(Forbes) -- Investors have long criticized Amazon for losing money. Now that it's getting more profitable, its growth is slowing down. Is Amazon still a growth company or is it a value play?
I'd say that it will make a terrible value play given its absurdly high valuation -- its P/E is 96. So unless it can restore its over 25% revenue growth rate, its shares will stop going up so rapidly.
(I have no financial interest in the securities mentioned in this post).
What prompted these thoughts is Amazon’s first quarter report released April 25. Amazon stock rose 0.8% after-hours when it reported revenue that met expectations and earnings that exceeded them.
Amazon matched Refinitiv's total revenue estimate of $59.7 billion and its AWS revenue target of $7.7 billion -- while beating by 50% its EPS target of $4.72, according to CNBC.
The bad news for Amazon is the deceleration in its top-line revenue growth. Total revenue was up 16.9% -- well below its five year average growth rate of 25.6%. Its North American revenue rose 17% increase -- well below last year's 46% growth, while international growth increased a mere 9% -- a paltry performance compared to 34% last year.
Even AWS slowed down -- posting 41% growth compared to 49% the year before. Amazon made a record operating margin of 7.4% in the quarter thanks to the more profitable services such as cloud, advertising and third-party seller services.
Amazon offered a disappointing revenue forecast for the second quarter. It expects growth in the 13% to 20% range -- between $59.5 billion and $63.5 billion— -- the midpoint of which is about $900 million short of the average analyst projection of $62.4 billion, according to the Wall Street Journal.
Amazon expects operating income for the current quarter to range between $2.6 billion and $3.6 billion -- the midpoint of which is 3% more than last year's $3 billion and about equal to analysts’ consensus estimate of $3.11 billion, according to the Journal.
I think it will be difficult for Amazon to sustain its high valuations unless it can restore its greater than 25% annual revenue growth. That's because investors like that Amazon has been able to repeal the law of large numbers which says that big companies can't grow as quickly because it is too difficult to add so much new revenue every year.
In the past, Amazon has sustained its high growth by taking market share from new markets in order to offset the slow-down in growth coming from markets in which it is a more established participant.
Indeed, while Amazon likes to say that only a small proportion of the retailing industry has gone online, Amazon dominates e-commerce. eMarketer says that Amazon controls 47% of the US ecommerce market -- which it believes will grow 20% in 2019 to $282.5 billion.
Amazon has been shifting more of its e-commerce business to what I'd describe as inventory-light operations. Rather than holding inventory in warehouses for its e-commerce operations, Amazon is shifting more of that cost to suppliers. eMarketer points out that 68.6% of Amazon's sales will come from Marketplace -- while only 31.4% will be direct.
Another inventory-light business -- in which Amazon competes with Facebook and Google -- is the fast-growing digital advertising market. eMarketer expects Amazon to generate net digital ad revenue of $14 billion in 2019 -- up 52% from 2018 -- and it will end the year with 4.2% of the market (up from 3.2% in 2018). Amazon's mobile ad revenue will grow nearly 75% this year to reach $4.96 billion -- accounting for 2.1% of the worldwide mobile ad market.
Sadly for investors, none of these existing growth opportunities were able to staunch Amazon's growth slowdown.
For that, Amazon will need to invest in new growth opportunities. In my 2016 book, Disciplined Growth Strategies, I praised Amazon for its ability to keep finding such opportunities -- from a mixture of five dimensions of growth (current or new customer groups, current or new geographies, built or acquired products, current or new capabilities, and current or new culture).
In its April 25 conference call, Amazon announced its intent to make an investment in new capabilities with the hope of selling more to its current customers and potentially to bring in new ones as well.
As CFO Brian Olsavsky said, Amazon will spend $800 million in the second quarter to enhance its fulfillment and logistics network to cut its shipping time for goods ordered by Amazon Prime members -- who pay $119 for the service -- from two days to one. To that end, he said, Amazon has "significantly expanded [its] one-day eligible selection and also expanded the number of zip codes eligible for one-day shipping."
If its investment in faster fulfillment and logistics pays off, Amazon hopes that one day delivery -- which it wants to add to the list of Prime benefits such as discounts at Whole Foods and streaming TV -- more people will be willing to become Amazon Prime members.
Prime members buy more so they're an attractive avenue for growth. Consumer Intelligence Research Partners found that Amazon customers without Prime membership spend $600 a year while Prime members have increased their annual spending from $1,300 in previous years, to $1,400 in 2018, according to the New York Times.
Amazon is already starting to benefit from higher capacity utilization of its existing fulfillment and logistics network. Its costs for fulfilling orders fell 4% because Amazon has been building fewer warehouses and hiring fewer new workers. As Olsavsky said, “Right now, we are on a nice path where we are getting the most of out of the capacity we have."
Amazon is a turning point -- it either needs to make sufficient investments to boost its growth rate way above the 17% it posted in the first quarter or accept that it has lost its touch when it comes to repealing the law of large numbers.
If that goes away, its best days as an investment may be behind us.