An article appeared in Barron’s just the other day, cautioning investors from buying Amazon (AMZN, Financial) on the fall because of its poor fundamentals and absence of considerable revenue growth in the near future. As per the Barron’s report, Amazon’s “just wait” approach is not pleasing investors anymore and, therefore, the fading investor sentiment would mean that the stock would trade on the basis of fundamentals over the next year. In my opinion, this is a highly accurate analysis of Amazon stock’s current predicament and as such, my intent in this post is to further decode the fundamentals of the company and understand if it is a good investment at this point in time.
Third-quarter earnings
Before we get into a discussion on the fundamentals of Amazon, let us take a few moments to ponder the e-commerce giant’s quarterly results. The company reported its 3Q earnings on October 23, wherein it reported a growth of 20% in worldwide revenue, to $20.58 billion, about in the middle of its July guidance range of $19.7 billion to $21.5 billion. Though the company hit the midpoint of its revenue range, the terrible part of Amazon’s earnings call was its soft guidance for the fourth quarter. Retail thrives during the holiday season, and Amazon predicts fourth-quarter revenue of $27.3 billion to $30.3 billion. Hitting the midpoint again would drop revenue growth to 12.5%. It’s possible that Amazon is being conservative with its guidance. If not, slowing growth could leave investors less patient for profits, and recent trends there aren’t great.
Well, the bad news does not end here for the investors. A couple of months ago, Amazon was expected to deliver a loss of 7 cents per share (analyst estimates) but when the company pointed out that it was investing heavily in many things (remember the billion-dollar acquisition of Twitch), the analysts pushed up the estimate quite aggressively to 74 cents a share. However, the actual results clearly disappointed investors as Amazon breached that estimate and reported a humongous loss of 95 cents a share. To be honest, a big loss like this was expected to spark off a selling session on the stock exchange, particularly because the company had assured investors of returning to a growth trajectory on the back of its big ticket investments. Sadly, those assumptions haven’t materialized at all.
The cause for worry
Now that I have given you a detailed picture of Amazon’s poor performance, let us get to that aspect of the result that is the most worrisome. One of Amazon’s core revenue generators has been its media segment, which reflects the sale of music, books, movies, etc., from the company’s own stable. Amazon website’s entire business can be segregated broadly into a couple of categories. The first is the third-party marketplace wherein Amazon acts as an intermediary between the buyer and the seller and earns on the basis of a percentage of sales. The second and crucial segment is media sales, wherein the company sells books, movies, etc., through its website. In the third quarter, the North American media sales grew a meager 4.8 percent on a year-over-year basis, the slowest growth in the last five years and a steep slowdown from a 13.4 percent increase in the second quarter.
As has been correctly pointed out in this article by Paulo Santos, one of the main reasons that Amazon’s media sales took a hit and might continue to do so is the rapid transition from physical to digital media. Though Amazon itself is a bigtime proponent of the digital media, the shift to digital is hurting Amazon’s revenues. This is because people are now increasingly downloading content from OS integrated stores (like iOS and Google play) either for free or for rent instead of buying the content. Though the company has also migrated from books to ebooks with the help of its Kindle ebook reader franchise, it has been unable to provide a holistic experience to its customers for the price and has suffered losses.
Besides the gigantic shift happening in content delivery and acceptance, Amazon’s feud with its publishers has also been a culprit to some extent. During Q3, Amazon was engaged in a highly public scrap with Hachette, the fourth-largest book publisher, over pricing of ebooks. Because of this feud, Amazon is discouraging sales of Hachette books as a way to gain the upper-hand in the confrontation. However, this act is gaining negative publicity for the giant because of protests from leading authors. Consequently, Amazon has lost some brand loyalty and at this juncture where its media sales are going down like a pack of cards, it is definitely not a good thing.
Takeaway
Amazon is a specific case of “chaos and confusion” where the only plausible conclusion is that the colossal giant is now undecided on the future course of action. By running in several directions, the company is only burning its resources without attaining any success. Take the case of Fire phone, for which Amazon had to take a whopping $170 million charge in inventory valuation adjustment. A marketing survey of 500 Amazon customers could not find any who reported owning a Fire phone. A great many reviews on Amazon’s site give the phone the lowest possible rating.
Hence, I side with Barron’s on the fact that Amazon is destined to trade on the basis of its fundamental over the next year and current trends clearly show that the company is just trying to catch the wind without the knowledge of its resources. This is not a justifiable scenario to be in (since the company is no more a startup) and investors should not put their money in such a company.
