In addition to its e-commerce dominance, Amazon.com Inc. (AMZN, Financial) leads in one of the most important segments today, the cloud. Not only that, but the company also operates in several other sectors in a complementary way, such as advertising, services and streaming. This shows us that Bezos' vision to set up an “everything store” has worked in recent years.
This constant innovation, combined with the prospects of profitability, presents an attractive picture for long-term investors.
Although Amazon's share price may not be a great bargain currently, it is important to understand it in depth, as a superficial price-earnings analysis can lead to misunderstandings that the stock is grossly underpriced, which is not the case.
When we evaluate its long-term growth prospects, through triggers such as margin gains, capital expenditure decreases and a series of growth paths, we have a company that, even with an extraordinary market cap, can continue to be a compounding machine and a good addition to a portfolio.
Great prospects ahead: Growth and profitability
This diversification is directly reflected in Amazon's financials. Of course, most of the revenue is related to e-commerce, but even this is divided between online stores (more representative), third-party seller services and physical stores. Away from this part, which has a more compressed margin, we have AWS (which, although not the largest source of revenue, is by far the largest source of operating income), as well as some optionalities and complementary revenues, such as subscriptions and advertising.
While consolidated revenue from North America grew by close to 12% in the first quarter of 2024, third-party services revenue advanced by 16%, with an increase in the adoption of optional services, such as fulfillment, global logistics and the like. In the earnings call, it was also mentioned that more than 100,000 partners are already using generative artificial intelligence tools offered by Amazon.
Overall, retail is doing well and even though it is already very advanced, Amazon is showing it is possible to go further. In the first quarter, the company showed the fastest speeds ever in delivery, increasing this speed in other regions beyond the U.S. Not only that, but it is also building partnerships to include new brands to continue growing with new audiences.
But for me, the real efficiency gains must come through robotics and automation, which although the company has mentioned “will take time,” it has a solid plan that includes standardizing processes and moving forward with robotics. I believe the maturing of these initiatives means margins in the pipeline and a more controlled capital expenditure. In other words, a huge amount of value generation for shareholders.
In the first quarter of 2023, the North America segment's consolidated operating income margin was 1.20%, while International came in at -4% and AWS recorded 24%. These margins rose to 5.80%, 2.80% and 37% in the first quarter of 2024. In International alone, which is less representative, this evolution meant an increase of $2.10 billion in operating income.
In the U.S., Amazon is the clear market share leader in e-commerce and still has prospects to continue growing by continuing to consolidate the market and exploring new avenues. But that's not the case for the International business as in several regions the company has room to capture and consolidate even more. In Europe, for example, its market share is 13% of the continent's 20 largest online stores. Therefore, I believe in this vertical, Amazon has room for a more aggressive compound annual growth rate, along with an improvement in margin (narrowing the gap between North American and International margins). Again, this means greater cash generation.
The outlook for AWS (which is also the market share leader in cloud) is also very positive. The company tends to benefit from AI momentum, which in the first quarter has already shown through good growth in generative AI and non-generative AI workloads in a number of industries. According to Grand View Research, the cloud computing market is expected to grow at a CAGR of 21% between 2024 and 2030, driven by factors such as adoption across various industries and increased use of technologies such as AI and machine learning. As the market leader, this growth will be driven by AWS. On the other hand, the robust margin of this segment cannot be perpetuated, as mentioned by Amazon Chief Financial Officer Brian Olsavsky:
“[...] we expect the AWS operating margins to fluctuate, driven in part by the level of investments we are making in the business. We remain focused on driving efficiencies across the business, which enables us to invest to support the strong growth we're seeing in AWS, including generative AI [...]”
As Olsavsky also mentioned, sustaining AWS's growth also requires an increase in capex (which is why it expects a slight increase in 2024). This, as already mentioned, is a crucial factor for the thesis and future value generation. To give you an idea, Amazon delivered cash from operations of approximately $19 billion in the first quarter, while its capex was $14.90 billion. In other words, for the company to be able to generate relevant value (considering that its market cap is approximately $1.90 trillion), there needs to be an evolution on both ends. This includes an increase in cash from operations (through the factors already mentioned) and lower capex as the initiatives mature.
In summary, I think it is difficult to list the number of optionalities that Amazon's thesis has, including streaming, services, subscriptions and so on. But to name the most important ones, there is continued growth in e-commerce, but with increased profitability, as there is greater automation (this also applies to international) and AWS benefiting from the AI trend.
The stock is not that expensive
Amazon's stock may seem expensive at first glance, but a closer look reveals a different story. As I mentioned previously, the price-earnings ratio can be misleading. The company has a very inflated multiple, but it is almost on purpose since Amazon's focus is currently not on net income (but on growth) and it does not reflect the cash from operations very well.
As stated by Warren Buffett (Trades, Portfolio) and Charlie Munger, Ebitda is not a very good metric. Even though I also do not like to remove depreciation (and SBC) from the account, I believe that in Amazon's case it is valid. Despite a net income of $10 billion in the first quarter and operating income of $15.3 billion, its cash from operations was $19 billion (almost $30 billion of operating inflow). I do not want to say that depreciation in this case is good or that we should not consider the dilution of the stock-based compensation, but it is an exercise to see the size of the cash generated in recent times.
When examining the company's cash multiples, we find reasonable levels, such as a price-cash from operations ratio of 19.70 and a price-to-free cash flow ratio of 42, even with the high capital expenditures. Indeed, both metrics cited are above the industry average and do not seem that attractive. But paying around 20 times the operating cash generation of Amazon, which is a premium company and has practically contracted growth, does not seem that bad to me. In other words, it is not a bargain, but it is not that rich a multiple either.
The GF Value Rank shows the company is no bargain with a score of 5 out of 10 due to high multiples. Further, the cash metrics are not so low as to sustain a good score or for the company to be considered cheap. But as is well known, multiples are not capable of capturing long-term growth, and this is what the market expects (which is why it is traded at these multiples) and I think some scenarios are quite feasible, in which Amazon manages to increase its operating cash flow through the initiatives mentioned and free cash flow through the decrease in capex, resulting in greater value generation for shareholders and lower multiples (even more reasonable).
Source: GuruFocus
In back-of-the-envelope math, let's imagine that Amazon manages to grow its revenue by 8% (in all segments) by 2027. If its operating margin is 7% for North America, 5% for International and 32% for AWS (a good evolution, but nothing out of this world), we would find an operating income of almost $82 billion, an increase of 2.20 times. Using this figure as a basis, it is not hard to imagine that by then cash flow from operations could double from $85 billion to $170 billion.
There's also capex, which in 2023 was $52.7 billion and is set to increase in 2024. But it turns out that in a number of years pre-2020, this number was substantially lower, below $20 billion. Thinking about a lower level of investment in 2027, but still a level that supports a large infrastructure, we could end up with something close to $40 (a number I took arbitrarily) based on FCF of $130 billion. I created this whole scenario just to prove the point that it's not difficult to see Amazon with free cash flow above $100 billion in a few years, which would be a multiple below 20 for a company worth just under $2 trillion.
Again, this multiple still would not be a huge bargain, but we should remember that Amazon will probably remain relevant for decades to come and the growth prospects will not be over.
Even four years from now, I believe Amazon will be priced at premium multiples that consider reasonable growth since new ventures are numerous, and many markets such as cloud and AI should maintain an aggressive CAGR. Amazon being traded for $2 trillion seems very reasonable to me, being an excellent company trading at a fair price.
The bottom line
In view of the information above, to be exposed to Amazon is to be exposed to a series of segments, which, despite their differences, have some similarities, such as being among the leaders in their respective markets and have high efficiency. This, coupled with the power of scale, translates into huge moats for Amazon.
Even so, Amazon is not traded at exorbitant multiples or for absurd growth, but at a price that, while not a bargain, is justified given its great prospects and financial and operational strength, leading me to believe Amazon should remain a solid portfolio option and a possible ongoing compounder.
