Amazon,
a fundamental analysis!
February 27, 2019
SHARE PRICE: $1627,6
MARKET CAP: $799,35B
1. INTRODUCTION
Amazon is the only FAANG stock left to be analysed here at All in Stocks. I’ve saved it for last because I suspect this isn’t an easy company to value. It is probably the single biggest disruptor I’ve seen in my lifetime. It seems there’s no industry it can’t get into without becoming one of its leading players. I’ll start this analysis by taking a look at their investor relations website.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
Jeff Bezos founded Amazon in 1994 as an online bookstore but he soon spread the business to other products and services like DVD’s, music, apparel, video streaming, online games, cloud services, etc. The company’s motto is “customer obsession” and whenever they see an opportunity to better serve customers on a new industry, they will go in.
“We seek to be Earth’s most customer-centric company.“, Amazon 10K
Although the company earns money in a lot of different ways, its core business has been online sales. As a retailer, it earns money by taking a small share of the selling price of all the products sold through its website.
2.2. LARGEST SHAREHOLDERS
With 16,1% of the total number of shares outstanding, Jeff Bezos, the founder, is still the main shareholder, and that 16,1% alone has made him the richest person in the world.
There is a great interview from 1999 with a young and nerdy Jeff Bezos where you can see the beginnings of it all. Here it is.
2.3. MANAGEMENT TEAM
Jeff is still in charge of the company, thankfully.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
Amazon’s IPO was back in 1997 at $1,5 (splits adjusted) and today’s stock price is $1.634,6. That’s 1089 times your initial investment or a 37,42% CAGR over 22 years, effectively making Jeff Besos one of the modern Outsiders (one of the best books I’ve read this year).
3.2. MARKET CAP AND SHARES OUTSTANDING
The company is valued at $803,8 billion right now, making it one of the most valuable companies in the US, alongside Microsoft, Google and Apple.
The number of shares outstanding has been growing at a CAGR of 2,9%, which I consider reasonable.
If we take a closer look at the market cap between 97 and 99, we can see that it multiplied by 17 times from $1,5B to $26,3B, and then it came back down to $4B in 2001.
The question an investor should ask himself (or herself) is “Would I be able to hold it through that 84% plunge?” I would like to think that I would, but the truth is I probably wouldn’t. But Jeff did, and look at him now.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
Amazon’s sales have been growing at a CAGR of 41% over the last 22 years, more or less in line with the stock price trajectory. In 2018 they had $233B in sales and consensus estimates are pointing to a record $376B in sales for 2021.
Until recently, Amazon pursued a strategy focused on growth and scale rather than profitability. Only now we’re seeing the profits showing up in a meaningful way.
In 2018 the operating income was $12 billion, up from $4 billion the prior year.
When looking at the sales figures and operating margin together, we can easily see how these guys have done it.
Unlike other retailers that take advantage of lower costs to improve their margins, Amazon lowers its prices whenever it lowers its costs. This is why there is so much “fear” when Amazon enters a new industry.
3.5. SALES BY GEOGRAPHY
The USA is Amazon’s largest market, having grown 33% in 2018 alone.
Sales from other countries grew 21% in 2018, and although the AWS (Amazon Web Service) isn’t a country per se, the company chooses to distinguish it as one. This “country” grew 47% last year.
But how profitable is each of these segments?
Although the cloud is the segment with the lowest revenue, it is the most profitable one. Because of its high margins (28,4%), it generated $7,3 billion in operating income whereas the e-commerce sales in the US generated $7,2 billion.
As we can also see from the chart below, the international operations are still losing money.
3.6. SALES BY SEGMENT
The retail business has grown at a 15,8% CAGR for the last 5 years to reach $123B in 2018.
To better understand the growth rates of each of these segments let’s look at the yellow column on the following table:
These rates are just astonishing. Remember that this isn’t the growth for the previous five years as a whole, but the compounded annual growth rate for each year.
And do you see the “other” segment on the bottom of the table? That is mostly advertising revenue there. It has grown more than 2 fold in 2018 alone. That’s something we’ve got to keep our eyes on in the future.
3.7. NET INCOME
In 2017 the net income was $3B and in 2018 it reached….
…. a record $10,1B!!! 3,3 times more.
And looking at the consensus estimates, it seems that they will be doubling that in 2 years time and almost tripling it in 3 years time!
Again, when looking at the net margin, we can see that Amazon hasn’t been worried about profitability.
These low margins are not a bug but a feature. This is already a famous line from Bezos:
"Your profit margin is my opportunity."
This means that he doesn’t mind losing money for many years while undermining the competition with prices they simply cannot match. And even if they can, the convenience of a well organized home delivery system across the USA (and increasingly, the world), is a major competitive advantage.
3.8. CASH FLOWS
So Amazon profited $10B in 2018, but how much cash did it really generate?
An impressive $17,3 billion dollars. Because of the high D&A charges that aren’t cash charges but just accounting ones, the FCF is usually higher than the net income.
3.8. PROFITABILITY RATIOS
Both return on equity and return on assets have been historically low because the company “chose” the strategy of delaying profits, so these aren’t helpful metrics this time.
3.9. FINANCIAL RATIOS
The company’s financial situation is pretty good with the debt to equity at 0,5 which is perfectly healthy, and although the current ratio at 1,1 suggests that this is a positive working capital business, if we take out the cash from the balance sheet, we see that, like most retailers, this is a negative working capital business.
3.10. PRICE RATIOS
Because of its strategy leading to depressed earnings, I don’t see the PE ratio as a helpful ratio. In fact, I’m not sure any ratio on its own will be helpful evaluating Amazon.
Anyway, I’ll leave it here. The forward 2019 PE ratio is 58!
Let’s look at the Price-to-FCF ratio too.
The P/FCF ratio for 2018 is at 47.
And while we’re at it, let’s take a look at the Price-to-sales ratio too.
The forward 2019 Price-to-Sales ratio is 2,9.
Let’s use Peter Lynch’s PEG ratio. Dividing the PE ratio by the expected net income growth of 41, we get to 1,41. According to Lynch, companies trading over 1 are overpriced.
So if we look at the traditional Price ratios, they all tell us that Amazon is overpriced by Mr. Market.
4. GAINING PERSPECTIVE
4.1. INDUSTRY AND STRATEGY
With 41% market share, Amazon is the undisputed king of e-commerce in the US and is also ramping up operations around the world.
But although e-commerce is their largest segment so far, there are a few other avenues for growth. Let’s take a look at a couple of them:
The first one, as we’ve seen before, is the cloud:
Amazon Web Services is the world leader in cloud computing and cloud storage way ahead of Microsoft and Google.
This industry is benefiting from major tailwinds right now, and there is a huge advantage in being the first mover.
When a company chooses a cloud provider, its staff has to learn how to use it and get used to it. After this training, if that company is satisfied with the service, it won’t change and go through the integration process all over again.
That’s one of the reasons for the 81B in revenue estimation for 2023.
Advertising: As stated on my previous analyses, advertising is a major source of revenue for Google ($116B) and Facebook ($55,8B). This is a high margin business and I think we can expect it to be a major growth driver for Amazon as well.
Amazon’s advantage over these two is that it knows what people buy and we can be sure that we are targeting adults with discretionary money to spend.
So for instance, if I want to sell my All in Stocks new Premium Membership, I can go to Amazon and set up an ad for people that bought, let’s say “One up on Wall Street” by Peter Lynch. I know these people are spending money to improve their knowledge about investing in the stock market. And that’s a big advantage right there.
Amazon doesn’t disclose its advertising revenue, but if we take into account that the digital advertising market is expected to reach more than $500B in 2023 and that Amazon’s 2019 US market share will be 8,8%, even if they don’t grow their market share, which is highly unlikely, their cut could be $44B.
And these are just the most obvious avenues for growth right now, but there are other profitable endeavours that can add up to this.
I’m talking about original content, pharmaceutical distribution, financial services, etc. When talking about Amazon, these can become huge in a blink of an eye.
4.2. SEASONALITY
Being a retailer, Amazon’s strongest quarter is the 4th quarter.
4.3. TYPE OF PLAY
Amazon is a growth stock.
4.4. RISKS AND COMPETITION
There isn’t a single big risk that the company faces. That’s one of the advantages of having a well diversified product mix (unlike Facebook). These are some of the risks I can think of right now:
Eroding margins as the AWS and advertising segments becomes more crowded.
Regulation.
Risk of execution.
5. OVERVIEW AND CONCLUSION
5.1. OVERVIEW
Amazon is definitely the most unique company I’ve ever came across, and valuing such a rapidly growing business isn’t easy. The company is engaged in so many battlefronts that it’s too hard to precisely predict the outcome of them all, let alone predict which new industries they’re getting into.
From a pure value investor’s point of view, I would disregard it the minute I saw its price ratios, but I won’t do that because the growth investor in me would be disappointed, so let’s try to do a quick and conservative sum of the parts (SOP) for the next 5 years:
E-commerce:
The US online sales have been growing at a 29% CAGR while the international sales have been growing at a 18% CAGR. Let’s say that these will grow at a 10% CAGR going forward and that both of them will reach a 5% operating margin. With no debt and a 21% income tax, that will lead to a combined net income of $10,5 billion, which at a conservative PE ratio of 15 should come to a $158 billion market cap.
Physical Stores:
I’m not sure how much this segment can grow so I’ll assume a 5% annual growth rate is reasonable for a company like Amazon. Revenues in 2023 will be around $22B and net income $870 million. At a PE ratio of 15, we get to a $13 billion market cap.
Advertising Business:
As we’ve seen previously, in 2023 their advertising revenue should be around $44 billion. This represents a 35% CAGR going forward while it is estimated that this segment grew 66% last year. At a 30% operating margin, and following the previous assumptions, this translates into an $11B net income. Multiply that by a PE of 25 (more or less in line with Facebook and Google) and we get to a $270 billion valuation.
Amazon Web Services:
AWS expected revenue for 2030 is $81B. At last quarter’s 31% operating margin, net income will be around $20B. If we apply a PE of 25 to that number, we get to a $496 billion valuation.
Subscription services:
These have been growing at a 50% CAGR, but let’s continue on the conservative side and say that they will grow at 25% annually, with operating margin around 20%. At a PE ratio of 25, we come to a $171 billion market cap.
Net Cash:
We should add to our estimation the net cash that the company has on its balance sheet. This is now $23 billion.
All of this combined gives us a $1.13 trillion market cap representing a 7% CAGR from today’s valuation.
Readers might argue that I’ve been way too conservative and that the growth prospects are much higher or that this is the greatest company ever. Guess what. All of that might be true. It wouldn’t surprise me if the company could do much better than what I’ve just projected. With Amazon, who knows?
But with the current stock price already factoring in most of that projected growth, I don’t see a clear and big margin of safety here.
5.2. CONCLUSION
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