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Weak growth muddies Amazon's prospects
Despite blowout Harry Potter sales, Amazon.com squeaks past analysts' forecasts. Traders knock 7% off online retailer's shares, but that's just the start.
By Robert Walberg
Harry Potter couldn't do it. Neither could high gas prices, which were supposed to push consumers to shop more online.
They couldn't salvage the third quarter for Amazon.com. Despite selling over 1.6 million copies of the latest Harry Potter book, Amazon saw operating income dip 32%, to $55 million, from the year-ago quarter.
Sure, the drop was due in large part to a one-time payment of $40 million to Soverain Software, for settlement of a patent infringement lawsuit. But even without the legal costs, third-quarter earnings were just 12 cents a share, two cents ahead of the consensus Wall Street forecast. Total sales jumped 27% to $1.86 billion, in line with the companys guidance but slightly above the Streets estimate of $1.84 billion.
Not bad, but with a single book generating so much business, not great either. And not good enough to keep Amazon.com (AMZN, news, msgs) shares afloat -- especially for a company that trades at a fat 71 times estimated fiscal-year 2005 earnings.
Traders wasted little time selling Amazon on the news, with the stock falling more than 7% in after-hours trading. Count me among those who think Amazon's a fine company with a stock price that will head even lower from here.
An on-target forecast still falls short
Amazon didn't exactly blow away investors with its forecast, either. Amazon said its fourth-quarter net income (not counting stock-based compensation) would be in the $165 million to $240 million range, with sales between $2.86 billion and $3.16 billion.
The Street had expected $223 million in net income and $3.08 billion in sales for the fourth quarter, so the in-range forecast didn't knock anyone's socks off.
After all, Amazon's shares had rallied recently on the assumption that high gas prices would drive shoppers online. Amazons guidance undercuts that theory, as the company sees sales growth in the fourth quarter of between 13% to 24%, a slower growth rate than the 30% of last year's fourth quarter.
The projected slowdown in top-line growth feeds another concern of investors and that is one of competition. With competitors such as Overstock.com (OSTK, news, msgs) and Buy.com offering select books and merchandise at lower prices, investors fear that Amazon will experience a slow but steady decline in its growth.
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Of course, Amazon could simply slash prices further in order to fend off the competition, but that raises another very sensitive concern -- eroding profit margins. Already nervous about Amazons big expenditures on marketing and its costly free-shipping program (especially with gas prices having jumped so much over the last year), investors will not be pleased if Amazon engages in a nasty price war to keep/win customers that would prove lethal to margins and profits.
Justifiable caution
Finally, there is growing angst on Wall Street that Amazons growth must slow given the declining rate of new online shoppers. But that seems like piling on to this analyst, as online shopping is still in its infancy. The growth rate remains plenty strong to feed the top-line growth of one of the Internets best run e-commerce companies.
The markets bearish response to Amazons numbers seems like an overreaction. The company hit its sales and earnings targets and forecast similar results going forward. Amazon also delivered some very encouraging numbers, such as the 35% jump in operating cash flow, the 13% rise in freecash flow (even after the $40 million one-time payment) and the 26% jump in international sales.
That Jeff Bezos & Co. chose to be cautious in their guidance rather than outwardly optimistic also seemed prudent, considering the uncertain impact of high oil prices, rising interest rates and hurricane Katrina. Such a move might dampen investor enthusiasm for the stock over the short-term, but it leaves the company in position to deliver a positive surprise for the critical fourth quarter.
The stock got ahead of itself over the past several weeks, and Tuesdays earnings news has created enough doubt to result in a sizeable pullback.
Stock pick?
Though the long-term outlook for Amazon remains encouraging given its increased international penetration, solid and improving balance sheet and strong brand recognition and leverage, theres no denying that the concerns created by yesterdays report will drive the stock over the short-term.
Consequently, I will close my Amazon position in the Street Patrol tracking portfolio as of Wednesday's close, take whatever gains are left, and wait for a decent re-entry point in the months to come.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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