A Monstrous Bubble—The Destroyer Called Amazon

By David Stockman

As far as we can tell, Jerome Powell is worse than Janet Yellen with a tie. That’s because he is the kind of Swamp based RINO (Republican in name only) who has no clue that Keynesian central banking is a mortal threat to capitalist prosperity; and because his history as a crony capitalist beneficiary of that regime at the Carlyle Group has left him blind to the wanton destruction it is unleashing.

Since there is a small chance that the Donald’s glandular impulses may accidentally do the world a favor and opt for Kevin Warsh as the next Fed chairman on Thursday morning, we will hold off on the hell and brimstone denunciation that Powell deserves. After all, no one with an inkling about sound money and honest price discovery would have voted 45 straight times for the money printing depredations of Ben Bernanke and Janet Yellen during his tenure on the Fed since 2012.

But when it comes to wanton destruction we can think of no better evidence than the $63 billionmarket cap eruption visited upon Amazon (AMZN) owing to its purported “blow-out” earnings report on Friday.

Except it wasn’t all that. In the year ago quarter AMZN’s pre-tax earnings came in at $491 million, which was actually alot more than the $316 million figure posted for Q3 2017. In fact, the company’s niggardly current quarter profit represented 36% plunge from prior year, but thanks to the company’s tax cut “selfie” the headline reading robo-machines didn’t even notice this rather dramatic setback.

To wit, AMZN effective tax rate plunged from an aberrantly high 46.6% last year to a quite low 18.4% this year. As a result, its reported net income remained flat relative to prior year.

Stated differently, the blow-out earnings figure of $0.53 per share reported Friday was exactly the same the same $0.53 per share reported last year, but the “blow-out” part was due to the “beat” from the $0.02 street consensus.

Then again, the street consensus had been for $1.91 per share only 90 days ago!

As per usual, it had been “guided “down by 99% in the interim. If nothing else, this proves that the whole SEC “Fair Disclosure” (FD) is an absolute farce and that the SEC itself is an utter waste of taxpayer money.

It also proves, of course, that a bevy of high priced advisors are far more efficacious at cutting tax rates than a House (of Representatives) full of Republicans foaming at the mouth about the topic.But how in the world does this kind of hyper-fiddling with accounting statement tax rates justify a market cap gain in one day ($63 billion) that exceeds the entire market cap of General Motors ($61 billion) or Aetna ($57 billion)?

As it happened, Amazon’s LTM net income of $1.926 billion for the quarter might be a slightly better indicator of its profitability because the company’s four-quarter tax rate averaged out close to the US statutory rate, meaning that the company is being valued at 280X under normal tax rates.

Moreover, even if you pro forma the results with the GOP’s vaunted 20% tax rate you would get LTM net income of $2.48 billion and a PE multiple of 217X; and for that matter, just go ahead and abolish the corporate tax entirely and AMZN’s PE at the zero bracket would still compute to 174X.

We dwell on the absurdity of Amazon’s PE multiple in the first instance because there is absolutely nothing in its financial performance that warrants these massive market cap gains.

Thus, way back in Q3 2014, AMZN’s operating income was $510 million. As shown below, it has been staggering around like a drunken sailor ever since—-lapsing to just $347 million in the purportedly red hot quarter just ended.
AMZN Operating Income (Quarterly) Chart

Actually, however, the speculative run in Amazon’s stock since early 2015 is far more ludicrous than even its current PE multiples suggest.

To wit, in early January 2015 its market cap weighed in at $135 billion compared to $535 billiontoday. So while it has reported no sustained improvement in its operating income trend during that 33 month interval, the company’s $400 billion gain in market cap is notable for one especial reason.

Namely, there are only five other US based companies (Apple, Google, Microsoft, Facebook and Berkshire Hathaway) that even have a total market cap of more than $400 billion.

For the sake of perspective, in fact, compare Amazon’s $400 billion valuation eruption over the past 33 months with the total market cap of century-old storied names like Johnson & Johnson ($381 billion), JPMorgan Chase ($360 billion), ExxonMobil ($355 billion), Anheuser-Busch ($231 billion) and Proctor & Gamble ($222 billion).

Needless to say, Amazon’s $535 billion market cap is lodged in the financial thermosphere (highest earth atmosphere layer) owing purely to massive speculative momentum that always gets concentrated into a few names in the final blow-off phase of a stock market bubbles.

But this case is especially egregious because usually there is a “story” that claims a young company in a new technology (radio in the case of RCA in 1929 and the internet in the case of Cisco in 2000, for example) can grow to the sky.

But Amazon is 24 years-old, not a start-up; it hasn’t invented anything explosively new like the iPhone or personal computer; and it has a unique business model (see below) based on relentless search for new sectors (such a groceries recently, and pharmacy next) in which to loose money by pricing below its costs.

As one astute investor, Kyle Bass, recently noted, Amazon is brilliant at destroying profitability in every business it enters, but so far has not succeeded in capturing those profits into its own income statement. Nor will it ever—so long as a runaway stock market bubble rewards it for profitless sales. And as we document below, its sales outside of its cloud service (AWS) generate massive, continuous losses.

The fact is, 91% of Amazon’s sales involve sourcing, moving, storing and delivering goods—a sector of the economy that has grown by just 2.2% annually in nominal dollars for the last decade, and for which there is no macroeconomic basis for an acceleration.

Yes, AMZN is taking share by leaps and bounds, but that’s inherently a one-time gain that can’t be capitalized in perpetuity at 280X. And it’s a source of “growth” that is generating its own pushback as the stronger elements of the brick and mortar world belatedly pile on the e-commerce bandwagon.

Wal-Mart’s e-commerce sales, for example, have exploded after its purchase of Jet.com last year—with sales rising by 63% in the most recent quarter.

Moreover, Wal-Mart has finally figured out the free shipments game and has upped its e-commerce offering from 10 million to 50 million items just in the past year.

It is also rapidly learning how to leverage its massive existing asset base for duty on the e-commerce side. This includes using its 4,700 stores as customer pick-up sites and even a free four hour delivery option called “Pickup Today”.

Wal-Mart is also tapping for e-commerce fulfillment duty its vast logistics system—including its 147 distribution centers, a fleet of 6,200 trucks and a global sourcing system which is second to none.

In this context, even AMZN’s year-over-year sales growth of 33.6 in Q3 2017 doesn’t remotely validate the company’s bubblicious valuation—–especially not when AMZN’s already razor thin profit margins are weakening, not expanding.

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Needless to say, it is doubly absurd to value a company at 280X when its true income generation rate has been heading seriously south. As indicated above, if you look through its manipulated, gyrating tax rate, the company’s pre-tax income during the September LTM period of $3.101 billion was 15% lower than the $3.664 billion figure for the September 2016 LTM period.

Likewise, for those who believe that net income and pre-tax income are antiquated concepts, the story based on operating free cash flow is no less absurd. After nearly three decades of operation, AMZN still generates niggardly operating free cash flow relative to its nosebleed valuation—-especially if you look through the fact that it is deliberately hiding its massive CapEx via capital leases.

In fact, at today’s $535 billion market cap, AMZN is being valued at 69.5X its LTM operating free cash flow of $7.7 billion as reported on its income statement ( i.e. $16.7 billion of cash from operations less $9 billion of CapEx).

Actually, the story is far worse when you factor in the capital leases disclosed in the footnotes, but even on its face, the implied cash-on-cash yield of the AMZN stock at its current nosebleed level computes out to 1.4%.

Needless to say, you can get a 2.4% yield today on a Treasury note. Why get in harm’s way by taking on Jeff Bezos’ relentless empire building and megalomania in order to stump up an 42% lower yield?

In point of actual fact, however, Amazon spent an additional $12 billion in LTM CapEx through the backdoor of capital leases. When viewed honestly, therefore, AMZN’s true free cash flow during the past year was negative $4 billion!

And that gets to our larger point about Amazon allergy to profitability. Between 2010 and the current LTM period, AMZN’s net sales exploded from $34 billion to $161 billion. But its pre-tax margin, which was already thin at 4.4% in 2010 clocked-in at just 1.9% in the year just completed.

Stated differently, on sales growth of $127 billion, AMZN posted only $1.6 billion of pre-tax profit gain because it is being rewarded by the casino for top-line growth at any cost.

Indeed, as we show below, apart from its cloud business (AWS) Amazon is essentially not a profit making institution at all.

And that’s also where the Fed’s destruction of honest price discovery and the resulting false signaling comes in. To wit, in an honest free market, Jeff Bezos would be more than welcome to run a profitless growth machine, but it would also be valued accordingly.

Even at net income of $1.93 billion for the September 2017 LTM period, AMZN would be capitalized at most at 25X or about $50 billion; and Bezos stock would be worth $8 billion, not  today’s $93billion!

We will readily grant that Bezos is a visionary and great capitalist innovator, builder and disrupter—who may be motivated by more than the last few billions of net worth. But we would also lay heavy odds on the probability that his business strategy might be dramatically different—and far more profit oriented—if his net worth were $85 billion lower!

Indeed, based on the true facts of the Amazon e-commerce juggernaut, we think Bezos’ assault on the brick and mortar sector would be far less menacing and reckless. And that’s giving full credit to the fact that on-line shopping and nearly instant delivery of goods is an enormous consumer boon that would be making great inroads even in an honest free market.

But not nearly as rapidly, wantonly or disruptively because Amazon would be required to post a reasonable profit, and to do that its pricing would have to be far less compelling than is on offer today.

Nevertheless, until Amazon’s gargantuan stock bubble collapses, we don’t think Amazon’s strategy of growth at any price is going to change or that Wall Street’s projected earnings hockey sticks will materialize at any time soon.

That point, in fact, gets us to the stunning evidence that the earnings of its $150 billion e-commerce juggernaut have now vaporized entirely.

That’s right. During the third quarter of last year (Q3 2016), AMZN’s core e-commerce business (excluding its AWS cloud service) had sales of $32.7 billion and operating income loss of $286 million. The resulting operating margin of negative 1% wasn’t much to write home about after 24 years of scorched earth expansion in the retail sector.

But it was something—even if you might think that one of these days there would be economies of scale from conquering the better part of the entire retail world.

By contrast, during the quarter just completed Amazon’s e-commerce sales were up 34% to $43.7 billion, but operating loss soared to a staggering $824 million.

So even if you give the company’s cloud service business (AWS) the benefit of the doubt and assume that it is an economic beanstalk that will grow to the sky, there is still n0 reason AMZN should be valued at $535 billion or be sitting atop the $1,100 per share magic mountain.

To wit, AWS’s operating income of $4.2 billion during the last 12 months would amount to about $2.9 billion of net income using a 3o% tax rate.

In turn, give the AWS cloud service segment a 34X multiple (compared to Microsoft’s 31X) and a $100 billion market cap, and it still implies that AMZN’s zero profit e-commerce business is worth $435 billion.


Then again, AMZN’s total operating profits during the latest 12 months was $3.24 billion, but fully 90% of that was attributable to AWS. So the e-commerce business earned the grand sum of$300 million in operating profits on $145 billion of sales.

So we really do believe that its 0.2% LTM operating margin is a rounding error in the scheme of things.

More importantly, if you allocate a proportionate share of the company’s $400 million of interest expense to the e-commerce segment and tax effect the result at 3%, the net income of Amazon’s core business would amount to nearly negative $100 million during the LTM period ending in the alleged blow out quarter of September 2017.

Needless to say, that begs the question of why you would value any company at an infinite multiple of net income!

Indeed, to capitalize at $435 billion the profitless sales of an e-commerce monster that just keeps spending and expanding like some sci-fi blob is surely a measure of the mania at loose in the casino.

The fact is, every dime AMZN takes in is being recycled to more distribution centers, package handlers, hired delivery trucks and drone prototypes; and now, apparently, same hour delivery service by out-of-work actors and bank tellers who happen to own a Vespa and are willing to deliver meals packed by Martha Stewart—who is also out of work at K-Mart—for comparatively meager.

And that’s not allAt the core of AMZN e-commerce business is its $99 per year Prime membership system, which gives subscribers access to free shipping and numerous other benefits. The company’s estimated number of Prime members in the US has been growing by leaps and bounds—-from 41 million two years ago to 80 million at present.

In turn, that means Amazon is currently collecting about $7 billion per year from Prime membership fees. Yet if you pull these revenues out of  its e-commerce financials, the true nature of the Amazon juggernaut becomes transparent.

To wit, during the last twelve months, its e-commerce revenues less membership fees would have totaled about $123.0 billion compared to operating costs of $129.3 billion. So AMZN essentially collected $7 billion of Prime membership fees during the last 12 months in return for shipping a $129.3 billion mountain of goods at a deep loss.

Based on that equation, Bezos will never make up with volume what he is losing in margin on each and every shipment. The Amazon business model is fatally flowed, and its only a matter of the precise catalyst that will trigger the realization in the casino that this is another case of the proverbial naked emperor.



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