Citigroup analyst Mark May raised his rating on Amazon.com to a Buy from Neutral with a price target of $354.
In his note titled “The Sun Will Come Out Tomorrow,” he urges investors to look past the more common profit metrics “consolidated segment operating income” (CSOI), and focus more on EBITDA. Yikes!
I always get nervous when I hear analysts creating justifications for using EBITDA, however I do agree that EBITDA in this case, does more accurately reflect Amazon’s underlying business.
May’s reasons for the upgrade include:
– GMV Valuation in-line with retail peers Wal-Mart (WMT) and Costco (COST) (deserves a premium)
– Downside risk below $300 is limited based on Valuation (I wish I had a crystal ball…)
– The potential for margin expansion based off of previous years results (don’t hold your breath knowing Bezos)
– Gross profit is still growing.
Although, we do believe Amazon to be the dominant player in online retail, the reasons for our fondness of the business are a little more (how do we say this)….simple.
Amazon’s strong brand loyalty, ecosystem, culture and various network effects should allow the business to grow and establish itself as one of the world’s greatest retailers over time.
However, the stock is not even close to being reasonably priced for investment.
The stock is priced for industry domination (and industry domination it may well accomplish). As a result, the market is currently giving us little chance to invest in this high quality business with any margin of safety.
Amazon trades at very hefty valuation levels with a forward P/E of 47.39 and P/FCF of 128. And of course, it’s always traded at these absurd valuation levels. But it doesn’t justify sacrificing our investing standards if there is no margin of safety.
A simple reverse discounted cash flow calculation shows us that the lofty (potentially unrealistic) expectations for the growth of the business gives an investor little room for error.
And it gives the investor an even smaller chance of earning a reasonable rate of return with an investment at current levels. The risk-reward does not favor the investor right now. And this stock seems priced for perfection.
Please don’t take away my Amazon Prime…:)
There is no question this is a great business, with an incredible management team at the helm. And there will undoubtedly be brighter days ahead for the business (maybe the stock too). However, we don’t have a strong conviction on the stock being able to sustain its current levels of excessive valuation.
We hope we are wrong. And we are sure others are bolder than us. We hope they make more money than they can count.
However, we are perfectly content waiting on the sidelines on this one at current levels.
You be the judge.