Amazon: Seize The 15% Margin Of Safety

Summary:

• A recent sell-off presents a buying opportunity for AMZN stock.
• The Company’s strong competitive moat and diverse business model support long-term success.
• Valuation analysis suggests Amazon is undervalued, offering a decent entry point for investors.

Investment Thesis

I am bullish on Amazon.com, Inc. (NASDAQ:AMZN) (NEOE:AMZN:CA) and rate it a buy following the recent sell-off, which I believe offers a decent entry point. On June 30th, I published an article where I recommended a hold decision because the stock was trading around a major pivot point. Since then and following the selloff that just happened, the stock has dipped 15.56% since my last coverage, something I believe offers a buy opportunity.

My long-term optimism following my buy recommendation stems from the company’s MOAT, which, I believe, will sustain the company’s long-term success and competitiveness.

Notable Sell-Off Amid Broader Market Tumble

Growing concerns about a faltering economy have caused a substantial market sell-off for Amazon recently. A 15%+ decline in the company’s shares is indicative of investor apprehension over lower-than-expected sales projections. This decline is part of a larger market downturn that has hit major indices. The Dow Jones Industrial Average fell 1,033.99 points, or 2.60%, to 38,703.27 on Monday, the greatest point and percentage loss since September 13, 2022, according to Dow Jones Market Data. The index has lost 2,139.52 points, or 5.2%, in the last three trading days, its largest three-day percentage drop since June 14, 2022. The S&P 500 lost 160.23 points (3%), finishing at 5,186.33, its worst point and percentage drop since September 13, 2022. The index has fallen 335.97 points, or 6.1%, in the last three trading days, the worst percentage drop since June 14, 2022. Further, the Nasdaq Composite dropped 576.08 points, (3.4%), to settle at 16,200.08. It has dropped 1,399.32 points, or 8%, in the last three trading days, its highest three-day percentage drop since June 13, 2022.

This phenomenon is largely due to economic uncertainty, among other factors. The global economy is confronting challenges, including increased living costs and the possibility of a recession. These concerns are weighing on consumer confidence and purchasing power. While this is a broader picture, AMZN has micro factors that also contributed to its current stock decline. A Major reason is its mixed Q2 2024 performance, released on August 2nd. It recorded $1.26 EPS, a significant rise from the previous year’s $0.65. On the other side, its sales totaled $148 billion, $760 million less than expected. Furthermore, its guidance indicated slightly lower sales, with a range of $154-158.5B compared to this quarter’s estimated midpoint of about $158.43. In my view, this mixed performance and lower guidance instilled a cautious approach in some investors, which led to the current sell-off in a bid to close some profits amid the uncertain economic outlook.

Despite these concerns, Amazon’s diverse business model, including its cloud computing and advertising units, continues to give some stability, which, I believe, makes the current scenario a buying opportunity rather than a cause for concern. In the MRQ, operating income for AWS was $9.3 billion, up $4 billion from the previous year.

With a 19% AWS sales growth, it appears that what had been a dipping trend in AWS revenue has now stabilized, since this was the third successive quarter without a revenue decline in the AWS segment. In the advertising sector, which in my previous coverage, I referred to as the new growth powerhouse; Amazon reported revenue growth of over $2 billion year over year and revenue generation of over $50 billion over the preceding 12 months.

Given the current double-digit price decline and considering its stable and diverse business model as exhibited by these two key growth centers, I believe the recent dip offers a buying opportunity.

Amazon’s MOAT: Secured Long-term Competitiveness And Success

AMZ possesses a strong competitive moat, which can be attributable to many main factors. To begin with are its network effects. Its extensive client base draws a great number of sellers, who in turn attract more customers. It is one of the biggest and most well-liked e-commerce platforms in terms of both vendors and customers, with over 310 million active users and 9.7 million sellers. This virtuous loop increases the platform’s value for consumers and sellers, making it challenging for competitors to replicate. By providing a greater range of products, it may leverage its substantial seller base and enhance sales and client acquisition by broadening its product offering. In the US alone, Amazon sold more than 4.5 billion individual products in 2023. In the MRQ, its revenue grew by 10.12% to $147.98 billion, solidifying the advantage the company draws from its network effect.

The second factor making up Amazon’s moat is its cost advantages. Due to its size, it can generate notable cost savings. It can save operating costs by investing in technology, maximizing logistics, and negotiating better terms with suppliers. Lower prices are one way that these savings are transferred to the clientele. Amazon offers an average of 16% lower prices than competitors. Compared to its peers BABA and PDD, AMZN has the lowest cost as a percentage of revenue at 9.2% with BABA at 24.6% and PDD at 35.7%. It is indeed beyond doubt that this company has a massive cost advantage.

The other factor is its intangible assets. Amazon’s brand is among the most known and trusted in the world. Its reputation for customer service, innovation, and dependability adds considerable value. The company ranks fourth in the most valuable brands in 2024 being the only one among its peers to make up the top 10 list.

Lastly is its AWS leadership. Amazon Web Services [AWS] is a leader in the cloud computing industry. It has been maintaining its cloud market share at about 30% since 2017 without major fluctuations, speaking volumes about its consistency, customer loyalty, and competitiveness in the market.

AWS’s enormous infrastructure, diverse service offerings, and ongoing innovation create a significant competitive advantage. The high switching costs associated with migrating cloud services help to strengthen AWS’s position. The advantages of being a Prime member, such as free shipping, access to streaming services, and special discounts, discourage users from switching to other platforms. This strong market position enables AWS to set industry standards while also attracting a diverse spectrum of customers, from startups to major organizations.

These factors combine to form a large and lasting moat for Amazon. The network effects assure a steady stream of buyers and sellers, increasing the platform’s supremacy. Cost benefits enable Amazon to offer competitive prices, attracting price-sensitive customers. High switching costs encourage customer loyalty and lower turnover, especially when accessed through Prime. Customer trust and engagement are increased by intangible assets like technological prowess and brand reputation. Ultimately, AWS’s dominance in cloud computing keeps Amazon in a high-margin, high-growth sector.

Generally, Amazon’s moat is built on a combination of scale, innovation, customer loyalty, and strategic market positioning, making it a formidable player in both e-commerce and cloud computing.

Valuation

To value this stock, I used a DCF model. With the company’s diverse revenue stream and strong cash flow generation, I believe this valuation method suits AMZN. To mitigate the model’s main flaw – it is overly reliant on assumptions – I used conservative growth rates and fixed the discount rate at WACC. Opportunity cost and risk accounting are both included in the WACC, since it takes into consideration the risk related to its capital structure.

In light of this justification, I used a cautious growth rate of 25%, compared to a 10-year free cash flow CAGR of 46.77% and a forward operating cash flow growth rate of 45.58%. My terminal growth rate was 10% more than the 25% growth rate. My discount rate was the company’s WACC, which is 8.3.

Given the above assumptions and adopting the trailing FCF/share of $4.66 as the base case, I arrived at a fair price of $187.19 translating to a 15% margin of safety. Given this undervaluation, I believe AMZN’s current valuation offers a decent entry point.

Risk

Aside from the economic instability risk, which, I feel, is lessened by Amazon’s broad business model and competitive price; I consider its reliance on third-party sellers as a significant risk. As of Q2 2024, 61% of its sales originate from third-party sellers.

While this approach has considerably boosted the company’s development and income, it also brings some concerns. First off, with millions of third-party sellers, ensuring consistent product quality and customer service can be difficult. Poor encounters with third-party sellers might hurt Amazon’s reputation and customer trust.

Again, Amazon’s partnership with third-party sellers has drawn regulatory scrutiny. Counterfeit goods, unfair competition practices, and compliance with local laws may result in legal challenges and fines, potentially hurting its reputation.

Conclusion

In conclusion, Amazon’s diverse and resilient business model, which includes e-commerce, cloud computing, and digital advertising, makes it an appealing investment option. Despite recent market volatility, the company’s basic strengths – such as AWS’s resiliency, the thriving advertising industry, and the unequaled customer loyalty program – demonstrate its long-term viability. AMZN offers a compelling opportunity for investors seeking stability and growth in their portfolios, with a 15% margin of safety after recent sell-offs. Consequently, I rate the stock a buy.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

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