Amazon Q1 summary
Amazon (NASDAQ: AMZN) released a mixed bag of Q1 figures last Thursday. After looking at the numbers and comments, I decided to stick with my purchase note, as Amazon continues to be a story driven primarily by revenue growth. After all, the vast majority of Amazon’s investments have been put in place to continue increasing their revenue and customer experience. If you think about it, if Amazon stopped reinvesting its profits in the growth of the business, the business would be a cash cow and the absurd evaluation based on P / E profits would be nonexistent. However, during its lifetime, Amazon chose to re-inject its cash flows and profits into the business, to continue to grow. This first quarter report illustrates this theme.
- Revenues of $ 75.45 billion versus $ 73.61 billion expected
- EPS of $ 5.01 compared to expected $ 6.25
Without breaking down the figures segment by segment, we can see that Amazon continued to develop its turnover (beating estimates by ~ 2.5%) at the expense of margins. As the company continues to invest heavily in coronavirus spending, margins will shrink in the second quarter potentially to the point of suffering losses. Management warned him during the conference call. Under normal circumstances, Amazon would have made operating profits of approximately $ 4 billion in the second quarter. However, these difficult times, they warned that they would reinvest this money in the fight against coronaviruses on Amazon. This will be invested in testing, PPE in Amazon Fulfillment warehouses and cleaning supplies. As the coronavirus dies out, these expenses are likely to be non-recurring.
Understand what makes Amazon unique
The real differentiator for Amazon, what makes them unique is the way they run their business. Since its creation, all the profits that the company has made have reinvested in the expansion of the Amazon ladder. It continues be the trend, because Amazon builds an exoskeleton around its activity to develop over time. Since its creation, profitability has not been the best measure to assess Amazon. The best way to track the progress of Amazon’s ongoing investments in revenue, not revenue. At least not yet. If these structural investments are paying off, which I think they are, then Amazon should be able to continue increasing its revenues at a rapid rate. And let’s look at 2020 for reference. Analysts predict that a $ 280 billion 2019 revenue base will grow to 22% in 2020. 22% growth for a company of this size is extraordinary, no matter how you try to run it. Ultimately, however, growth will begin to slow as the law of large numbers takes effect. When this growth slows, we must anticipate a drastic drop in spending and the start of strong profit growth. This is when you start to assess the stock on profit.
Again, Amazon can never “unleash” its profitability potential. They could continue to invest and disrupt new industries, further pushing the company’s profitability over time. This is how Amazon has conducted its activities essentially since its creation.
So how do you value Amazon?
My previous price targets on Amazon were calculated using a discounted cash flow model (a.) Or a sum of pieces model. Both of these models required precise timing of Amazon’s voluntary transition to a cash-generating business. Now, however, I take a different approach to evaluation. I’m going to value Amazon based on revenue. Given the fact that Amazon is likely to continue strong revenue growth for years to come, I think the stock should be valued on the basis of revenue. My estimate is that Amazon will increase revenues at a high rate of 21.7% year-on-year in 2020. Beyond 2020, I see growth slowing to 14% in 2021, 12% in 2022 and 10% in 2023 This continued deceleration in revenue growth is due to the scale of Amazon today. So I’m going to put a multiple on the 2020 numbers, assuming mid-teen growth in 2021, 4X income. Here’s why:
- 4X is certainly not an aggressive multiple
- Amazon has an incredible advantage
- Exposed to many growth verticals
- Possibility of capitalizing income in the future
On the first point, 4X turnover is not an aggressive multiple. It is not a 30-40% high-flying growth stock. It is a business that sees its growth gradually slow down as its business matures. Therefore, Amazon should not get a high-flying multiple. 4X reflects that it is a high-growth company, but its best growth days are probably behind it. This multiple also takes into account the fact that Amazon as a whole is not a high-margin company. Therefore, I believe that a 4X multiple is not aggressive.
Second, Amazon has a big advantage over its competitors: its scale. The scale and willingness of Amazon to reinvest its profits in the business have allowed Amazon to develop a broad competitive advantage and a moat. An example of the Amazon advantage is logistics. Apparently out of nowhere, Amazon has created a large-scale logistics network to improve shipping times for the delivery of Amazon products. This logistics operation is so important that competing companies have seen their share prices reduced (in part) due to strong competition from Amazon.
Third, Amazon is exposed to many growth sectors in the future, allowing for strong revenue growth despite the scale of the business. Vertical industries like video streaming, physical presence in stores, advertising, home hardware and cloud computing will all drive long term growth on Amazon.
Finally, as I mentioned earlier, Amazon has yet to collect the full potential margin on their gigantic source of revenue. As a result, as growth slows on the revenue side, Amazon will likely see accelerating profitability trends.
Overall, I think the 4X revenue allocation is fair considering the above factors.
The consensus estimate of analysts’ revenues for 2020 currently stands at $ 343.14 billion. My baseline scenario for revenues is $ 341.41 billion, which is a bit lighter than the consensus. On a multiple of 4X, I reach a market capitalization of $ 1.365 trillion. Out of a number of shares outstanding of 497.8 million, the valuation of Amazon should be ~ $2743.35, bringing me to my PT of $ 2740.
Amazon’s actions at this price, while using conventional profitability-based valuation measures seem expensive, are undervalued. We have to assess Amazon on the basis of revenue. When we examine the value of Amazon on its earnings, the stock seems undervalued.
Disclosure: I have / we have no positions in the stocks mentioned, and we do not intend to take any positions in the next 72 hours. I wrote this article myself and it expresses my own opinions. I do not receive any compensation for this (other than from Seeking Alpha). I have no business relationship with a company whose stock is mentioned in this article.
Additional disclosure: I am not a financial advisor. It is not financial advice. Please do your own due diligence on any of the securities mentioned before taking a position on any of the securities mentioned.