Amazon Surges as Wall Street Applauds

Amazon.com

(AMZN) - Get Report

shares surged Wednesday as Wall Street applauded the online retailer's second-straight blowout quarter.

A day after Amazon significantly

beat expectations for the first quarter, a number of analysts published gushing research reports, most with the same theme: that the company, which only a year ago was facing a rocky financial future, will not only survive but thrive.

Thin margins may keep the stock from regaining its former three-digit splendor, but in a sharp turnabout from just last year, Amazon now appears to be a solid growth story.

"This is no longer a valuation based on squishy cash-flow projections," says Shawn Milne, who covers the company for Soundview Technology and raised his rating Wednesday to buy from hold. "People can look to

2003 and see sustained profitability."

In midday trading Wednesday, shares were up $2.40, or 16%, at $16.46. Since Amazon reported its first-ever profit in January, shares are up about 60% and approaching their 52-week high of $17.92.

Live Free or Die

Perhaps most importantly for the profit outlook, Amazon was able to boost gross margins despite a highly publicized free-shipping offer that some had worried would eat away at margins. Gross margins in the quarter were 26.3%, 150 basis points better than some had been projecting and up 20 basis points from the fourth quarter.

Of course, how long that can last is open to question. Some were worrying Wednesday that Amazon's decision to cut prices for the third time in less than a year could be too much of a good thing. Tuesday, Amazon said it was cutting the price of most books over $15 by 30%. This followed July's price cut for books over $20 and the free shipping offer.

"While price cuts have clearly attracted more shoppers to Amazon based on the solid Q1 results, we are cautious regarding the potential long-term impact of continuing to trim prices in commodity categories where the company possesses no unique gross margin advantages," wrote Lauren Cooks Levitan of Robertson Stephens in a research report. "Specifically, we believe an ongoing price war could hamper the company's recent operating efficiency improvements and believe visibility into the longer-term impact of this strategy remains clear." (She kept her market perform rating; her firm has had a banking relationship with Amazon.)

That said, observers agree that the stock was rising Wednesday because Amazon has evolved from an outfit that chased sales at any costs to one that now focuses on the bottom line with every move. And as thin as margins may be, at least they are improving. In sharp contrast with the big telcos and many of the major information technology providers, for instance, Amazon is still showing solid sales growth.

For its part, Amazon contends that the price cuts play into the growth game, by spurring demand to such a level that average costs actually go down. "Driving unit volume does reduce costs," Amazon CEO Jeff Bezos said in Tuesday's conference call. "This isn't a short-term strategy."

Milne, the Soundview analyst, says, "They just proved that their price cuts have been extremely successful. They have the scale and the leverage to do it."

Limited Upside?

Even if sustained profits aren't a pipe dream anymore, investors still need to grapple with the valuation question. For perhaps the first time, investors Wednesday can look at Amazon and compile a price-to-earnings ratio with some confidence. (Previously, with the profit outlook so hazy, analysts had to resort to more esoteric measures such as taking the enterprise value -- market capitalization plus debt -- and comparing it to revenue and revenue growth.)

Take Deutsche Bank Securities analyst Jeetil Patel's revised estimates. He now projects earnings of a penny a share for the full year of 2002, and 15 cents a share next year. Based on current prices, this put's Amazon's P/E ratio in the stratosphere: 1,600 times this year's estimated earnings and about 107 times 2003 projected earnings.

Thus, even Milne, who slapped a buy rating on the stock Wednesday, said, "I don't think the stock will go to the moon."