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Why Amazon's shares will keep sliding
Slow growth in the fourth quarter sent the online retailer's stock price down sharply. With profit margins shrinking and competitors like Google and eBay growing, don't expect a rebound soon.
By Robert Walberg
Increased competition and aggressive incentives appear to have caught up with Amazon.com.
Despite what appeared to be a strong holiday season, sales at Amazon (AMZN, news, msgs) grew by a relatively modest 17% in the last three months of 2005, and fell about $200 million shy of Wall Streets estimate of $3.1 billion.
Those numbers help explain why the stock plunged in after-hours trading Thursday, falling to $39.22, down more than 10% from its close Wednesday.
Amazon shares are also 20% below where they traded in early December. Investors have grown increasingly skeptical about how Amazon plans to grow profits at a time when its operating expenses are being stretched by the companys free shipping program, dubbed Amazon Prime. For an annual payment of $79, Amazon Prime members get unlimited two-day shipping on most items.
While CEO Jeff Bezos trumpeted the jump in subscriptions to the shipping service, noting that membership doubled from November to December, investors were spooked by the 31% jump in operating expenses. Of particular concern was the 17% increase in net shipping losses.
Higher costs factored into Amazons disappointing profit forecast, too. The company predicted sales for fiscal 2006 in a range of $9.85 to $10.45 billion, with operating income of between $370 and $510 million. Both were well short of what analysts had forecast going into Thursday's earnings announcement.
The trend is clear
The big concern for investors is the slowing pace of revenue growth. At the high end of the companys target range, sales would grow at an annual rate of 23%, or the same as last year. At the midpoint of its range, sales growth slows to 19.6%. Not bad for a retailer. But the trend -- after 34% growth in 2003, 32% in 2004 and 23% last year -- is startlingly clear.
To have any hope of reversing the trend, Amazon will have to fend off ever more fierce competition. In addition to battling other online companies, such as eBay (EBAY, news, msgs) and Overstock.com (OSTK, news, msgs), Amazon must ward off challenges from increasingly net-savvy discounters such as Wal-Mart (WMT, news, msgs) and Target (TGT, news, msgs).
Obviously, one attempt to win customer loyalty is to offer incentives such as free shipping. But we can already see what that is doing to profit margins and the bottom-line. Any further combination of incentives or price discounting will only depress margins more, thereby increasing the likelihood of future earnings disappointments.
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Amazon is in a tough spot, though you wouldnt know it by the stocks premium valuation. Even with the stock down more than $7 from its December high of $50, Amazon went into the earnings announcement trading at 45 times estimated fiscal-year 2006 earnings of 94 cents a share. Thats a hefty premium for a retailing operation.
Picking a fight with heavyweights
Of course, defining Amazon is another one of the streets problems. The company is more than a retailer -- just look at recent initiatives like Amazon Fishbowl, an online show hosted by Bill Maher, and the movement toward showing full-length independent feature films online. In this sense, Amazon, like Yahoo! (YHOO, news, msgs) and Google (GOOG, news, msgs), is trying to become a destination site online. It's the hope that such a strategy could pay off that keeps Amazon's stock trading at a premium.
But investors are right to question whether such ventures will succeed or merely distract the company from its core retail operations. Lets face it, Amazon may have thought the battle with Overstock.com was tough, but going toe-to-toe with Google, Yahoo! and Microsoft (MSFT, news, msgs) (publisher of this Web site) is another thing entirely.
There were some things to like in Amazons report -- especially the 38% jump in worldwide sales of electronics and other general merchandise sales.
Unfortunately, there just isnt enough to get excited about -- especially not with sales decelerating, operating expenses climbing and competition intensifying. How much more will the stock fall in response to Thursday's? Tough to tell, but it could easily fall into the mid-$30 range over the next few months.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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