PDF Amazon.com Inc AMZN QQQQ

?

Inc AMZN [XNAS] | QQQQ

Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic MoatTM

249.74 USD 300.00 USD 180.00 USD

465.00 USD

High

Wide

Stewardship Morningstar Credit Rating Industry

Exemplary

A-

Specialty Retail

Strong Start to 2013 for Amazon as it Monetizes Market Share Gains, Fortifies Its Already Wide Moat

by R.J. Hottovy, CFA Director Analyst covering this company do not own its stock.

Pricing as of Apr 29, 2013. Rating as of Apr 29, 2013.

Currency amounts expressed with "$" are in U.S. dollars (USD) unless otherwise denoted.

Stock Price 300

250

200

150

100

50 09 10 11 12 13

Analyst Note Apr. 26, 2013 Amazon AMZN continued to build a case as one of the most disruptive and diverse players in the consumer universe in the first quarter, while also layering in a steadily improving margin expansion story. Active users grew 21% to 209 million, total units sold grew 30%, and third party units were up 33%, driving revenue growth of 21% (24% excluding currency). Although these trends represent a nominal deceleration on a sequential basis, they keep Amazon well ahead of global e-commerce sales trends, as well as comparable sales trends among most bricks-and-mortar retailers. This implies market share gains, and reinforces our views about Amazon's ability to price below peers through structural cost advantages as well as its strong network effect.

Gross margin grew 260 basis points, to 26.6%, which we attribute to third-party digital content sales, Amazon Prime memberships, and Amazon Web Services, each of which is a building block of our longer-term cash flow forecasts. The strong gross margins drove consolidated segment operating income, or CSOI, of $441 million, well ahead of the high end of guidance ($350 million). The CSOI figure was a modest contraction as a percentage of sales (down 30 basis points to 2.7%) due to increased fulfillment, AWS, and content costs (particularly in international markets). However, North American CSOI came in at $457 million, or 4.9% of segment revenue, which gives us increased comfort with our five-year consolidated CSOI margin target of approximately 6%.

We plan to make minor model adjustments based on the first quarter, but they won't sway our $300-per-share fair value estimate. We'd prefer a bit more margin of safety, but still find Amazon to be one of the more intriguing long-term growth stories in our consumer coverage universe. Near-term fundamentals could remain choppy amid further fulfillment center, AWS, and content investments (largely to support emerging market growth). We project a small contraction in

CSOI margins during the second quarter (versus 2.8% posted in the second quarter of 2012), with revenue comfortably within the $14.5-$16.2 billion guidance range (representing 13%-26% growth, or 16%-29% excluding currency). However, as the year progresses, modest CSOI margin gains could offer a possible upside catalyst.

Thesis Mar. 04, 2013 A shakeout among traditional brick-and-mortar retailers is under way, particularly in commodified categories. With minimal customer switching costs and intense competition, we've already seen Circuit City, Linens 'N Things, and Borders meet their demise in the past few years, while names like Best Buy, Barnes & Noble, Sears, Office Depot, and OfficeMax struggle to reverse deteriorating fundamentals. Mass merchants like Wal-Mart and Costco certainly have played a role in this trend, as has the rapid growth of key original-equipment manufacturers like Apple. However, we believe the most disruptive force in retail in recent years has been . Amazon's low-cost operations, network effect, and laser focus on customer service provide the company with sustainable competitive advantages that traditional retailers cannot match; this should yield additional market share in coming years. Armed with one of the most capital-efficient models in e-commerce, Amazon generates economic returns well ahead of our cost of capital assumption, supporting our view that it has a wide economic moat.

Amazon's primary advantage is its low-cost operations. The cost to maintain its network is much lower than having a large physical retail presence, allowing Amazon to price below its brick-and-mortar peers while still generating excess economic returns. Additionally, tax laws mandate that online retailers collect sales tax in states where they have a physical presence, with the tax responsibility falling to the end consumers themselves. As a result, Amazon currently collects sales tax in a handful of states where it maintains a physical presence, providing additional cost advantages.

Amazon also prides itself on superior customer service,

? 2013 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.

?

 Inc AMZN [XNAS] | QQQQ

Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic MoatTM

249.74 USD 300.00 USD 180.00 USD

465.00 USD

High

Wide

Stewardship Morningstar Credit Rating Industry

Exemplary

A-

Specialty Retail

Close Competitors Wal-Mart Stores Inc eBay Inc Best Buy Co Inc Barnes & Noble, Inc.

Currency (Mil) USD USD USD USD

Market Cap 258,095 68,575 8,198 1,089

TTM Sales 469,162 14,543 50,705 6,942

Oper Income 27,801 3,035 1,085 -117

Net Income 16,999 2,716 -1,231 -105

resulting in high-quality service scores. A user-friendly interface, product recommendations, and wish lists help drive (and retain) website traffic. In fact, the percentage of traffic to Amazon derived from search has fallen in recent years at a time when other online retailers have become more dependent on search. We think this indicates that Amazon is increasingly becoming the starting point for online purchases, akin to a mall anchor tenant. Not surprisingly, Amazon has grown its active customer base to 200 million users as of December, representing five-year compounded annual growth of more than 20%. This compares favorably with eBay's marketplaces, which has an active customer base of more than 112 million users that has grown at a 6% CAGR during the same period.

Despite its leading position in an industry with secular tailwinds, Amazon faces a few potential risks. Given state budget deficits and lobbying efforts by brick-and-mortar retailers, we haven't been surprised that online sales tax collection has garnered more attention, with lawmakers in several states introducing legislation encouraging online retailers to collect sales tax. Obviously, implementation of sales tax collection would narrow Amazon's advantages and make traditional retailers more competitive. Still, even if more stringent tax collection laws were put in place, we believe Amazon could maintain its value proposition and attract customers through other means, including changes to shipping policies or new Amazon Prime membership features. Margin expansion would be mildly more challenging to realize under these circumstances, but our longer-term outlook for profitable growth would remain intact.

As media products (which contributed 33% of total revenue

in 2012) move from physical to digital distribution, warehouses and an expansive distribution network will not provide the same advantages. Nevertheless, we like Amazon's chances to compete in digital media given its sizable customer base and the symbiotic hardware/software ecosystem of its Kindle products. We continue to the Kindle suite of products as meaningful customer acquisition tools that add multiple layers of upside to our base-case assumptions, including additional Prime memberships, accelerating digital media sales, and a positive halo effect on general merchandise sales. While we aren't expecting Amazon to supplant Apple's dominance in digital media, we believe it could develop into a formidable player given its vast content offerings and ability to sell hardware as a loss leader.

Although it's experienced its share of growing pains, we are also intrigued by the growth potential of Amazon Web Services. In particular, Amazon's cloud computing services (EC2) eventually could develop into a multibillion-dollar revenue stream as corporations look for ways to reduce technology expenditures. We estimate that AWS generated approximately USD 1.6 billion in revenue during 2012 and expect average annual revenue growth of more than 30% during the next five years. With recent investments for additional capacity, we also expect AWS to become an increasingly positive margin contributor due to its highly leverageable nature.

Valuation, Growth and Profitability Our discounted cash flow-derived fair value estimate is USD 300 per share. We do not believe traditional price/earnings and enterprise value/EBITDA metrics are meaningful in Amazon's case, given the impact that ongoing technology, content, and infrastructure investments will have on near-term margins. Still, we believe Amazon warrants a premium valuation based on its wide economic moat, meaningful avenues for growth, and margin expansion potential.

Amazon's strong competitive position and compelling value

? 2013 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.

?

 Inc AMZN [XNAS] | QQQQ

Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic MoatTM

249.74 USD 300.00 USD 180.00 USD

465.00 USD

High

Wide

Stewardship Morningstar Credit Rating Industry

Exemplary

A-

Specialty Retail

proposition should lead to additional share gains in 2013, putting full-year revenue growth around 23%. Our model assumes high-teen average annual revenue growth for the five-year period ending in 2017, the result of market share gains from traditional retailers, the secular shift to online retail, proprietary device sales, and international expansion (particularly China and other emerging markets). Additionally, we expect new product categories to drive average annual revenue growth of almost 20% in the electronics and other general merchandise category (nonmedia products) during the next five years. We anticipate slower (yet relatively stable) growth in sales of media products (high-single-digit average annual revenue growth) due to the shift to digital formats (e-books) and Amazon's already sizable market share.

We project that gross margins will expand to around 27% in the next five years, compared with 24.8% in 2012. Amazon's growing clout with suppliers, the higher proportion of third-party units in the sales mix, and Amazon Web Services' increased presence should allow for higher gross margins, but these will be partly offset by a mix shift to lower-margin nonmedia categories. We also forecast moderate operating margin expansion through increasing scale advantages (particularly in the fulfillment and G&A expense line items) amid accelerating third-party unit sales. We expect GAAP operating margins to remain around 1% in 2013 amid continued technology, content, and international infrastructure investments (2.3% excluding stock-based compensation and amortization) but to expand to over 5% by 2017 (in the low 6% range on an adjusted basis) because of greater scale in the core business, incremental Prime memberships, increased subscription-based services, and AWS contribution. Despite relatively low margins, we expect returns on invested capital to exceed our 9.5% cost of capital assumption, thanks to Amazon's capital-efficient business

model.

Risk Impairment to Amazon's low-price positioning, whether real or perceived, could have an adverse impact on fundamentals. Amazon must maintain its value proposition to drive site traffic while fending off other online merchants, mass merchants, warehouse clubs, and specialty retailers for market share. Amazon also faces some regulatory risk, as we expect a federal standard for collecting online sales tax to be put in place within the next several years, potentially weakening one of Amazon's key cost advantages. Additional risks include a constantly evolving e-commerce landscape, exposure to volatile discretionary spending patterns, and expansion into peripheral business lines such as cloud computing, which could distract management or lead to poor capital-allocation decisions. International growth brings unique challenges, as foreign governing bodies are constantly amending online commerce laws.

Bulls Say O Amazon dominates the online retail landscape with 2012

product sales (USD 51.7 billion, excluding service sales) that roughly equal the next six closest non-auction competitors combined. AmazonSupply should allow the company to better capture a larger portion of the B2B category for industrial and other business customers. O With more than half of the world's Internet users coming from developing markets, Amazon has a tremendous global opportunity. Amazon sells directly in nine countries outside of the U.S. and Canada (representing 43% of revenue in 2012), and we believe management is evaluating other geographies for expansion. International e-commerce trends are accelerating, and growth rates should exceed the U.S. over the next decade. O Kindle products are intriguing customer acquisition tools

? 2013 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.

?

 Inc AMZN [XNAS] | QQQQ

Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic MoatTM

249.74 USD 300.00 USD 180.00 USD

465.00 USD

High

Wide

Stewardship Morningstar Credit Rating Industry

Exemplary

A-

Specialty Retail

that capitalize on the ongoing transition to digital media (e-books in particular) while also promoting Prime memberships and demonstrating cloud computing capabilities. O Complementary e-commerce websites (, , ) and LOVEFiLM (an online movie rental subscription service) diversify Amazon and provide multiple layers for growth. O Amazon has leveraged its assets in creative ways, such as allowing third-party sellers to sell on and use its fulfillment services, licensing its platform to large merchants, and licensing its payment services. Third-party sales represented 40% of units sold in 2012.

demand service.

Financial Overview Financial Health:Amazon's balance sheet is in great shape. As of December 2012, the firm had USD 11.4 billion in cash and equivalents on its balance sheet compared with just more than USD 3.1 billion in debt principal obligations (largely the result of a USD 3.0 billion unsecured senior notes offering in November 2012). Amazon has manageable capital and financial lease requirements and can easily fund its growth using free cash flow. We believe Amazon could support substantial incremental debt for acquisitions or to recapitalize its balance sheet.

Bears Say O A rapidly changing Internet landscape may be disruptive

to Amazon's business model. The company faces competition from eBay, Google, Yahoo, Apple, and , which offer competing e-commerce websites, auction marketplaces, online payment services, comparison shopping sites, ad search engines, video streaming, and independent website hosting. O An evolving regulatory landscape exposes Amazon to uncertainty. Legislation forcing out-of-state retailers to collect sales taxes could impair Amazon's low-price perception, making online offerings from brick-and-mortar retailers in commodified retail categories more competitive. O International growth brings unique challenges, as foreign governing bodies are constantly amending online commerce laws. Additionally, in many instances, Amazon will square off with an incumbent local competitor in several international markets. O Beyond core retailing, many of Amazon's other ventures have not been successful, including the A9 search engine, Amazon auctions, and Unbox--Amazon's original video-on-

Company Overview Profile: Amazon is the world's highest-grossing online retailer, with USD 61.1 billion in net sales in 2012, or 7% of the USD 900 billion-plus global e-commerce market. Media represented 33% of sales in 2012, and electronics and general merchandise represented 63% of sales. The remaining 4% was derived from co-branded credit cards, fulfillment operations, and Amazon Web Services. Outside the U.S., Amazon operates sites in Canada, the U.K., Germany, France, Italy, Spain, Japan, China, and Brazil. International revenue represented 43% of sales in 2012.

Management: Chairman and CEO Jeff Bezos founded in 1994. Tom Szkutak became CFO in September 2002 after 20 years at General Electric, most recently as CFO of GE Lighting. We think that Amazon's management team is exemplary in terms of corporate stewardship. Not even the most senior managers have golden parachutes. Bezos owns about 20% of the shares, takes no equity compensation or bonus pay, and collects a paltry salary. Although the board is small, it is elected every year, receives no cash compensation, avoids insider relationships, and hasn't

? 2013 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.

?

 Inc AMZN [XNAS] | QQQQ

Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic MoatTM

249.74 USD 300.00 USD 180.00 USD

465.00 USD

High

Wide

Stewardship Morningstar Credit Rating Industry

Exemplary

A-

Specialty Retail

implemented antitakeover provisions. The company also provides a good deal of supplementary financial data in its quarterly releases. Our only complaint is that such disclosures have not increased as the company has expanded into new areas, including digital downloads, the Kindle suite of products, Prime memberships, and AWS.

? 2013 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.

?

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download