Amazon Is a Long-term Buy

Ishfaque is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Even though Amazon (NASDAQ: AMZN) has been growing its top-line rapidly, the company's stock price suffered a recent pull-back. Investors seemed to be worried about Amazon's profitability issues, in spite of the company's current investment phase and rock solid footing in its business segments. The e-Commerce giant's current capital expenditures will position the company supremely well in the long-run, as it is increasingly becoming a major player in most of its business segments.

Strong Financials

In Q1 2013, Amazon’s revenues grew 22% on a Y/Y basis and stood at ~$16.1 billion. The company has been facing substantial F/X headwinds which left a negative impact of $302 million. On an ex-F/X basis, Amazon’s top-line would have grown 24%. Amazon’s operating income for 1Q2013 stood at $181 million which represents a 6% Y/Y decline, and the net income decreased 37% Y/Y to end at $82 million.

The company's heavy investments are weighing down its free cash flow which declined 85% from the year ago quarter to end at ~$177 million. However, Amazon's liquidity position is solid as it holds cash and securities position stands at $7.9 billion.

Stellar Growth

The number of users on Amazon's massive platform surpassed 209 million customer accounts which is up from the earlier quarter when the company had 200 million customers. Amazon’s net shipping costs for the quarter stood at $763 million, which represents 4.7% of total worldwide sales.

Amazon’s revenue growth was 26% year-over-year in North America, which showed very strong revenue growth in particular the electronics and other general merchandise items for retail. And for the higher margin non-retail activities including Amazon Web Services, Advertising and credit cards etc., Amazon’s growth was at a solid rate of 64% Y/Y and stood at $750 million.

Amazon’s business in international markets primarily in Europe and Asia grew steadily and stood at $6.6 billion, which represents a growth of ~16% from the year ago quarter. The F/X headwinds in the quarter as well as macro-economic weakness in Europe swung the company to an operating loss for the international business in Q1 2013. On an F/X neutral basis, growth from the international segment would have come in at 21%.

Third Party (3P) Revenue Gaining Momentum

Major positives for Amazon are the consistent growth in paid units which was 30% for the last quarter. Sales from third party vendors made up 40% of total paid unit sales which reflects a 100 bps increase from 1Q2012 when 3P units made up 39%. Amazon's total seller accounts globally exceeded the 2 million mark. Since Amazon's margins from the 3P business is higher, because it acts as a middleman just like its e-Commerce rival eBay (NASDAQ: EBAY).

eBay's business model of being the marketplace where buyers and sellers meet, and not handling inventory, customer orders and fulfillments has worked wonders for the company. eBay has been delivering consistently strong bottom line numbers and Free cash flow numbers, along with strong revenue growth. eBay's Free cash flow as a % of revenue has been in double digits in each of the last 4 quarters, with the most recent number being 17%.

Increased competition

In Q1 FY2013, Amazon changed its fulfillment fees for the Fulfillment by Amazon (FBA) service, which might have an impact on 3P sales as some merchants might be unhappy and take their business to eBay, and even Google (NASDAQ: GOOG). And merchants are likely to be wary of using Amazon's service because Amazon's own massive retail operations compete directly with the sellers themselves, something the sellers don't have to be worry about on eBay and Google's shopping business.

Google has been listing products on its shopping platform for the last few quarters, and now the company's online shopping catalog consists of more than 1 billion products that are listed. And Google recently started rolling out these product listing ads (PLAs) to monetize the billions of search queries to find out information about new products.

Google Shopping shows the catalog of products along with pictures, pricing and shipping information to the end-user, as a result, the consumer might not end up browsing on Amazon. Google introduced product listing ads in European markets, as well as on mobile both of which might increase competition for Amazon.

However, customers love Amazon because of its broad selection and low prices. Amazon ranked number 1 in customer satisfaction for 8 years in a row, according to customer analytics firm, ForeSee, and this serves as a massive competitive advantage for the company.

Amazon's big investments

Amazon continues to invest heavily in its numerous business segments to gain market share. It is adding three new fulfillment centers in the U.S. and a few abroad as well. In addition, Amazon is still heavily investing in China and some European countries to gain more scale for its massive platform.

The company's sales of digital items are growing at a much faster pace, relative to physical unit sales. As a result, the company continues to sign up newer video content licenses with numerous studios, and also building out original content shows with the recent release of a number of pilot TV shows.

Also, Amazon’s cloud computing business, AWS is continuously launching newer offerings while simultaneously cutting prices for its cloud-computing business. AWS has slashed prices 31 times since its launch in 2006 to gain newer customers and smaller businesses to use its computing powers on a pay-as-you-go basis.

Going forward

The company’s razor-blade business model seems to be working as incremental service sales are paving the way for gross margin expansion. The company's third party business as well as Amazon Prime will benefit from the locations of fulfillment centers, which in turn will lead to substantial efficiency gains for the company in terms of net shipping costs. The increased transaction volume along with additional market shares paves the way for substantial free cash flow in the long run. The company's recent sell-off represents a decent buying opportunity for the long haul.

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