Author | Ben Alaimo
Compile | US Stock Research Institute
01
Summary
Amazon (NASDAQ: AMZN ) is the world’s largest e-commerce company and continues to build out its Prime ecosystem.
Its cloud computing business, AWS, is the market leader and continues to grow rapidly while driving the bulk of Amazon’s profits.
At the time of writing, Amazon stock is grossly undervalued, with shares trading at similar levels to 2018.
Amazon is the world’s largest e-commerce company and the market leader in cloud computing infrastructure. Amazon has benefited greatly in recent years as brick-and-mortar retail has been shut down and people have no choice but to shop online.
Shares more than doubled from a 2020 low of $89 to a November 2021 high of $183. Since then, however, the stock has given up all of its gains and is now trading at around $90 per share. That’s a “ridiculous” price because that’s the same share price it was in 2018.
And Amazon’s sales more than doubled to $502 billion in the past 12 months from $233 billion in 2018. In this article, I’ll provide an analysis of Amazon’s financials and valuation, while also discussing its new CEO.
Data by YCharts
02
New CEO – Andy Jassy
I get a lot of questions about whether Andy Jassy becoming CEO will affect the future of the company as it is no longer “founder led”, which is a key part of my investment criteria.
Here’s what we know so far, with founder Jeff Bezos stepping down as CEO and Andy Jassy taking over the top job in July 2021. In an interview at a recent (November 2022) New York Times event, Andy Jassy told the story of transformation. Andy Jassy was apparently “shocked” when Jeff Bezos informed him that he wanted him for the top job.
Instead of accepting the position directly, he discussed it with his wife first. This was probably the first red flag in my eyes, because while I understand that people’s wives do have a significant impact on their lives, the fact that he doesn’t aspire to the role is a bit worrisome.
However, Andy Jassy does have a lot of positives, starting with the fact that he joined Amazon way back in 1997, just a few years after Amazon was founded in 1994. Andy Jassy joined as a Harvard MBA graduate. Andy Jassy’s main achievement, however, is that in 2003 he and Jeff Bezos came up with the idea of Amazon Web Services [AWS], which launched in 2006.
Andy Jassy led the first team of just 57 people and grew the business into a $60 billion behemoth that is Amazon’s main profit driver even today (I’ll talk more about that later). So, in terms of experience and credentials, it’s hard to doubt that Andy Jassy played a big part in Amazon’s success.
In my opinion, he doesn’t have the charisma and public speaking qualities of Jeff Bezos, but he’s still well respected in the company. So overall, I think Jeff Bezos is “better” and I’d prefer him as CEO. However, Jassy is also an option.
My question is that Amazon is currently going through one of its most challenging times, even though Andy Jassy seems like a “nice guy”. I’m not sure he has the physical ability to inspire companies the way Jeff Bezos did. One positive at the moment is that Jeff Bezos is still the executive chairman and talks to Andy Jassy almost every week, which is a positive sign because it’s great to have a mentor like Jeff Bezos of.
03
Third Quarter Financial Status
Amazon reported tepid financial results for the third quarter of 2022. Net sales of $127.1 million were up 15% year-over-year but missed analysts’ consensus estimate by $370 million. The company faced headwinds from unfavorable foreign exchange rates, as a strong dollar led to a 5 percent drop in international revenue to $27.7 billion. On a constant currency basis, international sales grew a solid 12% year-over-year and net sales increased 19% year-over-year.
Net Sales (Q3 ’22 report)
By region, North America remains Amazon’s strongest market, contributing about 61% of revenue, up 20% year-over-year to $78.8 billion. A preference for North America is actually a positive sign for a number of reasons, from geopolitical volatility to currency risk.
Amazon has built a large ecosystem of third-party sellers who drive 58% of the total paid units sold on the platform. This is a key point to note because even in tough economic times, these sellers will remain active on the platform and be ready to offer more when economic conditions improve.
Amazon Prime also continues to offer more value to customers. These benefits include free, fast shipping, Prime Reading and a lightweight version of Prime Music. Amazon Prime Video looks to be the main driver of growth as the company spends heavily on content. Its flagship original series, The Lord of the Rings, had a staggering 25 million viewers on its launch day.
But more importantly, the show generated more Prime sign-ups than any other Amazon original. That’s a positive sign, but I don’t want to see Amazon go on the “content treadmill” and basically fall into a loop like Netflix (NASDAQ:NFLX ). I’d personally prefer to see them license content or acquire a TV studio/brand to handle that part of the business.
Jeff Bezos on Twitter promoting Lord of the Rings (Twitter)
04
strong cloud business
Cloud has become a popular buzzword, but I personally don’t think most people actually understand what cloud is, so here’s my simplified explanation to help you out. Cloud basically refers to the footprint of a data center owned or leased by a cloud provider, such as Amazon Web Services [AWS] in this case. The idea is basically to provide “computing as a service”.
Traditionally, large organizations have an on-premises data center or server room that houses all of their “compute” and “storage” functions. From the server hosting the company’s website, to the database and applications. However, the problem with this model is that it is not very scalable and also requires regular maintenance.
Thus, by “digitally transforming” to the cloud, companies can effectively take advantage of unlimited scalability through a pay-per-use consumption model. This frees large enterprises from having to think about it, as they can improve business performance and ultimately save costs in the long run if their business has different needs.
Amazon Web Services has also built a huge product portfolio on its platform. This includes machine learning, artificial intelligence, and even satellite communication services.
AWS Services (AWs)
AWS, historically the fastest-growing part of Amazon’s business, continues to perform strongly. In the third quarter of 2022, the company reported revenue of $20.5 billion, representing a solid 28% year-over-year increase. The company also reported an annualized revenue run rate of $82 billion, which is staggering. AWS continued to drive strong profits, generating $5.4 billion in operating income, up 11% year-over-year.
AWS (Q3 ’22 report)
05
Profitability and Expenses
Amazon reported a 48% drop in net income from $4.9 billion in 3Q21 to $2.5 billion in 3Q22. This was due to a 17% increase in operating expenses, which rose to $124.6 billion.
This is further driven by a range of inflationary factors such as higher oil prices, freight and labor costs. This led to an 11% year-over-year increase in fulfillment costs to $20.6 billion. Amazon’s e-commerce business operates on tight margins as the company passes a lot of the benefits back to customers in a virtuous cycle.
However, when costs rise, businesses feel the pain. One positive is that management is focusing on addressing the issue and has announced a number of cost-saving initiatives that are expected to save around $1 billion.
Amazon Expenses (Q3 ’22 report)
Sales and marketing expenses also jumped 37 percent to $11 billion. I suspect this is mostly due to new product launches, Prime Video series, etc. Sales and marketing are discretionary expenses for the most part, so I don’t think this will be a huge issue, assuming the company generates positive ROAS (return on advertising spend) in the long run.
Technology and content spending jumped 45% year-over-year to $19.5 billion. This was driven by Prime Video content, investments in AWS products, and the launch of new regions such as the Dubai AWS region. Investing in these factors is not necessarily a “bad thing,” assuming the company generates returns over the long-term.
Amazon has a strong balance sheet with $58.6 billion in cash and short-term investments. The company does have high debt of $164 billion, but “only” $4.5 billion of that is current debt maturing within the next two years, so it’s manageable.
06
Valuation
I have fed Amazon’s financial data into my discounted cash flow (“DCF”) model. I forecast 10% annual revenue growth over the next 1 to 5 years. Considering the previous growth rate of 15%+, this is quite conservative. I expect the cloud computing business to continue growing rapidly and Amazon’s market position to recover as consumer demand improves.
Amazon Stock valuation 1 (created by author Ben at Motivation 2 invest)
I also capitalized Amazon’s R&D expenses, shifting those expenses onto the balance sheet and boosting net income. Over the next 8 years, I forecast a 1% increase in its operating margin. That’s fairly conservative, as growth could easily exceed 5% as the company executes a series of cost-saving programs.
Also, I expect the impact of inflation to diminish over time as the Fed raises rates.
Amazon stock valuation 2 (created by author Ben at Motivation 2 Invest)
Given these financials and forecasts, I get a fair value of $184 per share. At the time of writing, Amazon stock is trading at $89 per share, making it 52% undervalued.
With a price-to-sales ratio of 1.8, Amazon is 51% cheaper than its 5-year average.
Data by YCharts
07
risk
recession/high inflation environment
Many analysts are predicting a recession in 2023 due to the environment of high inflation and rising interest rates. That means Amazon could continue to experience rapid cost pressures, and consumer demand could weaken.
08
in conclusion
Amazon is a remarkable company, arguably one of the greatest businesses of all time. Its crown jewel is AWS because that’s the fast-growing, highly profitable part of the business.
However, the company does have issues with its fulfillment centers and cost structure, yet Amazon is still a good investment in the long run.
(Disclaimer: This article only represents the author’s point of view, not the position of Sina.com.)
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