Tag Archives: Whole Foods

More Accounting Games At AMZN

On January 31st, Amazon reported an expected “beat” for Q4 revenue and net income. After the headline report hit the tape, the stock soared $59 to $1777 from the closing price ($1718) minutes earlier. But then the stock began plunging. It closed the after-hours session at $1635, down $142 from the earnings headline spike and down $83 from the NYSE close. The Company guided Q1 revenues down below the consensus estimate. Amazon’s Q4 numbers also reflected a slow-down in revenue growth.

I predicted Q4 would show slowing growth based on the fact that AMZN enjoyed four quarters of year-over-year comparisons which included Whole Foods numbers for Q4 2017 to Q3 2018 vs comparable year-earlier quarters which did not include Whole Foods numbers (A GAAP rule-change allows companies to avoid restating historical numbers after a big acquisition – this enabled AMZN to report 3 quarters in 2018 with WF numbers but leave WF numbers out of historical financials). Q4 2018 is the first year-over-year quarterly comparison which was an “apples to apples” comparison of the numbers. And AMZN did not disappoint me by disappointing.

If the AMZN Einsteins on Wall Street are aware of the Whole Foods accounting gimmick, they certainly never mentioned it in their analysis, which probably explains why AMZN’s stock is down 6.4% since reporting Q4 while the SPX is up 2.6% in the same time period.

AMZN’s year-over-year revenue growth rate for Q4 came in at 19.7%, the slowest growth rate since Q1 2015. If AMZN revenue comes in at the mid-point of Q1 2019 guidance ($58 billion), it would represent a year-over-year growth of rate of 13.6% – the slowest revenue growth rate since 2001.

I noticed an interesting development in AMZN’s numbers which the analyst community will no doubt overlook or fail to see. AMZN’s gross margin jumped from 37.1% in 2017 to 40.3% in 2018. This made no sense given that Whole Foods’ gross margin was running about the same as AMZN’s prior to the merger. The obvious place to look for gross margin accounting manipulation (understating cost of goods sold) is the balance sheet. Property, plant and equipment jumped 27% from 2017 year-end, or $13 billion. This increase is not attributable to the WF acquisition because the 2017 year-end balance sheet would reflect the WF acquisition. I also noticed a 27% jump in “other assets.” Other assets contains the “intangible” value of video content acquired.

While I can’t prove this without seeing the inside books, I would suggest that the likely explanation is that AMZN is capitalizing costs that should be expensed in the year the costs are incurred. I would also bet that AMZN has slowed down the rate at which it depreciates its media content. This is the primary source of accounting manipulation utilized by Netflix. Capitalizing expenses and slowing down the rate of depreciation has the effect of reducing cost of goods sold and increasing gross profit, thereby increasing the gross margin.

A counter-argument would be that AWS continues to grow at 40% and is a high margin business. However, AWS revenues have been running about 10% of AMZN’s revenue base for quite some time. Thus, while AWS’ business might contribute to a small improvement in AMZN’s gross margin, a 300 basis point jump in one year is too good to be true.

I would suggest that AMZN altered its cost recognition accounting in order to offset slowing revenue growth with a higher reported gross income, which translates into higher operating and net profits. This enables AMZN to “beat” earnings estimates – at least in the short run.

As I’ve detailed in the past and in the Amazon dot Con report (available to Short Seller’s Journal subscribers), AMZN presents its “free cash flow” in a non-GAAP format in order to make it look like the business model generates a lot of free cash flow. As AMZN discloses in a footnote buried in the 10Q/K, its presentation for free cash flow is non-GAAP. At the bottom of its statement of cash flows from operations is a section titled, “supplemental cash flow information.” This section includes “property and equipment acquired under capital leases” of $10.6 billion and “property and equipment under build-to-suit leases” of $3.6 billion. Together, this is cash spent during 2018 of $14.2 billion.

These expenditures have been growing annually for many years and should be netted out from AMZN’s “investing activities” section in the statement of cash flows. Subtracting the $14.2 billion from the cash used or provided by operations, investing and financing yields negative $3.4 billion. This is the actual “free cash flow” generated by AMZN’s operations in 2018 vs. the  positive $11.6 billion “free cash flow” number shown on page 1 of AMZN’s Q4 earnings presentation.

One last point. My biggest contention is that AMZN’s revenues are driven primarily by the attraction of 2-day free delivery for Prime members. Stripping away AWS from AMZN’s revenues and operating income gives AMZN a 2.5% operating margin. This is about half of the operating margin generated by AMZN’s comparable competitors like Walmart, Target and Best Buy. Most of that 2.5% operating margin is attributable to Whole Foods. AMZN’s cost of fulfillment (the cost of getting a product from the “shelf” and delivered to the buyer), surged to 25.6% of revenues from 22.8% in 2017. In 2010, before Prime really began to take off, AMZN’s cost of fulfillment was 13% of revenues.

AMZN’s e-commerce business barely generates an operating profit (international e-commerce generated a $2.1 billion operating loss in 2018). If we could calculate a net income for just e-commerce, it’s likely that AMZN would show a net loss. As the rate of AMZN’s revenue growth slows, the cost of fulfillment is going to consume AMZN’s operating margin.

My point is that AMZN stimulates e-commerce sales with the allure of free 2-day shipping. AMZN’s stock price keys off revenue growth. Unless AMZN can keep revenue growing at historical rates, the stock price is going to reprice down to a multiple based on a hybrid cloud computing services and retail business. The growth rate in Prime subscriptions has been the “holy grail” of AMZN’s revenue growth rate. But the growth rate in Prime memberships plummeted to 26% year-over-year in Q4, down from 50%+ growth rates historically.

AMZN’s stock trades at an eye-watering 65x operating income. It trades at 76x trailing EPS. Keep in mind that there’s a good argument to be made that AMZN stretched its GAAP income measurements with accounting games that reduced cost of goods sold and increased operating/net income. The jump in gross margin is a one-time event and likely not sustainable. Perhaps Bezos will plan another big acquisition in order to keep kicking the accounting indiscretions down the proverbial road.

Regardless, the stock remains insanely overvalued. As a comparison, Walmart trades at 22x operating income and a P/E of 18. Target trades at 9x operating income and a P/E of 11. AMZN’s stock price could get cut in half and it would still be overvalued relative to retailer comps. That said, AMZN’s stock price will likely trade directionally with the stock market, although it will outperform to the downside when the bear market resumes.

If you are looking for ideas for shorting the stock market, try out my Short Seller’s Journal. Each week I review the key economic data and provide analysis like AMZN analysis above plus offer suggestions for using options to short stocks.  Learn more about this newsletter here:  Short Seller’s Journal information

Amazon Is Desperate To Generate Sales Growth – Why?

I’m already fatigued and disgusted with Christmas promotions. They’re everywhere now, including every other ad on television.   I’ve come to loathe the holiday season because of the extreme materialism and consumerism into which it has degenerated.

That said, Wall Street has overlooked or ignored an interesting aspect reflected in Amazon.com’s Q3 earnings circus.  Amazon is now desperate to generate sales growth.  The Company announced that it waived the $25 minimum spending requirement for free shipping during the “holiday season.”  This move devalues the $119 annual fee for a Prime account, other than the fact that non-Prime free shipping will be regular mail rather than 2-day.  As a colleague remarked,  “at least for the holiday season Prime becomes nothing more than low-level streaming service.”  Moreover, the free shipping will annihilate AMZN’s gross and operating profits.  

In 2001, FASB removed the “pooling” method of accounting for mergers which required the financials of the combined entity to be historically restated to reflect the numbers from both companies.  From Q3 2017 to Q3 2018, AMZN optically has generated a huge year-over-year quarterly growth rate because AMZN’s income statement prior to late Q3 2017 did not include WF numbers.  This fact is buried in a disclosure in the SEC filings but, of course, not mentioned by analysts or the dopes on financial television.

But AMZN will be hurt going forward because every quarter, starting with Q4 2017, contains a full quarter of Whole Foods numbers. The consequence of this for AMZN is that, optically, the “growth rate” in AMZN’s revenues will fall significantly in year-over-year quarterly comparisons. Thus, the year-over-year year quarterly comparisons thru Q3 2018 show a much higher growth rate visually even though the comparisons are not “apples to apples” (e.g. Q2 2018 included WF numbers, Q2 2017 did not). Going forward, WF’s numbers will “dilute” the growth rate of AMZN’s revenues. One of the reasons AMZN’s stock was massacred in the previous week’s market sell-off is because AMZN guided the Q4 growth rate lower.

While some of AMZN’s competitors – like Target – are offering free shipping without a spending requirement, the move by Amazon is a act of desperation designed to generate sales growth.  AMZN’s stock price is and always has been tied to revenue growth rate.  Anyone who has bothered to pull apart the financials to the extent I have knows that AMZN burns cash every quarter.  I opined a few years ago that AMZN’s stock would be demolished once the Company reaches a point at which sales growth approaches zero or declines.

AMZN’s stock plunged $252 (14.1%) in the first three trading days after AMZN reported Q3. It would have tanked even more if it wasn’t “saved” by the massive short-squeeze rally last week.  But it’s down another 4.1% today – after hitting its head on its 200 dma.  If the stock market heads south, the decline is AMZN’s stock price is just getting started…

Amazon: The Devil Is In The Details

Jeff Bezos/Amazon is the poster-child for the degree to which this entire economic and political system is profoundly corrupt. – Investment Research Dynamics

Amazon stock made a big after-hours “shock and awe” move after it reported a huge headline “beat” of its Q3 earnings.  It’s a funny thing how the “beat the Street” game works.  Ninety days ago the consensus estimate for Q3 was $1.09, with one estimate as high as $1.59. The estimates were systematically “walked down” over the last 3 months to a mean estimate of 2 cents and a high-end estimate of 26 cents. This is how the game is played.

Make no mistake, the Company knowingly “guides” analysts down in order to engineer a “headline” surprise. This is how absurd this game has become. The “beat the numbers” game is one of the many frauds connected with corporate earnings reports. That said, AMZN’s EPS in Q3 2017 were the same as Q3 2016 – zero EPS growth. Bear in mind that GAAP acquisition accounting manipulation is heavily at play here.  Acquisition accounting enables a company to boost revenues and hide expenses.

Here’s just a cursory look at the “Devil in the details” (Short Seller Journal subscribers will get the in-depth, eye-opening analysis in the next issue released Sunday afternoon).

Amazon’s headline revenue “growth” cost AMZN a lot money in terms of operating earnings.  Despite the “marquee” 34% sales “growth” rate, AMZN’s operating income plunged nearly 40% year/year for Q3.  This drop in operating income has accelerated, as YTD for the first 9 months of 2017, AMZN’s operating income has dropped 32%.

This should have been the quarter that AMZN literally “printed” GAAP income because the quarter included its highly touted “Prime Day” record sales.  Furthermore, AMZN should have been able to reap the benefits of merger/acquisition accounting from its Whole Foods acquisition.  M&A GAAP standards enable companies literally to manufacturer GAAP accounting profits.   I would suggest that Bezos’ price-cut strategy at Whole Foods has driven WFM’s operating margin toward zero (from 4% pre-acquisition) – like the rest of Bezos’ consumer sales businesses.  But there’s more…

AMZN’s GAAP net income showed no growth – literally in Q3.  In 2016 AMZN reported $252 million in net income for Q3.  In 2017 it reported $256 million.  EPS were flat at 53 cents (basic).  Zero growth.  For this, AMZN’s market cap after hours increased by $37 billion.  But there’s more…

Without going into the monotony of GAAP tax rate accounting, suffice it to say that anyone who has taken a basic accounting course knows that the GAAP tax rate is highly arbitrary and a major source of EPS manipulation.  Again, the Devil is in the details…

In Q3 2016, AMZN used a 47% GAAP tax rate.  This latest quarter, AMZN capriciously applied an 18% GAAP tax rate.  Had AMZN maintained the same GAAP tax rate used last year, its net income in Q3 2017 would have declined to $200 million, or 41 cents/share. For this, the last buyer after hours ($1,047) was willing to pay 266x trailing twelve month earnings.

This is just the beginning of an in-depth look at the rotting condition of the numbers buried in AMZN’s financial statements.  The next issue of the Short Seller’s Journal will pull back the curtain on areas of AMZN’s SEC-filed numbers where no Wall Street analyst or financial media cheerleader would ever dare venture.  AMZN’s cash flow is declining – and its true free cash flow – not the Bezos non-GAAP “free cash flow” – is negative.  I can prove it.

The highly-touted acquisition of Whole Foods could turn out to be Jeff Bezos’ “Wings of Icarus.”  He may have flown too close to the sun on this one.

The information I present in the Short Seller’s Journal is actionable.  The last two times AMZN’s stock shot up I put a short recommendation on AMZN’s stock (including put option ideas) which led to profitable short-covering opportunities.  In the last issue I advised waiting until after Q3 earnings, stating that a big gap-up in after-hours would lead to another opportunity to short the stock.  You can find out more about the Short Seller’s Journal here:  Subscriber Information link.

The Housing Market Bubble Is Popping

As with all other highly manipulated data, the financial media has a blind bias toward the “bullish” story attached to the housing market. Understandable, as the National Association of Realtors spends more on special interest interest lobbying in Congress than any other financial sector lobby interest, including Wall Street banks.

New home sales were down last month, according to the Census Bureau, 11.3% and missed Wall Street’s soothsayer estimates by a rural mile. Strange, that report, given that new homebuilder sentiment is bubbling along a record highs. Existing home sales were down 2.3%. You’ll note that the numbers reported by the Census Bureau and NAR are “SAAR” – seasonally adjusted annualized rates. There is considerable room for data manipulation and regression model bias when a monthly data sample is “seasonally adjusted/manipulated” and then annualized.  You’ll also note that mortgage rates have dropped considerably from their December highs and May is one of the seasonally strongest months for home sales.

It’s becoming pretty clear to me that the housing market’s “Roman candle” has lost its upward thrust and is poised to fall back to earth. I believe it could happen shockingly fast. Fannie Mae released its home purchase sentiment index, which FNM says is the most detailed of its kind.

The report contained some “eyebrow-raising” results. The percentage of Americans who say it’s a good time buy a home net of those who say it’s a bad time to buy a home fell 8 percent to 27% – a record low for this survey. At the same time the percentage of those who say its a good time sell net of those who say its a bad to sell rose to 32% – also a new survey high. In other words, homeowners on average are better sellers than buyers of homes relative to anytime since Fannie Mae has been compiling these statistics (June 2010).

Currently the prevailing propaganda promoted by the National Association of Realtors’ chief “economist” is that home sales are sagging because of “low inventory.” He’s been all over this fairytale like a dog in heat. The problem for him is that the narrative does not fit the actual data – data compiled by the National Association of Realtors – thereby rendering it “fake news:”

The graph above shows home inventory plotted against existing home sales from 1999 to 2015 (note:  when I tried to update the graph to include current data, I discovered that the Fed had removed all existing home sales data prior to 2013).   As you can see, up until Larry Yun decided to make stuff up about the factors which drive home sales, there is an inverse correlation between inventory and the level of home sales (i.e. low inventory = rising sales and vice versa).   I’m not making this up, it’s displayed right there in the data that used to be accessible at the St Louis Fed website.

Furthermore, if you “follow the money” in terms of new homebuilder new housing starts, you’ll discover that housing starts have dropped three months in a row. The last time this occurred was in June 2008.   IF low inventory is the cause of sagging home sales – as Larry Yun would like you to believe – then how come new homebuilders are starting less homes? If there’s a true shortage of homes, homebuilders should be starting  as many new units as they can as rapidly  as possible.

Although the Dow Jones Home Construction Index is near a 52-week high – it’s still 40% below it’s all-time high hit in 2005.  Undoubtedly it’s being dragged reluctantly higher by the S&P 500, Dow, Nasdaq and Tesla.   Despite this, I presented a homebuilder short idea to subscribers of the Short Seller’s Journal that is down 13.6% since  I presented it May 19th.  It’s been down as much as 24.2% in that time period.   It is headed to $7 or lower, likely before Christmas.  I also  presented another not well followed idea that could easily get cut in half by the end of the year.

The next issue of the Short Seller’s Journal will focus on the housing market.  I’ll discuss housing market data that tends to get covered up by Wall Street and the media. I have been collecting some compelling data to support the argument that the housing market is rolling over…you can find out more about subscribing here:  Short Seller’s Journal info.

In the latest issue released yesterday, I also reviewed Amazon’s takeover of Whole Foods:

I just read it and the analysis on Amazon is awesome. This has the potential to be the short of year when the hype wanes and reality sets in – subscriber, Andreas