Amazon's stock is overvalued, overloved
The Internet retailer has become more expensive than the far superior Apple.
By Jake Lynch, TheStreet
Superlative inventory management, low pricing and innovative rewards programs have helped Amazon propel revenue 32% a year since 2008. But despite Amazon's outstanding fundamentals, its stock is overvalued and overloved.
There are signs that the growth trajectory at Amazon is tapering. Whereas sales expansion remains brisk, hitting 36% in the seasonally strong fourth quarter, profit growth was marginal. Amazon's quarterly net income rose 8.3% and earnings per share ascended 7.1%, earning a growth score of 1 out of 5 from TheStreet Ratings' quantitative equity model.
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Traditional valuation measures, such as price-to-earnings and price-to-book ratios, demonstrate a still-sizable growth premium for Amazon. Its forward earnings multiple, at 42, book value multiple, at 12, and cash flow multiple, at 24, are all more than triple their respective S&P 500 ($INX) averages. Amazon, with an $83 billion market value and $34 billion of 2010 sales, is a large-cap trading like a fast-growth small-cap.
Of note for tech enthusiasts: Amazon is considerably more expensive than Apple (AAPL), a company with superior growth rates, substantially wider margins, more than $60 billion in net cash and the best analyst sentiment in the market.
Perhaps most telling is Amazon's PEG ratio -- its trailing P/E divided by researchers' long-term growth forecast. The PEG ratio, popularized by mutual fund legend Peter Lynch, is ideal for valuing growth stocks. Amazon's, at 3.2, suggests that its equity may be overvalued by as much as 70%. Granted, the outlook for Amazon's growth varies widely and its stock may continue on its meteoric pace, having returned 25% in the past 12 months. But, surfeit optimism often provides a set-up for disappointment and an accompanying stock drop.
Two prominent equity researchers disagree on Amazon's future. Goldman Sachs (GS) ranks Amazon's stock "buy" and forecasts it will advance 22% to $225 in the next 12 months. In contrast, Credit Suisse (CS) rates Amazon "neutral" and believes it's fairly valued, currently, at $185. Going further, boutique researcher BGC Financial (BGCP) has a "sell" rating on Amazon and a $125 price target on the stock, suggesting that it may fall 32% over the next 12 months.
In a note issued April 11, BGC warned clients that slowing revenue growth may be evident in Amazon's first-quarter report, due April 26, and advised them to avoid the stock. Although BGC expects sales to increase 30% from the year-earlier quarter, it's expecting a tough sequential decline of 28%. Its sales forecast, at $9.3 billion, is well below consensus.
BGC forecasts a modest beat, by 2 cents, on the bottom line, but warns that further proof of slower profit growth may catalyze a correction in the stock. As mentioned above, Amazon is priced for perfection, despite evidence of a slowdown and potentially damaging economic reports, ranging from lower consumer confidence to higher gasoline prices, which suggest a cannibalization of consumer demand. BGC estimates sales losses in Japan, stemming from the earthquake and tsunami, of $100 million, with "the potential to triple in the June quarter." Expensive gas, in addition to crimping consumers' shopping, raises Amazon's shipping costs.
BGC, convinced that Amazon is using Kindle as a loss-leader in order to lock in sales for its music and streaming-movie businesses, expects continued aggressive pricing as the company tries to grow its market share in the quickly digitizing movie and music business. Books, movies and music accounted for a disproportionate 40% of Amazon's sales in 2010 and as those products shift from physical to digital form, it may lose its edge in e-commerce.
Like many Internet companies, Amazon faces stiff competition and no economic moat, or sustainable competitive advantage. It will be forced to compete with Apple, Google (GOOG), Netflix (NFLX) and the privately-held Facebook in online media sales, as pay-to-download and streaming become commonplace.
The silver lining to BGC's bearish thesis is that Amazon is still growing at an attractive pace, has a clever management team and has prudently managed its balance sheet, carrying nearly $8.8 billion of cash and $865 million of long-term debt at the fourth-quarter's conclusion, for an ample quick ratio of 1 and a modest debt-to-equity ratio of 0.1. Still, Amazon's profit margins are paltry, with an operating spread that declined from 5.2% to 3.9% in the fourth quarter and a net margin at 3.2%. Amazon's other major competitor, which looms large as the world's most dominant retailer, is Wal-Mart (WMT), which is rapidly expanding online.
Interestingly, Amazon is more internationally diversified than Wal-Mart, in relative terms, with 45% of 2010 sales coming from overseas markets, compared to Wal-Mart's 26%. However, in absolute terms, Wal-Mart dominates with $109 billion of international sales in 2010, compared to Amazon's $15 billion. Make no mistake, Wal-Mart's global retail strategy is multi-channel. It intends to compete in domestic and international Internet markets. In summation, there's no shortage of Amazon competitors, presenting risk to its current equity premium.
BGC's Street-low price target, at $125, is still equivalent to a generous 38-times the researcher's 2011 earnings projection. Fiscal-year consensus has declined by 2 cents in the past four weeks as analysts revised down their 2012 estimates. The stock has been a recent top performer around earnings as Amazon has beaten the consensus in five of the past six quarters. The company has an average earnings beat rate of 16% and its stock has an average absolute price change of 10%, reflecting abnormal volatility around reports.
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The push is on for undervalued, cash-rich technology companies to return more money to investors. And there's still room for dividend growth.
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