Friday, February 02, 2007

Color on quarter: (NASDAQ:AMZN)

Several firms are commenting on (NASDAQ:AMZN) after the co issued Q4 results and guidance last night. At least one firm is downgrading their rating this AM.

- Goldman Sachs notes Amazon reported 4Q2006 revenue, OI, and EPS of $3,986 mn (up 34% yoy), $229 mn (up 24% yoy), and $0.26 versus their $3,732 mn, $225 mn, and $0.27 estimates. Operating income grew for the first time in 4 quarters, reflecting yoy growth of 24%; however, operating margin missed our expectations by 30 bps and incremental margin of 4.4% disappointed relative to GS 5.3% forecast and the company's 6.0% guidance. 2007 operating income guidance at the midpoint is $595mn, 10% below firm's estimate and consensus, reflecting operating margin of 4.5% (vs. 5.3% forecast) and down versus 2006 at 4.7%, negating the expanding margin thesis. 2007E incremental margin of 3.6% is below firm's 7.7% forecast and ~480 bps below Street forecasts. Incremental margins are the best proxy for long term margins and another year below double digits begs the question on whether long-term margins can reach high single digits, which is required to justify a return from current levels. Results/guidance reinforce their doubt that Amazon margins are truly at a trough and they see a return to double digit incremental margins as unlikely in 2007.

- Stifel is probably the most optimistic of the bunch saying the midpoint of 2007 guidance is down about 20 bps YOY but the midpoint of revenue is up by $700 million (6 percentage points) versus original expectations. They expect that operating profit guidance is conservative and that leverage shows in Amazon's business in 2007 and continues in 2008. Firm believes, though, that this is a balanced investment thesis of revenue growth and operating leverage. They think the leverage comes, in the meantime the revenue growth is extraordinary at 30% ex-currency in the quarter and 28% domestic ex- Toys adjustment. Thinks of Amazon as the online version of Costco and, just as was the case in COST's business, that AMZN will lever and experience a cycle of outsized equity returns. Amazon is singularly focused on one extremely important constituent " ITS CUSTOMER " and they believe that this attitude toward its business may be its most valuable hidden asset. They have patience, they trust management, and they believe business is performing quite well; sooner or later, the stock will follow. As we wait, AMZN trades for a 3.6% forward taxed FCF yield which is about a 30% discount to Wal-Mart and Target despite AMZN having a capex-to-operating cash flow ratio of 30% well below WMT and TGT at around 80%. Maintains Buy and $44 tgt.

- RBC Capital notes that although 4Q06 results were a clean beat, initial FY07 guidance disappointed yet again as Amazon pointed the way toward another year of pro forma operating margin compression. FY07 pro forma op margin guidance calls for 4.0%-4.9% range vs. consensus 5.1% and FY06 ending 4.9%. Firm's revenue estimates for FY07 and FY08 rise by 6% and 8%, but EPS estimates are down by 7% and 14% respectively. Although they are rolling their valuation metrics to 2008 estimates, firm's price target remains unchanged at $37. In short, margin compression has eliminated about six months of shareholder value. Maintains Sector Perform.

- Bear Stearns is downgrading their rating to Underperform from Outperform saying that as they watch gross margins decline for the 4th consecutive quarter YoY and 2007 operating margin guidance lower than 2006, they think the NT performance of the stock will be challenging. So while the firm remains positive LT, they are downgrading from Outperform to Undeperform based on margin erosion, lack of NT leverage, and valuation.

Firm notes Jeff Bezos made a very interesting comment at Web 2.0 in November about his business and the industry by saying "I've always believed that a low margin / high volume business is easier to defend than a high margin / low volume business". While the firm agrees with his philosophy as a company, they think it is difficult for the stock to outperform in a possible declining margin environment.

Over the long term innovations and endeavors may be what helps Amazon maximize its value and are a big reason why Amazon is a great company. However, it may take some time for the Street to see any proof and hence could make it a tough stock. With declining NT margins and a lack of demonstration of leverage to show Amazon is on its way to double digit operating margins, the firm does not believe Amazon's current valuation levels support any NT outperformance to the industry.

Notablecalls: AMZN is sacrificing s-t margin performance in order to grow over the next 3-5 yrs. I believe they can easily double their revenue base in that timeframe. Operating leverage will kick in at some point for sure and the stock will probably be higher than it's now. But meanwhile, it's a tough stock to own. A leap of faith is needed to own this one and I suspect it's too early to take it. I see very little reason to own this one around current levels.

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