Amazon Stock: This Is Getting Ridiculous (NASDAQ:AMZN)
Amazon.com, Inc. (Nasdaq: AMZN) is the world’s largest e-commerce company and market leader in cloud infrastructure. The company benefited greatly from the lockdown in 2020, when physical retail was shut down and people had no choice but to shop online. The The share price more than doubled between a low of $89 in 2020 and a high of $183 in November 2021. However, since that point, the stock has given up all its gains and is now trading at $90 per share. That’s a “ridiculous” price, given that this is the same share price in 2018. While Amazon’s sales more than doubled from $233 billion in 2018 to $502 billion in the subsequent 12 months. In this post, I’ll break down Amazon’s financials and valuations, while also discussing its new CEO. Let’s dig deeper.
New CEO – Andy Jassy
I’ve gotten a lot of questions about whether Andy Jassy who becomes CEO will influence the company’s future because it is no longer “founder-led,” which is a key part of my investment criteria. Here’s what we know so far, in July 2021, founder Jeff Bezos stepped down as CEO and Andy Jassy took over. In a recent (November 2022) interview at a New York Times event, Gacy tells the story of the transition. Jassy was apparently “shocked” when Bezos told him he wanted him to take the lead. He did not accept the position immediately and had to “discuss it with his wife” first. This may have been the first red flag in my eyes, though as I understand that people’s wives have a huge impact on their lives, the fact that he wasn’t really hungry for the role is a little worrying. “Hunger,” drive, and vision are what make great founders great, think of Elon Musk and his drive to do whatever it takes to transform the company. However, Jassy has plenty of positives, first he joined Amazon in 1997, just a few years after it was founded in 1994. Andy Jassy joined as a Harvard MBA graduate when Amazon just sold books and has been with him ever since. However, Andy Jassy’s main achievement is the fact that in 2003, he and Bezos came up with the idea of Amazon Web Services. [AWS], which launched in 2006. Andy Jassy headed the first team of just 57 people and grew the business into a $60 billion behemoth and a major profit driver for Amazon even today (which I’ll discuss more later). So, in terms of experience and credentials, it’s hard to doubt Andy Jassy played a major role in Amazon’s success.
In my opinion, he did not have Bezos’ charisma and public speaking quality, but he was still highly respected in the company. In conclusion, I would like to say that Jeff Bezos is “better” and I would prefer him to be CEO. However, Jassy isn’t a bad alternative. My problem is that Amazon is currently going through one of its toughest periods, even though Jassi seemed like such a “nice guy”. I’m not sure if he has the burning power to inspire the company like Bezos does. The positive for now is that Jeff Bezos is still the CEO and talks “almost weekly” to Gacy, which is a positive sign because having a mentor like Bezos is great.
Third quarter financial statements
Amazon reported tepid financial results for the third quarter of 2022. Net sales were $127.1 million, which were up 15% year over year, but came in short of the $370 million analyst consensus estimate. The company faced a headwind from “unfavorable” foreign exchange rates, as a strong dollar caused international revenue to drop 5% to $27.7 billion. On a constant currency basis, international sales increased 12% year-over-year, and net sales increased by an even greater 19% year-over-year.
Breaking down the results by region, North America remains Amazon’s strongest market contributing approximately 61% of revenue and growing 20% year-over-year to $78.8 billion. A bias towards North America is actually a positive sign for a number of reasons from geopolitical fluctuations to exchange rate exposure.
Amazon has created a vast ecosystem of third-party sellers who account for approximately 58% of all paid units sold on the platform. This is a key point to note even in tough economic times, these sellers will remain on the platform, active and ready to supply more goods as economic conditions improve.
Amazon Prime also continues to bring more value to customers. Benefits include free and fast delivery, Prime Reading, and a lightweight version of Prime Music. Amazon Prime Video appears to be the main driver of growth as the company has invested heavily in content. Its flagship original series, The Lord of the Rings: Rings of Power, garnered a staggering 25 million viewers on the day of its launch. But more importantly, the series generated more Prime sign-ups than any other Amazon Original. That’s a positive sign, but I wouldn’t like to see Amazon go into a “content treadmill” and basically get stuck in a cycle like Netflix. Personally, I’d rather see them license content or have a TV studio/brand handle that part of the business.
Cloud is still king
‘Cloud’ has become a popular buzzword, but personally I think most people don’t really know what it is, so here’s my simplified explanation to help you guys out. “Cloud” basically refers to the footprint of data centers owned or leased by a cloud provider such as Amazon Web Services [AWS] In this case. The idea is to offer “computing as a service”. Traditionally, large organizations have a local or “on-premises” data center or server room that is used to house all of their “computing” and “storage” functions. From a server that hosts a company’s website to databases and applications. However, the problem with this model is that it is not scalable and also requires regular maintenance. Therefore, by “digitalizing” to the cloud, companies can effectively benefit from unlimited scalability through consumption and pay-per-use model. This makes it a no-brainer for larger organizations as they can improve business performance and ultimately save cost in the long run, if they have a business with varying demand.
Amazon Web Services has also built a huge suite of products on top of its platform. This includes machine learning, artificial intelligence, and even satellite communications as a service.
AWS has historically been the fastest growing part of Amazon’s business and continues to perform strongly. In the third quarter of 2022, the company reported $20.5 billion in revenue, which increased 28% year-over-year. The company also reported an annual revenue run rate of $82 billion which is staggering. AWS continues to deliver strong earnings and generated $5.4 billion in operating income which increased 11% year-over-year.
profitability and expenses
Amazon reported a shocking 48% drop in net income, from $4.9 billion in the third quarter, 21 to $2.5 billion in the third quarter. 22. This was driven by a 17% increase in operating expenses which rose to $124.6 billion. This was due to a series of inflationary factors such as rising costs of oil, freight and labor. This increased implementation costs by 11% year over year to $20.6 billion. Amazon’s e-commerce operates by narrow margins, with the company returning many of its benefits to customers in a virtuous cycle. However, when costs go up, the business feels the pain. It is positive that the administration is focused on addressing the problem and has announced a series of cost-saving initiatives, which are expected to save about $1 billion.
Sales and marketing expenses also increased by 37% to $11 billion. I suspect this is mostly due to new product launches, Prime Video series etc. Sales and marketing is a discretionary expense most of the time, and so I don’t consider this to be a big deal, assuming the company achieves a positive return on ad spend (return on ad spend) over the long term.
Technology and content expenses increased 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 “bad” assuming the company generates a long-term return.
Amazon has a strong balance sheet of $58.6 billion in cash and short-term investments. The company has a high debt of $164 billion but “only” $4.5 billion of that debt is current, due within the next two years, and therefore manageable.
I have entered Amazon’s financial data into my discounted cash flow (“DCF”) form. I project annual revenue growth of 10% over the next 1 to 5 years. This is conservative given past growth rates of over 15%. I expect the cloud business to continue to grow at a rapid pace, and for Amazon to recover as consumer demand improves.
I also capitalized Amazon’s research and development expenses, which moved those expenses to the balance sheet and boosted net income. Over the next eight years, I expected operating margin to increase by 1%. This is somewhat conservative as the increase could easily be over 5%, as the company implements a series of cost saving programs. Additionally, I expect the inflationary effects to lessen over time as the Federal Reserve raises interest rates.
Looking at these financials and projections, I get a fair value of $184 per share. Amazon stock is trading at $89 per share at the time of writing and is therefore undervalued by 52%.
Amazon also trades with a price-to-sales ratio of = 1.8 which is almost 51% lower than its 5-year average.
Recession/high inflation environment
Many analysts expect a recession in 2023, due to high inflation and an increasing interest rate environment. This means that Amazon is likely to continue to experience rapid cost pressures and consumer demand is likely to wane.
Amazon is an iconic company and arguably one of the greatest businesses to ever exist. However, the company has fundamental problems with its completion center and cost structure. Its crown jewel is AWS, because that’s the fast-growing and highly profitable part of the business. I’d like to invest in AWS alone, and I’ve written previous posts urging Amazon to spin off this unit. However, if we had to invest in the entire company, it would be greatly undervalued right now. Things can get worse before they get better, but in the long run, Amazon is in a tremendous position.
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