Friday, 24 April 2015

Amazon - it is still all about the cash flow...

Back in February I noted in my last exclusive report on Amazon that 'it is all about the cash flow' and that in terms of levels:

'I have talked at buying the stock below US$300 as this level reflects a low sentiment point.  Ex a material crack in the markets I wonder if we shall see this level again.  Nevertheless reflecting the still high current earnings-based metrics (a x100+ P/E ratio and an equivalent EV/ebit multiple) I recognise the potential for volatility.  I have raised the 'buy on a bad day' level to sub US$315 though reflecting progress (and historic chart resistance at this point)'

Of course the share has not got anywhere near these levels since February reflecting last quarter's well-received numbers...

...and after yesterday's after the US close results the shares are called up a further 10%.  So why is this?  Well back to that cash flow again...a mega result here.  To put this into context if you annualise it up then it is a 6% free cash flow yield.  Most investors can make that work.  

Of course the company's profitability - even on the most favourable measure which excludes stock compensation under non-GAAP principles - is little more than half and actually was slightly down year-on-year.  Nevertheless Amazon is a growth business as shown by the constant currency 20% year-on-year increase in sales.  Usefully - and for I believe the first time - the contribution of the Amazon Web Services (AWS) division was split out.  In sales terms it is dwarfed by the US and global non-US core businesses.  

That is not so true from an operational perspective however.  Whilst North America is the most profitable part of the business and still showing good progression in results...
 ...the patchy profitability of the global non-US business (undoubtedly not aided by FX translation issues) means that the AWS business...

 ...starts to look like a relatively stable profitable performer.  For the latter not too bad for a business which Amazon noted had 'had 48 price decreases since inception. The team is doing a terrific job in terms of working on behalf of customers to pass on savings as they see it. But in terms of any comment on what to expect going forward there is not really much to add there'.  So not the easiest to value but at a US$1bn+ of likely nearer term profitability and growing at nearly 50% year-on-year in terms of sales you could certainly attribute a US$20bn+ valuation quite easily.  

So what should we expect for the overall business?  Amazon's management gave the following guidance: 

'For Q2, 2015 we expect net sales of between $20.6 billion and $22.8 billion or growth of between 7% and 18%. This guidance anticipates approximately 750 basis points of unfavorable impact from foreign exchange rates...GAAP operating income or loss to be between a $500 million loss and a positive $50 million of income, compared to $15 million loss in second quarter 2014. This includes approximately $600 million for stock-based compensation and amortization of intangible assets'.

So a nice broad guidance range...which will certainly not satisfy those looking for clear profitability progression.  But so long as they are generating strong cash flow I think you can justify holding the shares.  

Amazon shares will move around with the market and related sentiment but from a purely technical perspective I would imagine in a material general sell-off a first level of technical support will be around the US$345-360 level.  That is one level to consider a position augmentation/initial purchase.  For the moment though I am continuing to run my positions.  On the basis of longer-term positioning in an increasingly online world, sheer growth and, most importantly, cash flow generation. 

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