Amazon.com - Research Report Part 3
Is Amazon.com an interesting investment?
“To be Earth's most customer-centric company, where customers can find and discover anything they might want to buy online.”
This research report is divided into three sections. This is Part 3 of 3. In this segment, we will explore:
Financials
Income statement
Cash flow statement
Balance sheet
KPI’s
The valuation
Scenario analysis
Conclusion
Conclusion on Amazon.com
5) Financials
5.1 Income Statement
The revenue growth trajectory of Amazon, depicted in Figure A, highlights a significant rise from $89 billion in FY 2014 to $575 billion in FY 2023, with an average annual growth rate of 22.1%. The year 2020 saw an acceleration in growth due to the COVID-19 pandemic. However, this acceleration was not sustainable, leading to a slowdown in 2022 before growth picked up again in 2023.
Given the integral role of AWS (Amazon Web Services) in Amazon's overall success, understanding AWS's performance is crucial. The scale of the graph might present a slightly distorted picture. Between 2014 and 2022, AWS consistently grew at an annual rate of over 30%. In 2023, for the first time, AWS did not achieve this growth rate, slowing down to 13.3%. This deceleration is attributed partly to AWS's expanding scale and partly to spending cuts in the tech sector. Another logical reason for this slowdown could be market share gains by Microsoft Azure. Although Figure B of the analysis indicates Azure's market share growth, it doesn't necessarily come at AWS's expense. However, AWS might have had the opportunity to capture this market share as well. The distribution of market shares among cloud service providers suggests that AWS, Microsoft Azure, and Google Cloud are increasingly dominating the cloud market as an oligopoly.
In 2023, Amazon's total operational expenditures amounted to $538 billion. Figure C delineates the distribution of Amazon's expenditures.
This cost structure yielded an operational margin of 6.4% in 2023. Figure D illustrates the evolution of Amazon's operational margins over recent years.
In 2017, Amazon reported an operational profit of $3 billion, which surged to $24.9 billion by 2021, marking a 720% increase primarily attributed to AWS, which itself saw a 328% increase in operational profit during this period. Without AWS, Amazon's profitability would have been significantly lower. The e-commerce segment of Amazon experienced notable challenges in 2022, but 2023 was characterized by a strong comeback in terms of profitability. Significant cost savings and robust growth in Amazon's highly profitable advertising segment were the driving forces behind this doubling of operational profitability in 2021. 2023 stood out as a year where Amazon flexed its financial muscles, demonstrating how to monetize a platform with 2.7 billion monthly visitors.
Investors, including myself, are often surprised by the rapid growth of the advertising segment. In hindsight, considering the dominance of platforms like Google, Meta, and traditional media in the past, Amazon's success in generating substantial revenue from advertisements seems logical. The entity with the largest user base wields significant power, including the ability to charge advertisers premium rates to reach these users. Thus, the number of users on Amazon and the volume of spending on the platform are critically important. Investors in Meta experienced this firsthand, as the company's stock price took a significant hit in 2022 when user numbers declined.
Shares outstanding. As of 2018, Amazon had 10,000 outstanding shares. This number has increased to 10,492 shares today. Therefore, there has been a share dilution of 4.92% over the past five years.
This dilution affects shareholders in a couple of key ways:
Ownership percentage decreases.
Potential impact on Earnings Per Share (EPS).
In Amazon's scenario, the 4.92% increase in outstanding shares over five years is relatively modest, especially for a company actively investing in growth and expansion. Amazon has historically reinvested its earnings into new ventures, technology, infrastructure, and acquisitions, driving its expansion into new markets and sectors beyond its core e-commerce business.
While existing shareholders may experience a temporary dilution of their ownership percentage, the key is to assess whether such dilution is a strategic move that could lead to greater company value and, consequently, shareholder value in the long run. Given Amazon's track record of successful reinvestment and expansion, the possibility of future growth may very well justify the dilution.
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5.2 Cash Flow Statement
Table 2 highlights that Amazon's free cash flow was negative in 2021 and 2022, primarily due to substantial investments in data centers and distribution networks. However, in 2023, Amazon demonstrated its capability as a free cash flow generator. Amazon does not pay dividends and engages in relatively few share buybacks, indicating that a significant portion of its free cash flow is reinvested into the company.
5.3 Balance Sheet
Currently (Q1 2024), Amazon holds $73.4 billion in cash and faces $58.3 billion in debt. Of this debt, $27.9 billion is due by 2029. Given Amazon's cash position of $73.4 billion and a debt-to-EBITDA ratio of 1.55, the company should easily manage its debt obligations.
5.4 Key Performance Indicators (KPIs)
Monthly Active Users
The e-commerce platform of Amazon benefits from a clear network effect. A significant decrease in the number of users could collapse this network effect, making the user count crucial for a successful investment in Amazon.
Revenue Growth and Profitability in E-Commerce Segment
While a high number of users is valuable, the essential metric is how much money users spend on Amazon. It's crucial that this revenue can ultimately be converted into profits.
Revenue Growth and Profitability of AWS
Investing in Amazon solely for its e-commerce platform may lead to overvaluation. For an investment in Amazon to be successful, the success of AWS is essential. Pay close attention to AWS's revenue and profitability to keep track of this success. Additionally, AWS's market share and technological lead are critically important.
6) The Valuation
Amazon's valuation is challenging due to its various segments with varying profit margins. The analysis involves a scenario analysis for AWS, North America, and international segments. Amazon's profitability is distorted due to management's decision to operate with minimal profitability. However, a less precise valuation is better than drawing conclusions based on incorrect methods. Many investors value Amazon based on its price-to-earnings ratio, despite Amazon's clear intention to reinvest profits into customer satisfaction.
6.1 Scenario Analysis | North America
Figure 1 shows the revenue and revenue growth for the NA segment. Revenue growth was 12% in 2022 and 11% in 2023. Given the strong moat of the North America segment, the trend from physical sales to e-commerce, and the rapidly growing advertising and third-party seller segments, it is reasonable to assume that the North America segment will grow by an average of 10% per year over the next five years.
Table 1 shows that the North America segment had an operational margin of:
5.1% in 2018;
4.1% in 2019;
3.7% in 2020 and
4.2% in 2023.
The years ‘18, ‘19, '20, and ‘22 were when Amazon invested heavily in distribution centers and logistics. As a result, Amazon has demonstrated the ability to maintain operational margins of 4-5% and that its investments are profitable. As a result, the scenario analysis for North America forecasts a 4.5% operational margin in 2028. Of course, there is a chance that this margin could be higher.
6.2 Scenario Analysis: International
Figure 2 depicts the revenue and growth of Amazon's international segment. In contrast to the North American segment, the international segment's revenue increased in 2023. However, the slowdown in revenue for the international segment was greater, making it easier to resume growth. Table 2 shows that revenue growth in Germany, the United Kingdom, and Japan has stagnated, similar to the North American segment, at around 10%.
The rest of the world accounts for the vast majority of revenue. This portion of the revenue appears to have the potential to increase even further in the coming years. However, it is unclear how profitable this revenue is. In Table 1, we discovered that the international segment has never been profitable.
In Germany, Amazon holds a market share of 53.6%, while in Great Britain it is around 27.5%, and in Japan it is about 22.5%. Amazon holds approximately 38% of the market share in the US. Assuming Amazon continues its dominance in these markets, we assume a 3% operational profit margin by 2028. In this scenario analysis, it is assumed that the operational profit margin in the rest of the world is 0%.
The combined revenue of Germany, Great Britain, and Japan in 2023 amounted to $97.2 billion. We multiply the number by 10% for the following 5 years. In 2028, the revenue is projected to reach $156.5 billion. We expect a profit margin of 3%. The operational profit for North America is projected to reach $4.7 billion in 2028.
6.3 Scenario Analysis | Amazon Web Services (AWS)
Figure 3 shows AWS's revenue and growth. In 2023, its growth rate was 13.3%, the first time it grew by less than 25%. Despite being slow, AWS's growth started to pick up slightly, from 12.2% in Q2 2023 to 13.3% in Q4 2023. The growth of AWS over the last two years has been closely tied to the tech sector's economy, showing that its growth doesn't quickly bounce back when the economy does. Also, AWS's growth began slowing down even before 2021.
Given the cloud market's predicted growth from $650 billion to $1,500 billion by 2030 (a 12.7% annual growth rate), and considering the factors mentioned before, it's realistic to expect AWS to maintain at least a 13% annual growth rate for the next five years. Table 1 shows AWS's operational margin has varied between 26% and 30% in the last six years, making a 28% operational margin in 2028 a sensible estimate.
Based on a 13% annual growth rate over the next 5 years, AWS's revenue in 2028 would be approximately $167,214 million. With an operational profit margin of 28%, the operational profit for AWS in 2028 would be about $46,820 million.
6.4 The Valuation
When adding up the expected operational profits for 2028 from the North America, International, and AWS segments, the total operational profit is estimated to be $77.1 billion. Assuming the stock price follows the profit, this suggests an annual return of 16.1% over the next five years.
However, this does not account for a lower operational profit multiple. As of 2024, Amazon is trading at about 49 times its operational profit. There's a real possibility that Amazon could trade at a lower multiple in 2028 due to likely lower growth expectations by that time. Table 3 shows the annual returns associated with different profit multiples.
Table 3 assumes that Amazon's operational profit in 2028 will be $77.1 billion. However, there's also a chance that the operational profit could be significantly higher. For example, Amazon's capital investments were $48.1 billion in 2023, up from $12.7 billion in 2019. It's possible that these capital investments will decrease by 2028, which would benefit the profit. Additionally, there's a case to be made that operational profit margins in the North America segment could exceed 4.5% due to Prime, third-party seller services, and ads.
If Amazon has significantly fewer users in 2028 or if AWS loses a large portion of its market share, this valuation could be almost negligible. It's crucial to realize that Amazon has many moving parts, each capable of exponential growth or rapid contraction. This makes valuing Amazon very challenging, but ignoring its valuation is unwise. Hopefully, this analysis provides a clearer understanding of Amazon's worth.
7) Conclusion
Innovation, innovation, innovation. That's the essence of Amazon. The company's culture is defined by customer obsession, a long-term focus, operational excellence, and, of course, innovation. Jeff Bezos's vision has always been to become the largest and most dominant company by leveraging megatrends, with the internet being the first and most significant one he capitalized on.
Today, Amazon earns 40% of its revenue from online stores, 24% from third-party sellers on these platforms, 16% from AWS (Amazon Web Services), 8% from advertising, 7% from subscriptions, and 3% from physical stores. These segments are fortified by a deep moat, with shared-scale economies being Amazon's key competitive advantage. Amazon creates a network effect to achieve scale economies, which are then passed on to customers in the form of lower prices and better customer experiences. Key risks for investors to monitor include changes in consumer behavior, Microsoft Azure, regulation, and competition.
The management team is heavily invested in the company's success, with their compensation tied to a single performance metric: the stock price. This approach encourages innovation and aligns management's interests with those of the shareholders.
Financially, Amazon is strong, with revenue growing by at least 10% per year, a free cash flow of $36 billion in 2023, and a manageable debt position. Despite the complexity of Amazon's business making it difficult to value, the company appears attractively valued when performing scenario analysis on the North America, International, and AWS segments. If the operational profit multiple drops from 49 to 35 over the next five years, an annual return of 8.6% is expected for the next five years.
7.1 Score
What is this score for? The score aims to quantify the analysis and express it in a number. Of course, a company is not just a 'number,' but by assigning scores to the different parts of the analysis, we want to show that all components together tell a story. The higher the scores, the more interesting the company is likely to be.
What does each number mean?
0-4: Poor, below average.
4-6: Fair, not great.
6-8: Average.
8-9: Good, above average.
9+: Excellent, outstanding.
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