seriously compete with the likes of Amazon despite probably being more expensive.
To sum up, Amazon has the growth drivers for exponential growth but it will need to keep its growth levels elevated in order to justify its valuation. Its AWS division is booming, but much of its growth has been financed by debt so rising interest rates could be a factor here. Furthermore retail sales are sluggish, and if this metric falls from here Amazon will need to take more market share off its competitors to keep revenue growth buoyant. As fulfillment centers across the world grow in number, local businesses will continue to push the local argument. Furthermore we have seen from other multinationals that one business model may not have the same success in another part of the world. Nevertheless this stock will continue to charge forward whilst its competitors play catch up but any slip in operating margins and gross margins will definitely harm this stock. It needs to keep its perceived "value proposition" to keep the share price charging ahead.

Jack Foley Jack Foley   on Amigobulls :
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  • I do not have any business relationship with the companies mentioned in this post.
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