Amazon: 1.5% Is 'Good Enough'

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NEW YORK (TheStreet) -- Even though Amazon beat first-quarter earnings estimates last night, the company's operating margins are still razor thin. Nonetheless, investor concerns have been alleviated. For now.

In the first quarter Amazon's operating margins came in at 1.45%, roughly stabilizing from 1.5% in the prior quarter. Wall Street was looking for operating margins of 0.9%, so while this is better than expected, it's still down sharply from 3.7% during the same period last year. Return on invested capital fell to 22% during the quarter, from 34% in the fourth quarter of 2010.

There were concerns that Amazon's consumer electronics strategy, with its Kindle Fire, would hurt margins even more as it competes with Google's Android operating system and Apple in the hardware space. Those fears have been alleviated.

Despite margin concerns going into the quarter, several analysts upgraded Amazon as revenue has continued to accelerate better than most thought. Revenue rose 34% year-over-year to $13.2 billion, with non-GAAP earnings of 28 cents a share.

Bank of America Merrill Lynch analyst Justin Post upgraded shares to "buy", as revenue outpaced expectations, led by 60% growth in third-party (3P) sellers.

"We think Amazon remains well positioned to benefit from the long-term secular growth of eCommerce, and increasing use of mobile devices, and we expect the Street to continue to value stock on potential (not actual) margins," Post wrote, in his note. "With increasing spending, Amazon could miss third-quarter street margin estimates, but we think the stock can see positive returns over the next 6-8 months versus the $220 after-market price."

This, according to Post, will be driven by accelerating growth in the second half of the year, new Kindle tablet launches, and optimism on 2013 margin expansion.

The analyst raised his Amazon price target to $270, up from $235.

Amazon Web Services, Amazon's cloud services offering, continues to prove strong, which Nomura analyst Brian Nowak cited as a major reason for his upgrade.

"After having been on the sidelines since our initiation November, we are beginning to see clouds part in the Amazon investment case as we believe we and the Street are under-appreciating the growing and expansive drivers within Amazon's gross margin," Nowak wrote in his research report. He now rates Amazon shares "buy" with a $285 price target, up from $200.

Capital expenditures are expected to soar in the second quarter, moving to between $800 million and $900 million, up from $386 million in the first-quarter. That's not a fear for Citigroup analyst Mark Mahaney, who raised his target to $275, up from $215.

Mahaney said the long-term thesis is still intact, and Amazon is poised to benefit as it increased investments in mobile, cloud and the company's Local offering. Mahaney noted that Amazon's management team, led by CEO Jeff Bezos has a record of being able to succeed through its investment cycles.

As Amazon continues to invest heavily in its business and watch revenue grow, it seems as if the company's shareholders will accept the razor-thin operating margins.

Jeff Bezos is no stranger to spending the company's cash if he believes it will help the business long term. Amazon shares have gained 254.59%, versus a 19.16% return for the Nasdaq over the last five years, which should keep shareholders sitting pretty.

Amazon shares are soaring in Friday trading, up 13.32% to $221.90.

Interested in more on Amazon? See TheStreet Ratings' report card for this stock.

--Written by Chris Ciaccia in New York

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