- Amazon.com, Inc. sees continued, yet slower, revenue growth.
- This is accompanied by real margin pressure, certainly in the first half of 2022.
- Valuations have come down a great deal, but earnings have fallen at nearly the same pace.
- The appeal of Amazon is gradually improving, but it still feels a little too early to get involved.
Shares of Amazon.com, Inc. (NASDAQ:AMZN) cannot seem to catch a break, trading near their lows even as the market at large has seen a rebound as of late. My last take on the company goes back to May 2020, when I believed the valuation was hard to justify.
At the time, the world, including investors in Amazon.com, was grappling with the pandemic. This resulted in a boom in sales, but resulted in a lot of related costs as well, including worker safety measures, overruns, and higher wages.
Some Perspective – Back To The Outbreak Of The Pandemic
Amazon generated $280 billion in sales in 2019, on which it posted GAAP operating margins of around 5%. First quarter sales for 2020 grew 26% to $75 billion and while the situation was highly uncertain, net cash balances rose to $32 billion, or $63 per share. Growth, but notably margins, was driven by Amazon Web Services (“AWS”), and to a lesser extent the North American and international retail operations. That said, the latter segment was still posting losses, as they have been doing for years.
Based on the situation at the time, I believed it was fair to say that sales could rise 20% in 2020, translating into sales of $336 billion, as a similar 5% margin number could translate into operating earnings of $17 billion, yet pandemic-related measures made that number rather unlikely. Assuming it could be achieved under more normal circumstances, after-tax earnings could come in at $13 billion, equal to $25 per share.
While this looked solid in combination with a strong net cash balance, it translated into a sky-high valuation with shares trading at $1,700 at the time, down from a $2,500 number in April 2020. Besides valuations, there were concerns about worker safety, treatment, and even monopolistic behavior and consequential potential actions taken by regulatory bodies, or antitrust agencies.
Doing some modeling, and assuming 10-15% growth, I could see a route to $700 billion to a trillion in sales by 2030. If margins could rise to 10% and no change was seen in the share count, earnings could come in anywhere between $80 and $200 per share. A market multiple would translate into a valuation between $1,600 and $4,000, leaving little potential in my eyes, with shares already trading above the lower end of the range.
Where Are We Now?
With shares currently trading at $90, or $1,800 if we account for a 20-for-1 stock split, shares trade at $1,800 per share based on the old share price, virtually unchanged from May 2020. This is, of course, a bit too simplistic, as shares hit a high at $180 late last year, or $3,600 if we adjust for the stock split.
As it turned out, my 2020 projections were far too conservative, with sales of $386 billion coming in $50 billion ahead of the 20% growth assumption. Operating earnings rose to $23 billion, for very decent margins as interest income and low tax rates resulted in earnings of $42 per share.
Revenues rose in a convincing manner to $469 billion in 2021 with operating earnings increasing modestly to $25 billion, albeit that GAAP earnings rose much quicker due to one-time benefits. Net cash balances rose to $50 billion, about $100 per share, based on the old share tally, as signs looked good, but growth was slowing down towards the end of the year.
After-tax earnings could probably come in around $20 billion, or $40 per share (or $2 per share post the split) indicating that a high of $180 per share represented a nosebleed valuation at 90 times earnings, despite a net cash position equal to $5 per share.
2022 has become a tough year as growth was slowing down already, seen in the second half of 2021 already as well. First quarter sales rose by just 7% to $116 billion as operating earnings were more than cut in half amidst deleverage amidst slower growth. Slower growth and margin pressure were seen in the retail business, with AWS still thriving.
Second quarter sales rose another 7% to $121 billion with operating profits again more than cut in half, with a lot of deleverage coming from sales, marketing and general investments. Even the North American retail operations were posting losses now following an investment spree in combination with slower growth, despite being a solid profit contributor in recent years.
Third quarter sales growth accelerated to 15% with revenues coming in at $127 billion, despite a $5 billion headwind from a strong dollar. Operating earnings were cut in half, as the year-over-year profit declines were improving from the declines reported in the first half of the year.
With 10.3 billion shares trading at $90, the company commands a $927 billion equity valuation, amidst a flattish net cash position, mostly because of poor working capital conversion, large capital spending, and some initial buybacks.
The company called for fourth quarter revenues to rise at 5% by the midpoint of the guidance, including a massive headwind from the dollar, albeit that recent dollar weakness could leave a small upside surprise. Operating earnings are likely seen lower, but not that bad compared to the deleveraging seen so far this year. Amidst all this, full year sales are likely seen above the half a trillion mark, but operating earnings of $25 billion in 2021 should come in closer to $10 billion. This means that Amazon still trades around 90 times operating earnings, at 36 times if Amazon could post margins of $25 billion again, as it did last year.
The reality is that Amazon seems to be firmly on track to post sales between $700 million and a trillion dollars by 2030. If the business can double its 2021 operating margins to 10%, driven by profitability in the retail segment and a relative larger share of AWS, the potential is there.
In such a case, net earnings might come in between roughly $65 and $80 billion, or between $6.50 and $8.00 per share, as a 20 times multiple might work down to a fair valuation around $130-$160 at that point in time. This leaves a relatively modest upside over an 8-year time frame from a current valuation at $90 per share.
The reality is that these valuations are still quite high, but relative to Amazon’s past valuations they have come down, in part because of slower growth, but more so because 5% margins were cut more than in half this year, amidst slower growth than anticipated. This comes as Amazon is being hurt by a return of pandemic-related trends, the impact of inflation, and slower economic growth, with Amazon having overbuilt capacity, creating a tough setup.
The reality is that Amazon’s valuation is probably still a bit too rich, as I cannot compel myself to pull the buy trigger just yet.
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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