Firm notes they believe that current valuations give Amazon insufficient credit in three areas. First, they think consensus revenue growth estimates of 32% YoY for 4Q:09 and 25%YoY for 2010 are too low. They think Amazon's revenues will re-accelerate to 41% YoY in the seasonally high 4Q:09 and average at least 35% in FY2010 (versus 28% for FY 2009) driven by a) the higher spending power of Amazon customers, which they think has been underestimated; and b) the company’s 30 new product category introductions in 2009.
Second, Sanford thinks consensus GAAP operating margins of 4.6% in 4Q:09 and 5.1% in 2010 have also been underestimated. They expect GAAP operating margins to reach 5.3% in 4Q:09 and 5.4% in 2010 driven by: a) the company's improved ordering and safety stock algorithms and b) a growing share of apparel in the mix.
Third, although they see some risks from increased capital expenditures, they think the market is underestimating the strength of Amazon's free cash flow in 4Q:09 and in 2010 in particular the benefit of negative working capital, which they think will boost free cash flow by just over $1 billion in 2010. Accordingly the firm is increasing their 4Q:09 (GAAP) earnings estimate to $2.04 and their FY 2010 (GAAP) estimate to $3.07. Firm forecasts that 52% earnings growth will enable Amazon to maintain a 46x GAAP P/E multiple on 2010 earnings ex-cash (or 52x 2010 total earnings) giving them new price target of $160, which is also supported by firm's DCF model.
- Sanford expects revenue re-acceleration to continue through 2010: They think 4Q:09 revenues will come in at just under $9.5 billion or 41% YoY in 4Q:09 and slightly exceed $33 billion or growth of 35% YoY in 2010 thanks to: a) faster than expected revenue growth – especially the N. American media business: b) continued expansion into new high growth categories; c) strong overseas growth boosted by a currency tailwind in 2010; and d) higher than average discretionary spending from the company's superior consumer demographics.
- Sanford expects sustainable improvements to both gross and operating margins. Although the one-time costs of $35 million associated with the Zappos acquisition will impact 4Q:09 GAAP operating margins, they think the recent underlying 100bps improvement in U.S. margins is sustainable and expect operating margins to reach 5.4% (GAAP) or 6.9% (pro-forma) in 2010 thanks to: a) a shift in product mix to higher margin apparel, which they think will offset the deceleration in book sales; b) continued buying power and scale leverage; and c) superior logistics management, especially shortening of wholesaler delivery times which was a major factor in the 3Q:09 margin improvement and is eminently sustainable.
- Although they see some risks from increased capital expenditures and possible further acquisitions, they think the market is underestimating the continuing strength of Amazon's free cash flow. Specifically, they believe the following: a) Amazon's large cash flow boost from negative working capital is sustainable and will increase in 2010; b) much of the increased capital expenditure needed for distribution center expansion was incurred in 2008, greatly benefiting cash flow in 2009 and 2010; c) although the company plans to expand overseas it can currently serve almost all international regions from its existing distribution network – Sanford thinks it is unlikely to tackle new geographies before 2011.
Notablecalls: Sanford Bernstein analyst Jeffrey Lindsay is surely making a name for himself here with the new Street High target of $160 (previous high was J.P. Morgan with their $150 target).
The call itself doesn't highlight anything new but given the trading dynamics, it may prove to be a significant one. The thing is that a lot of people have been using AMZN as the vehicle of choice to lean short the general market. It's up a lot, carries a hefty valuation and is hated for its accounting.
Yet, it started perking up again yesterday. That should create some nervousness among the shorts. There is little doubt about Q4 being very strong and that could yield a $130-$135 stock. Nobody on the short side wants to be 10-15 pts in the hole even from current levels.
One thing to remember about AMZN is that despite its size the stock is a stealthy mover. It can sit quietly for hours in the pre market just to explode again after the open. Given it's Sanford Bernstein (and not a tier-1 firm) upgrading the stock that looks to be a likely scenario.
With the little help from the market I think AMZN can trade to $124 (or higher) today.
PS: We have non-farm payroll data out 8:30 AM ET today so that's a variable one must consider here as well.