LOS ANGELES – Amazon.com's (AMZN) plan to cut prices on many of its products is seen boosting revenue growth at the Internet retailer but is feeding lingering concerns among analysts and investors about the company's long-term ability to improve profits.
Amazon, which has faced slowing sales growth, continues to announce investments in its business at the same time investors were hoping costs would drop. As a result, concerns over the company's profitability are still rife four-and-a-half years after posting its first ever quarterly net profit.
The company Tuesday cut its operating income outlook -- while raising a 2006 sales forecast -- due to stepped-up investment in its toy business and lower prices on many items, sending its stock down over 20 percent to a more than three-year low Wednesday.
Fears of eroding profit margins drove several analysts Wednesday to lower price targets on Amazon shares. Piper Jaffray cut its rating on the stock to "underperform" from "market perform."
"The company is striving to be a growth company," said Pacific Crest analyst Steve Weinstein. "It seems the only way they can do that is at the expense of margins. If they wanted to be more profitable they probably could be, but revenue growth would be a lot less."
In a research note, Piper Jaffray analyst Safa Rashtchy noted that lowered gross margins could eventually result in higher operating income longer-term, but noted that "near-term investors are likely to become impatient with this strategy."
Amazon's move to drive revenue growth through lowered prices is a necessity, said Global Crown Capital analyst Martin Pyykkonen. The company is battling to stay competitive as conventional retailers like Wal-Mart Stores Inc. (WMT) and Best Buy Co. Inc. (BBY) increase their online presence.
Adding to the pressure on profits are costs for rebuilding its toy business after a severed partnership with ToysRUs.com. Spending on technology and content also rose 58 percent in the latest quarter due in part to hiring more programmers and investments in things like video and music downloads.
The company has said that that spending will slow in the second half of 2006, but analysts are skeptical.
"We fear that excessive investments may be destroying shareholder value," wrote Goldman Sachs analyst Anthony Noto in a research note.
And Pyykkonen said that while Amazon may take a breather from tech spending in the second half of the year, the company will need to keep investing in its business.
"I would encourage anyone looking at this as a stock to buy not to assume 2007 (spending) will continue to pull back," he said.
Deutsche Bank analyst Jeetil Patel wrote in a research note that "all is not lost." He cited Amazon's healthy 22 percent sales growth in the quarter and said the company appeared to be gaining market share from eBay Inc. (EBAY), the web's most popular e-commerce site.
Still, itchy investors appear to have lost patience. As recently as last year, many investors anticipated double-digit operating profit margins by 2006, though they have since dropped to the low single digits.
Pyykkonen pointed out that "the next shoe to drop" for the stock would be if Amazon's revenue growth becomes more in line with traditional retailers and spurs further skepticism over over the stock's relatively high valuation.
As of Tuesday's close, Amazon's shares traded at 38 times analysts' 2007 earnings estimate, compared with a multiple of 19.6 for eBay, 30 for Google Inc. (GOOG), and 13.5 for Wal-Mart.
Amazon shares closed down $7.33, or 22 percent, at $26.26 on Nasdaq on Wednesday.