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Jan 26, 2011
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Amazon distracts with sales, but margins are focus

By
Reuters
Published
Jan 26, 2011

Jan 25 - Investors focused on Amazon.com Inc's 2010 holiday results later this week may be blinded by eye-popping revenue gains, but an improvement in 2011 profit margins are the hoped-for wild card that could boost the shares further.

Amazon.com

Double-digit revenue growth and the much ballyhooed Kindle e-reader have kept the world's largest online retailer in the spotlight throughout 2010, overriding a historical skepticism towards operating margins.

But that could change as Amazon provides a first look at its full-year 2011 profit margin outlook on Thursday, when the company posts its 2010 fourth-quarter results.

"People will want to see in the back half of this year some sort of payoff in terms of margin recovery and then margin expansion again," said Citigroup analyst Mark Mahaney. "If they don't start rising year over year, that would cap Amazon's stock."

Amazon shares reached all-time highs last week and the company's stock price is 71 times expected 2011 earnings. That far exceeds rivals in both the technology and retail sectors. Apple Inc trades at 14.6 times expected earnings and Wal-Mart Stores Inc is at 13.5, to name two.

Amazon has been a bright spot in a global environment of protracted economic uncertainty and wavering consumer confidence, where many brick-and-mortar retailers, including Wal-Mart and Best Buy Co Inc, have faced erratic sales.

Robust revenue growth managed to deflect much criticism away from the topic of Amazon's profit margins last year.

Revenue is expected to grow between 26 percent and 30 percent in each quarter of 2011, based on average analysts' estimates, according to Thomson Reuters I/B/E/S.

Benchmark Co analyst Frederick Moran recently upgraded Amazon to "Buy" from "Hold," citing accelerated U.S. e-commerce spending and Amazon's holiday momentum spilling over to 2011.

But while Amazon has beat Wall Street revenue estimates in every quarter since the one ended June 2009, it missed profit expectations in the second quarter of 2010.

That was caused by an unexpected jump in costs from new distribution centers and other investments -- which will make it easier for Amazon to book gains in operating profit midway through 2011 because comparisons will be low.

Shareholders will now expect continued improvements as the year progresses, analysts said.

"I don't think the operating margin story has gone away," said BWS Financial analyst Hamed Khorsand, who added that operating margin, an issue that raised eyebrows just a few years ago, became secondary when revenue growth blew past estimates. "The Street said: 'Ok, we'll compensate for that.'"

Wall Street expects a fourth-quarter revenue gain of 36.5 percent to $12.99 billion on earnings of 88 cents per share.

For the first quarter, analysts, on average, are expecting a revenue gain of 30.5 percent and an operating profit margin of 5.0 percent, down from the 5.5 percent seen a year ago.

Cost pressures are less easily disguised by revenue in a low-volume quarter such as the first.

"We believe investors' expectations are high for 4Q, and we would not be surprised to see conservative 1Q operating income guidance, and, hence, we expect a relatively neutral reaction," wrote ThinkEquity analyst Aaron Kessler in a recent note.

IS IT WORTH IT?

That means the pressure is on for Amazon to prove through profit margin gains that its investments in warehouses, people and technology are scaling.

For full-year 2011, Wall Street expects a 4.9 percent operating margin, up from the expected 4.4 margin in 2010.

If Amazon cannot deliver higher margins, it will have to woo Wall Street with the promise of future revenue gains with some competition-killing device such the Kindle.

"They'll (investors) want to see some new long-term revenue growth opportunity that justifies why margins don't start to stabilize," said Mahaney.

"They would need to get back to at least 6 percent plus in 2011 with a goal in 2012 to get to 7 percent for people to feel the company is back on track for long-term margin expansion," he said.

Currently, Wall Street's expected operating profit growth for 2011 ranges between 3.7 percent to 6 percent when based on analysts' average revenue projection.

Still, Amazon investors are more confident today that the long-term investments the company makes -- such as the intense period of technology spending that resulted in the Kindle -- ultimately pay off.

They also understand that Amazon makes margin-eroding bets, like free-shipping, to help grow its revenue base and cement loyalty that can pay off in the long run as Amazon becomes the go-to online store.

Just last week, Amazon offered a half-off gift card deal through LivingSocial, the discount coupon site in which it recently bought a $175 million stake. Over 1.3 million subscribers signed up for the deal, which will serve to raise LivingSocial's profile.

And as more people around the world move online, Amazon has to continually ramp up categories to keep up, said Hudson Square Research analyst Scott Tilghman.

"They add capacity and then they grow into it," said Tilghman. "Investors better understand how Amazon spends for a two- to five-year benefit rather than the current year."

By Alexandria Sage
(Reporting by Alexandria Sage; editing by Andre Grenon)

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