Investment Thesis
Amazon (AMZN) continues to defy expectations, remains a high growth machine, utterly focused over the customer, and is cheaply valued.
I make the argument that AWS is not the driver of the real story here and that Amazon’s retail segments are the reason why Amazon should continue to see its shares migrating higher with time.
Amazon trades for just under 5x sales, which is not an exuberant valuation.
Ultimately, this stock is worth considering. Here’s why:
Ingrained in Our Lives
Last week, I highlighted Amazon’s stock as a highly compelling investment given the fact that its retail operations are now so ingrained in our lives that shopping on its platform has become a habit too difficult to be broken. It’s on this vein that I’ll elaborate now.
Source: author’s calculations, **mid-point company guidance
Two attributes should stick out in the graphic above.
Firstly, Amazon is still reporting and guiding for rapid growth rates. There are many smaller cloud stocks that would die to report these sorts of figures. To me, it’s astonishing that still now, to be writing that Amazon is a growth machine.
Secondly, and an even more surreal attribute of the above graphic is that 2020 is reporting even faster growth than 2019. How is that even possible? Surely, back in 2019, the economy was so much stronger than it is in 2020?
Every other day we hear economic predictions of where the economy is going, but in practice, Amazon’s results do not appear to reflect the underlying economic landscape.
Prime, Seriously Sticky
We know that Amazon’s Prime members order more frequently with larger basket sizes. Accordingly, Prime members are very attractive to Amazon’s platform. During Q2 2020 we saw this theme repeating once again.
For its part, it makes a lot of sense for Amazon to continue to invest heavily in Amazon Video and to even go against the likes of Netflix (NFLX).
Prime Video is a perk that keeps users engaged with the platform and gives a reason for customers to become Prime members. During shelter-in-place, worldwide streaming video hours doubled y/y driven largely by Prime Video.
Hence, it should be no coincidence that as streaming hours increased during Q2 2020, that renewal rates improved and Prime member growth rates accelerated too.
AWS: Cash Stream
In my article last week, before earnings came out I used the graphic below:
Source: author’s work
In that article, I wrote,
Accordingly, even the most bullish Amazon analyst will have to come to terms this week that Amazon’s AWS would in the best case also be marked by a level of deceleration.
I estimated that Amazon’s AWS would be slowing down to 30% y/y growth rates — and since I was spot on in my estimate, I’m patting myself on the back.
I assumed that given the level of competition in the cloud space, together with Microsoft’s (MSFT) Azure numbers the week before the article, that 30% growth rates for AWS were a reasonable estimate.
For my Amazon bullish thesis to provide strong returns to shareholders I’m assuming that AWS continues to slow down in Q3, but that AWS continues to provide strong free cash flow to Amazon’s retail operations.
Put another way, AWS continues to subsidize Amazon’s retail operations.
Indeed, the reason why I believe that Amazon is still undervalued is predominantly driven by Amazon’s bright prospects in its retail operations.
Future Prospects Remain Bright
Looking ahead, Amazon doesn’t appear to be slowing down any time soon.
Several insights percolated during the earnings call. Personally, I considered the most striking attribute being that Amazon is retaining the 125K temporary employees and making them regular full-time positions. That speaks for itself. While so many companies are having to furlough their staff, Amazon is hiring and hiring.
Moreover, Amazon noted that as 2020 progresses Amazon deems it necessary to ramp up its facilities further, adding significant fulfillment center and transportation capacity to meet demand.
During 2019, network square footage increased by approximately 15% y/y. Presently, for 2020, Amazon expects square footage growth to increase by 50% y/y.
Consequently, even the most bearish investor would have to agree that valuation aside, Amazon is a high growth machine.
Despite Its Size, It’s Still Undervalued
It’s easy to get highly emotional when considering Amazon as its so ubiquitous to our daily lives.
Surely being one of the most followed companies, at close to $2 trillion market cap, it can’t surely keep growing? It has to be dramatically overvalued?
Realistically, I felt the same earlier in 2020. But the obliterating period of March-April taught me a very valuable lesson. Great companies don’t go on sale for long. And cheap companies can go on cheaper for much longer than one can remain rational.
Source: author’s calculations
At the most superficial level, Amazon trades at close to 5x sales. And truthfully, investors have very little clue as to how Amazon’s profit margins will ultimately transpire.
What we do know is that Amazon is annihilating the retail landscape and is showing no signs of slowing down. Even though Amazon has more serious competition right now than it has had for a while, for example from Shopify (SHOP), we also have to bear in mind just how far ahead Amazon is from the rest of the competition.
What’s more, as Warren Buffett exclaims, companies with positive consumer mindshare will see this reflected in their share price.
Consequently, even though I’m not able to give a hard number to just how valuable Amazon could be, I know that it’s not overvalued right now, even while it makes its way eerily close to the $2 trillion market cap mark, having just recently crossed the $1 trillion mark.
The Bottom Line
Amazon is a high-quality company that is growing at a breakneck speed. Not only is it showing no signs of slowing down, but it continues to positively impress all stakeholders and customers.
Whether you are invested in Amazon or not, as an investor you simply have to smile at Amazon. They have achieved more than anyone could have ever thought possible.
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Disclosure: I am/we are long AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.