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The Bullish Case for Amazon


Its stock has been on a tear, but it may still have more room to run.

Since the start of the fourth quarter, (AMZN) has been one of the best-performing stocks. It's gained nearly 40% since October 1 and it's up 57% from its quarter low to high. Amazon's move has left many investors slap-jawed because of valuation concerns.

But not everyone is worried. Citigroup came out with a very bullish report this morning on how Amazon shares could climb to $170 within a year, up from today's open of $130. Citigroup raised its non-GAAP 2011 EPS estimate to $4.88 from $4.18 and arrived at the $170 price target by using a price to earnings multiple of 35.

Citigroup is basing its upgrade on four main points:

1. In his channel checks, Citi analyst Mark Mahaney sees annual growth in online retail sales between 10-12% in the fourth quarter. Moreover, he notes that holiday spending for Amazon is accelerating as comparable sales for clients that sell on Amazon were up 73% over last year. In contrast, comparable sales at eBay (EBAY) clients are down 3% from last year.

2. According to comScore, Amazon's November traffic was up 22% over last year and up 19% quarter to date. This shows that more holiday shoppers are at least visiting Amazon before they make their purchasing decisions this holiday season.

3. After looking at various traffic trends, Mahaney and his team conducted a unique study to see how competitive Amazon's pricing is compared to various online retailers. The team developed a basket of the top 60 popular goods and compared the pricing and availability with eBay, Walmart (WMT) and The analysts found that Amazon sold all of the items at an average of 20% lower than standard retail price. eBay sold 98% of the items at a 20% discount, Walmart sold 87% at a 19% discount, and sold 85% at the 19% discount.

4. Last but not least, the Kindle e-book reader is becoming the crown jewel of Amazon. Citi expects Amazon will sell two million Kindles this year, up from a previous estimate of 1.5 million. They believe that Amazon could reach $1.6 billion in Kindle book and device sales in 2010, which would account for 5% of its revenue.

Citi painted a very bullish picture for the online retailer. But Amazon still has a lot of critics, whose main concern is valuation. Let's face it, shares of Amazon aren't cheap.

Using Citi's FY 2010 Non-GAAP EPS estimate of $3.83, Amazon currently sells at 33 times 2010 earnings. This high multiple may make some squeamish but it's actually right in line with Amazon's historical multiple of 36 times earnings. Mahaney notes that this isn't a high price to pay for the stock considering Amazon was able to generate organic bottom-line growth of approximately 50% "during the worst recession most of us have seen." Over the next three years, Citi sees Amazon generating 30% growth.

Other than valuation, another issue to consider with Amazon is increased competition in the e-book market. Barnes & Noble (BKS) recently released the Nook, (though reviews have been poor), Sony (SNE) has e-book readers on the market, and smaller private companies have recently developed readers including Booken, iRex and Plastic Logic. Amazon also faces significant pressure from publishers to raise the price at which it sells their content.

Amazon shares may look pricey but the company seems to have positioned itself in the right areas for growth over the next two to three years. It's no wonder that Citi is calling the Kindle the "iPod (AAPL) of the book world."

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No positions in stocks mentioned.

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