Amazon (AMZN.O) is igniting a “fire” under a number of new products – the Fire smartphone and Kindle Fire tablet. However, the introductory pricing strategy is keeping margins razor-thin and that may weigh on current earnings.
You’ve got to give Amazon credit for investing heavily in the future. The revolutionary Amazon Fire smartphone is priced low in an effort to hook consumers onto its higher margin software. In addition, the Kindle Fire tablet has yet to take off as a major competitor to the iPad.
Amazon also received plenty of buzz with the talk of drones dropping off packages at doorsteps. Investors have been patient with the visionary Jeff Bezos, but may be getting anxious to see profits finally materialize. The company currently has a negative Predicted Surprise of 11%, which could be an early indicator of an earnings miss when it reports results on July 24.
Source : Eikon/StarMine
Elusive earnings
As you can see in the chart above, analysts have been lowering estimates for Amazon over the last 90 days. Throughout the period, the StarMine SmartEstimate has remained below the I/B/E/S consensus. The current consensus calls for a loss of 15 cents per share, and the SmartEstimate remains lower at a loss of 16 cents per share. For a company with the earnings base of Amazon, it remains to be seen how long investors can tolerate losses, with just an expectation of future earnings. Earnings for the full year have also been taken down from close to $3 per share to just over $1 per share in the last year. Once again the SmartEstimate remains lower at less than $1 per share. Looks like analysts may still revise estimates lower in the coming months.
Source: Eikon/StarMine
Flickering flame
Amazon hopes the much-anticipated Fire smartphone will inspire users to take advantage of its higher-margin services. However, analysts do not seem optimistic about large numbers of consumers adopting Amazon devices.
The company recently announced a deal giving customers unlimited books at $9.99 a month, and while this may entice a lot of readers, it might cannibalizes book purchases, a high margin business. As you can see in the chart above, operating margins have been gradually falling over the last five years and now stand at just under 1%. While the company continues to increase revenue, this trend could be viable, but any missteps could lead to sharply lower earnings.
Source: Eikon/StarMine
Burning expectations
Amazon shares are by no means cheap. The current F12M P/E ratio is 126, and far above the 10 year historical median, a period in which Amazon has seen tremendous growth. Can the company continue to grow earnings at this exponential rate? Based on the StarMine Intrinsic Value (IV) model, the company needs to grow earnings at 53% for the next 10 years in order to justify the current price. That could prove to be challenging, even for an innovative company like Amazon with a low earnings base.
Amazon announced a price increase for its Amazon Prime services and it remains to see what effect that will have on customers. If the company sees that customers are not leaving because of the price increases as it noted in the previous earnings call, it may be tempted to raise prices again, in an attempt to raise margins. However, it’ll be tough to identify what price will cause customers to leave, and it’s something management will need to navigate carefully.
Amazon is also looking to get into the streaming video business, which will require large upfront payments for content. It would not be surprising to see Amazon miss earnings estimates as it continues to ramp up spending on the future, but will investors eventually pour water on its campfire?
Receive stories like this to your inbox as they are published. Subscribe here and follow us @Alpha_Now on Twitter or check out the Eikon blog. If you are looking to access our data or analytics, register for a free trial.
