One of those stocks, Amazon (NASDAQ:AMZN), which, despite the pandemic’s acceleration of e-commerce and cloud computing growth, is currently seeing its stock price trade at or below pre-pandemic levels. Investors appear to have focused exclusively on Amazon Web Services after high investment and inflation caused a decline in e-commerce margins (AWS). Yet Amazon stock price suffered when the business issued guidance for a sharp slowdown in AWS growth rates. Wall Street has an overly pessimistic view of AWS’s long-term growth potential and places little value on the company’s arguably more significant retail business, especially given signs that the company is placing more emphasis on profit margins.
Amazon Stock Price
Amid a general decline in tech stocks, Amazon’s stock price has dropped to levels comparable to those of 2018. Even though the stock may have been overvalued in 2018, the business’s revenue base has increased by 120% since then. Operational income is still at the same levels as it was in 2018, which can contribute to the negative outlook for Amazon stock.
In an article published in January, I talked about how I remained confident in the stock despite the pessimistic expectations built into the stock price. Since then, the stock has increased by 16%, most likely as a result of a recovery in the larger tech industry. I still believe that Amazon has excellent potential for multiple expansions in addition to the potential for accelerating growth rates as the economy stabilizes.
Key Metrics for Amazon Stock
With net sales of $149.2 billion, or 9% year-over-year growth (the business had previously forecast revenue between $140.0 billion and $148.0 billion), AMZN recently delivered a modest revenue beat.
Operating income was $2.7 billion, in line with the forecast of $0 to $4 billion.
On the conference call, management stated that operating income would have been $2.7 billion greater if “employee severance, impairments of property and equipment and operating leases, and changes in assumptions linked to self-insurance obligations” had not occurred. The international division of AMZN posted its worst results, with revenues falling 8% year over year while rising 5% year over year on a constant currency basis.
The results in AWS, which disappointed with only 20% YOY sales growth and 5.5% operating margin compression, I believe caught the attention of the majority of investors.
The management noted specific areas of difficulty brought on by the environment of rising interest rates, particularly in industries like financial services and mortgage firms. However, the leading cause of the slowdown appears to be “optimization efforts” by their clients, who want to spend less on cloud computing, with Amazon probably bending on pricing. The management predicts that these challenges will continue for “at least the next couple of quarters.” AWS growth was in the “mid-teens” in the first month of the next quarter, according to management, signaling that growth rates had further slowed down. I still believe that this slowdown is short-term in nature and caused by the macroenvironment. With “90% to 95% of worldwide IT spend still on-premises,” according to management, the move to cloud computing has a very long growth runway.
In contrast to its $67.2 billion in debt, Amazon concluded the quarter with $66.3 billion in cash and $3.7 billion in equity investments, the majority of which came from its investment in EV manufacturer Rivian (NASDAQ:RIVN). I consider this balance sheet position to be extremely strong given that Amazon can potentially support significant leverage over time.
Management anticipates sales growth of up to 8% to $126 billion in the first quarter of 2023, which includes an anticipated 210 basis point negative impact from foreign exchange rates. Once more, management anticipates operating income to range between $0 and $4 billion.
Although the low-profit margins may displease some investors, it’s vital to remember that the company has been actively expanding its e-commerce infrastructure. In order to increase their capacity to provide 2-day or even 1-day shipping speeds, AMZN has been pushing the envelope in terms of shipping speeds, doubling the size of their fulfillment centers in just a few years. Regarding increasing retail margins, management expressed optimism, saying that they “made good headway in 2022” and “expect to make big improvements in 2023.” After the previous 18,000 layoffs in January, the corporation has announced additional 9,000 layoffs since the end of the quarter. Investors might be underestimating the mega-cap tech giant’s capacity to use cost reduction to overcome top-line difficulties.
Should I Buy, Sell, or Hold Amazon Stock?
Because Amazon stock appears to consistently trade at high P/E ratios, it might be confusing for value investors. Even with reliable consensus projections, it takes many years before the stock appears to be undervalued.
But as I have previously mentioned, it is important to take into account the likelihood that Amazon is overspending on its products. By placing value on Amazon Web Services before the retail operation, we can determine the stock’s fair market value. TTM’s operating income for AWS was $22.8 billion. If that is evaluated at 50 times earnings, it has a value of $1 trillion. Assuming 20% revenue growth and greater earnings growth because of operating leverage, that valuation seems acceptable. As an alternative, I could envision AWS being valued at 12 times sales, or $1.03 trillion, based on 20% annual revenue growth, 40% long-term net margins, and a 1.5x price-to-earnings-growth ratio (‘PEG ratio’). The retail industry generated TTM revenues of $433.9 billion.
Amazon generated a 3.6% operating margin in North America in 2020, but the retail industry was not profitable globally or in either North America or other regions. I anticipate that over time, as Amazon reaps the rewards of its decades-long investments in logistical infrastructure, it will create margins that are significantly higher than that. Yet even with only a 3.6% operating margin (7% or greater is my best guess), that would result in earnings of almost $15.6 billion. Given that this industry generates a significant amount of subscription and advertising revenues, it might be argued that it merits a higher multiple than companies like Target (NYSE:TGT) or Walmart (NYSE:WMT). But, by using a similar 20x earnings multiple, we arrive at a value of $312 billion. We arrive at a fair value of about $125 per share by adding these up.
I consider the assumptions and multiples I used in this estimate to be conservative, so I wouldn’t be shocked if Amazon exceeded those profit projections in the future, along with its stock price. The most recent round of layoffs mentioned above may serve as a helpful reminder to investors that this company is still committed to generating strong margins over the long term. It may also be able to demonstrate an unusual ability to accelerate that margin expansion despite a challenging macro environment.
What are the main dangers? Due to the macro environment, AMZN can have significant short-term difficulties. Due to difficult pandemic comparables and recessionary fears, the company’s growth in its retail business has already slowed, and now AWS is also displaying overt signs of difficulty. The aforementioned “cloud optimization efforts” by consumers may prove to be more long-term in character or be an indication of pricing competition. However, it’s likely that long-term growth rates are far lower than widely expected; perhaps AMZN is already too huge. I can see Amazon calming investors with margin improvements that should help lead to multiple expansions, even though the company might not demonstrate accelerating top-line growth until the broader economy improves.
It bears repeating that it would be very impressive if AMZN could improve margins despite the challenging macroeconomic environment. If management is successful in realizing these goals, I anticipate that the stock will experience significant multiple expansions in the long run. As one waits for a broader tech recovery, AMZN remains a top selection in the portfolio. I repeat my buy recommendation.
Featured Image: Unsplash @ Piotr Cichosz
