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Magic for Amazon.com?
Stock Spotlight: Its 10th birthday and Harry Potter are reasons to cheer but investors are wary.
July 14, 2005: 4:53 PM EDT
By Rob Kelley, CNN/Money staff writer
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NEW YORK (CNN/Money) - Amazon.com will celebrate its 10th birthday on Saturday with a big bash featuring performances by Bob Dylan and Norah Jones.

That's not the only big news for Amazon that day. The company will also be cheering the comeback of a certain boy wizard -- the sixth book in the Harry Potter series goes on sale starting at midnight.

Amazon reported this week that advance orders of "Harry Potter and the Half-Blood Prince" reached a record, with nearly 900,000 copies ordered as of Thursday morning in the United States alone.

But for Amazon's investors, the 10th anniversary and the new Potter release are more of an opportunity to focus on future prospects rather than the company's past.

Amazon has been a bellwether of Internet commerce -- with a correspondingly rocky history since going public in May 1997. But now that Amazon has established itself as a survivor in the online world, investors are anxious to see consistent profit growth after Amazon's insistence on building market share.

The company is set to release second-quarter results on July 26. Analysts expect sales to come in at $1.73 billion, a 25 percent increase from last year. But earnings excluding one-time charges are forecast at 9 cents a share, a 50 percent drop from a year ago.

Despite strong sales growth, Amazon is still making major investments in a bid to build customer loyalty and fend off the influx of competitors who've set up shop in online retail.

Investors, however, aren't certain if this strategy is the right one. Shares of Amazon have fallen about 18 percent this year after sinking 16 percent in 2004. What will it take for the stock to get back on track?

Branching beyond books

With online retailing maturing, Amazon has branched into new areas. In looking to boost its profit margins -- typically slim on things like books and DVDs -- it has added electronics, jewelry and clothing and other lines, and now sells goods in 21 major categories, so it's obviously more than an online book shop.

But as of the first quarter of 2005, books, CDs & DVDs were still its main gig, generating nearly three-quarters of sales.

Consumer electronics is one category on the rise for Amazon. Last Thanksgiving weekend, Amazon's consumer electronics sales outpaced book sales over that key holiday shopping period for the first time.

But some analysts worry that even Amazon's entry into new growing markets won't be enough to significantly boost profits since the retailer keeps prices low on these items. "Amazon's aggressive pricing will keep overall margins stuck in the mud," said Martin Pyykkonen, an analyst with Janco Partners.

Still, others said Amazon should be able to improve earnings with its growing business of running online commerce sites for traditional retailers. The company has added Macy's, Sears Canada and OshKosh B'Gosh to its roster in 2005. Amazon receives a portion of the sales generated from its third-party partners and also gets fees from the retailers.

In the first quarter, third-party sales represented 27 percent of the number of sales on the site, up from 23 percent a year ago, Amazon said, which Legg Mason analyst Scott Devitt called encouraging since this business is far more profitable.

Shipping blues

Amazon's biggest challenge, however, is convincing skeptical investors that it can not only stem threats from other retailers but do so without further sacrificing profitability.

Continued growth is certainly not in the bag for Amazon. It faces increasing competition from such operations as Overstock.com, Walmart.com and the proliferation of shopping search engines that drive Web users to bargains.

"Consumers are becoming more sophisticated about places to buy goods online and price competition," said Steve Weinstein, an analyst with Pacific Crest Securities.

Amazon is well-known for having one of the easiest to use retail sites on the Web, but analysts say it will need to differentiate itself in other ways soon -- and that probably means more aggressive spending.

To that end, the company says its debut of Amazon Prime in February -- offering unlimited two-day shipping for a one-time fee of $79 a year -- has kept loyal customers on its site.

But there are worries that the new service may raise shipping costs. In fact, shipping costs -- and losses from shipping -- both rose in the first quarter, so while sales were up 24 percent, operating margins actually fell.

Take me to the river?

With all this in mind, is Amazon's stock worth a look? At about $37 a share, the stock currently trades at 57 times 2005 earnings estimates. That's fairly expensive but it's a slight discount to other Internet companies such as Google and Yahoo!

"The basic question: is this an Internet stock or a retailer?" said Janco's Pyykkonen. "The nature of the business, the margins, point to retailer." Pyykkonen argues that if you compare Amazon to a company like Wal-Mart, a fairer valuation for Amazon would be a P/E in the low 20s. Wal-Mart trades at about 19 times 2005 estimates.

Granted, the argument in favor of Amazon is that sales are growing faster than most other retailers, particularly in international markets. International revenues jumped 28 percent in the first quarter, compared to 21 percent growth in North America.

But investors are clearly hungry for more than just impressive sales growth.

So while many Amazon customers eagerly await the arrival of the new Potter book, investors realize it's going to take more than fat book sales to put the magic back in the stock.

Is Harry Potter overexposed? Click here.

For more about Potter mania, click here.

For more about Amazon's earnings woes, click here.

Analysts quoted in this story do not own shares of Amazon and their firms have not performed investment banking for the company during the past 12 months.  Top of page

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