Bank of America / Merrill Lynch is upgrading Amazon.com (NASDAQ:AMZN) to Buy from Neutral and raising price tgt to $103 from $95 based on following six factors:
1) Leader in a growth sector – We believe eCommerce sales will rebound to double-digit y/y growth in 2010 (see our eCommerce industry report), resuming the secular shift Online that was interrupted by the recession. Amazon has built sustainable competitive advantages in eCommerce including customer loyalty, distribution infrastructure, as well as technology investments, and these advantages have shown through with a sales gap to ecommerce growth between 1,700 and 2,800bps over the past six quarters. The gap shrank a bit in 2Q due to Amazon’s added exposure to video game category, but we think the gap could re-expand if the category improves (we have the gap shrinking in our estimates). This seems too conservative. Our improvement in y/y industry growth to 11% in 4Q is driven by easy y/y comps. as well as our assumption that the industry could see a normal 4% sequential growth in 4Q, consistent with 2006 and 2007.
2) Upside potential vs. eCommerce group - We believe the street is underestimating the potential eCommerce sector growth acceleration benefit for Amazon’s (just 54bp acceleration in 2010 growth vs. 2009 growth in street estimates) relative to other eCommerce stocks. Table 1 shows that street is modeling a much better growth rate in 2010 vs. 2009, while this isn’t the case for Amazon, and Amazon screens best on this metric. We note that Amazon has the second best underlying metrics in eCommerce/travel sector (behind Priceline) as measured by unit/transaction growth which, if sustainable, should drive revenue upside. The company grew units 28% in 2Q’09 and if this growth rate is sustainable in a 2010 recovery, we think revenue growth will accelerate to better match unit growth.
3) Positive eCommerce channel checks - Our online retail checks indicate accelerating growth for the sector driven in part by higher traffic conversion rates. We see Amazon as a play on an improving economy and think sector is starting to see improvements from increasing discretionary spending. See our eCommerce sector report published Sept. 16th outlining our expectations for the gap in growth between eCommerce spending (which is more discretionary in nature) and retail to re-expand in 2010.
4) Positive seasonality – Amazon’s stock outperformed from Sept. 15th through Nov 30th in 2005-2008 and we think this year’s 4Q seasonal acceleration will likely be aided by easy currency comps. Looking back at last 7 years, the average P/S multiple has expanded 6% from September through December, and excluding the recession in 4Q’08, this expansion has been 10%.
5) Valuation upside based on history, with valuation support expected at 18x FCF. Amazon’s stock has traded at between 0.8x–2.0x sales over the past 5 years, and when company was beating estimates in 2007 stock moved toward higher end. We believe a similar scenario could play out over next 12-months. Assuming results just match expectations, while P/E is high relative to group, we believe stock will see support at around 18x FCF.
6) Competitive risks overblown, at least for next 12-months - Amazon’s stock has underperformed the Internet peer group since April due, in part, to competitive fears. This concerns have been driven by weaker media sales in 2Q (video game exposure) and a corresponding closing of US sales growth gap vs. eBay, loss of Target as a 3rd party partner in 2011, launch of Wal-Mart’s 3rd party online marketplace, and eReader announcements from Barnes and Nobel and Sony. We believe that none of these competitive developments will impact Amazon’s sales in 2009 or 2010 (Wal-Mart’s sales are a small fraction of Amazon’s, and eBook sales barely impact Amazon’s total sales this year), with the outside possibility that Amazon lowers Kindle HW price to increase sales at the expense of margins. While there could be competitive margin pressure in sector long-term, Amazon’s customer, distribution and technology advantage position the company well long-term.
We are raising our estimates for currency and for expected integration of Zappos. For 4Q, we are at revenues/GAAP EPS of $8.3bn/$0.64, above street at $8.1bn/$0.62. Adding $725mn for Zappos in 2010, we are now at $28.5bn/$2.29 vs. street at $27.0bn/$2.16. We believe our 24% growth rate for 2010 could be conservative given Zappos (300bps of growth) and currency benefits.
Action: This call will get some attention anyway, but I believe the market will underestimate the stock reaction, at least early on.
I like the fact that BAC/ML is calling for upside to estimates, not just making a case for valuation. Well, they do make a case for valuation too, but that's not the focus of the upgrade.
I also like how confident the analysts seem to be in this call. Sure helps selling the idea to the clients when you believe in the idea.
I also like that AMZN has lagged the recent moves by EBAY and YHOO. Some catch-up to do.
To sum it up, I believe AMZN has 4-5% move in it today, which calculates to roughly $87- 87.50 range. Early birds can probably get shares below $85.50, offering up to two points of upside.
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