David Ryder
Investment Summary
The story is that CEO Andy Jassy is finally owning Amazon.com, Inc. (NASDAQ:AMZN). After, a false start in 2022, when the company reported dismal financial results, he delivered a solid rebound in revenues and earnings for 2023. It is the beginning of a new era at AMZN, Andy Jassy’s AMZN.
Considering the period following the sudden departure of Jeff Bezos from AMZN, things have never appeared better for the company. AMZN has just come off of delivering strong financial results, Andy Jassy has settled into the CEO spot, the retail business is growing nicely into the expanded fulfillment and transport networks (which were doubled in size during the pandemic), the advertisement, subscription, and third party seller businesses are demonstrating strength, and Amazon Web Services (AWS) customer optimizations are in the rearview mirror, with subscribers signing larger and longer commitments.
Mr. Market, smelling the roses at AMZN, has not been far behind – AMZN’s shares have rallied 13%, following the blow-out earnings report. Nevertheless, based on our 10-year Discounted Cash Flows model, shares have adjusted for near-term growth expectations. AMZN is a long-term story. Incorporating growth potential three years out, AMZN’s stock appears undervalued. To be specific, to reflect growth associated with the evolving AI revenues and earnings opportunity, we have increased our 10-year straight line revenue growth rate to 22% from the previous 20%. In addition, to represent a growing shift towards AMZN’s high-margin businesses, we have expanded our 10-year normalized operating cash flow margin to 17% from the prior 15%. Based on these changes, we arrived at our updated Price Target of $222/share versus the earlier $154/share. Reiterate Buy Rating.
Investment Thesis
AMZN is resoundingly back. During 2023, compared to 2022, revenues expanded by 12% to $575, net income increased to $30.4 billion from a net loss of $2.7 billion, earnings per share escalated to $2.90 from negative $0.27, and free cash flow advanced to $36.8 billion from an outflow of $11.6 billion. In addition, revenues associated with North America, International, and AWS accelerated by 12%, 11%, and 13%, to $353 billion, $131 billion, and $91 billion. Further, operating income for North America, International, and AWS expanded to $14.9 billion from negative $2.8 billion, to negative $2.7 billion from negative $7.7 billion, and to $24.6 billion from $22.8 billion. Moreover, on a year-over-year basis, revenues attributed to Online Stores, Physical Stores, Third Party Seller Services, Advertisement Services, and Subscription Services advanced 5.4%, 5.6%, 19%, 24.3%, and 14.2%, to $232 billion, $20 billion, $14 billion, $46.9 billion, and $40.2 billion, respectively.
Overall, for 2023, compared to the period just prior to the pandemic, revenue growth came in significantly softer. However, considering the explosive growth experienced by AMZN during the Covid-19 years, that the company has reverted to strong growth, is a testimony to the potential of its business. But there is more. During the year, AMZN’s margins across the board surpassed pre-pandemic levels. In addition, free cash flows handily beat figures ever previously experienced by the firm. Nevertheless, AMZN’s tremendous 2023 financial performance is history.
Is the company going to keep up with the recent rapid growth or is growth going to stabilize to marginal levels? We believe AMZN is at the cusp of breakout growth in revenues, earnings, and free cash flows, over the upcoming three years and beyond. We steel-man our thesis below by analyzing the organization’s revenue growth drivers and margin expansion opportunities.
With respect to AWS, the cloud computing market is projected to generate $1.44 trillion in sales by 2030, reflecting a growth of ~65%. Although, undoubtedly, the growth appears lofty, we believe the estimate under-appreciates the potential of AI, a solid feature of cloud computing, to drive revenue generation. By 2032, AI revenues are projected to accelerate at a CAGR of 42% to $1.3 trillion. Considering that AI tools and services are distributed through the cloud, for the most part, we believe actual revenues associated with the cloud computing industry will likely surpass estimates. Based on December quarter financial results, AWS represents 31% of the cloud computing market, Microsoft Corporation’s (MSFT) Azure 24%, and Alphabet Inc.’s (GOOG, GOOGL) Google Cloud 11%.
In the context of AWS, given that AMZN is stacking compute power with both hands and considering its ever-growing arsenal of AI tools, features, and applications, it appears that AI is being positioned as primary not only to AWS but to the broader organization. In that regard, AWS has covered all bases when it comes to Generative AI. The platform provides training and inference chips to support customers that appreciate building their proprietary large language models ((LLMs)), to supply them with compute power. In addition, AWS’s Bedrock provides subscribers with ready-to-utilize LLMs, to customize with their own data. In regard to the application space, AWS provides Code Whisperer, which supports the generation of computer programs, and Q, a coding companion, that supports customer efforts to write, test, and debug code, as well as analyze data repositories, by asking questions, to receive answers and action ideas.
In addition, it is notable that aside from AWS, AMZN is solidly embedding AI into additional segments such as retail, with AI-driven applications that provide customers summaries of consumer product reviews, predict potential customer fit for apparel, and a shopping assistant that is trained on product catalog, community Q&A, customer reviews, and the broader web. Further, the firm has developed an AI application that forecasts inventory levels for fulfillment centers, and another that generates an advertisement sales copy from a picture and vice versa, to support AMZN’s Advertisement Services customers.
In regard to AMZN’s retail segment, the International business is far from caught up with that of North America, representing, a substantial growth opportunity – given that management has indicated that growth trends associated with the ten countries AMZN has expanded to over the previous seven years, mirrors the growth trajectory of its developed overseas market’s such as the U.K., Germany, and Japan, which expanded revenues by 11.7%, 11.9%, and 6.6% over 2023.
Moreover, despite the momentous growth experienced by the North American retail business, growth is far from saturated, particularly in the context of the U.S. grocery market. Growth opportunities for AMZN exist in the non-perishables category on Amazon.com, in combining shopping carts associated with Amazon.com, Whole Foods Market, and Fresh, and in the offline grocery market. In the grocery segment, AMZN is active through its Fresh online and physical stores, and its Whole Foods Market online and physical stores. However, there are over 500 Whole Foods Market brick and mortar stores (AMZN has opened 60 since the acquisition) and a few handfuls of Fresh physical locations. AMZN debuted several Whole Food Market and Fresh stores (in Southern California and across the Chicago Metropolitan Area) during the fourth quarter. The company’s top leadership has indicated that launching Fresh stores is an immediate priority.
The physical format grocery store chain business is capital and labor-intensive. To succeed, AMZN will require considerable skill in regard to handling merchandise and employees and store operations. Therefore, the venture is likely to be a decade-long slog, with gradual growth in the front years building to rapid growth over the out years, through trial and error, and a steep learning curve. Nevertheless, our assessment is that Fresh is likely North America’s next large physical grocery store chain. With respect to market potential, the U.S. opportunity is worth $750 billion, and 70% of Americans grocery shop offline. In regard to the competition, there are more than 500 Whole Foods Market stores, several handfuls of Fresh stores, 4,600 Walmart stores, and 2,800 Kroger stores. Whole Foods Market has 1% of the U.S. grocery market share, whereas Walmart and Kroger command 19% and 9%. Net-net, North American offline grocery shopping represents a significant market opportunity for AMZN.
Third Party Seller Services is an easy business for AMZN. Given that the firm already has fulfillment centers, storage facilities, and transport networks, the segment is a high-margin venture for AMZN. Considering growth figures, the category appears to represent a win-win for both AMZN and the vendors. During 2023, Third Party Seller’s accounted for 61% of AMZN’s retail revenues and AMZN’s revenues associated with the service expanded by 19%, on a year-over-year basis. Given that a majority of the company’s retail geographies remain under-penetrated, we anticipate substantial growth in Third Party Seller Services revenues, over the years.
During 2023, the subscription business accounted for ~7% of AMZN’s total revenues and expanded by 14.2% to $40.2 billion. We surmise that growth was driven, for the most part, by strong customer uptake of Amazon Prime, which provides, among other services, free same day/next day delivery on products and access to Prime Video. Amazon Prime has 200 million members across 25 countries, with the U.S. accounting for 173 million, representing a share of 71% of the total. Considering that barely 29% of AMZN’s international customer base is subscribed to Amazon Prime, as the service becomes more popular due to customer growth and greater awareness surrounding the perks associated with the platform, we anticipate a dramatic uptrend in the number of members located in foreign geographies.
In that context, it is important to note that Prime Video is likely poised to be spun off, as an independent segment. Given that, during the most recent award season, AMZN MGM Studios achieved 16 Golden Globe nominations, 68 Emmy nominations, 5 Oscars nominations, 21 Critics Choice awards, and secured 9 trophies, it appears that Prime Video content is reasonable, if not superb. In addition, considering customer statistics, including 24% year-over-year growth in Thursday Night Football viewers, and overall 14% year-over-year growth in the hard-to-reach 18- to 34-year-olds demographic, it wouldn’t be a stretch to believe that customer demand for Prime Video is gathering momentum. Cumulatively, business dynamics suggest that Prime Video is likely an additional strong next leg of growth for AMZN.
In regard to the competitive landscape, compared to Prime Video’s 200 million subscribers, Netflix, Inc. (NFLX) has 260 million, The Walt Disney Company (DIS) 158 million, and Warner Bros. Discovery, Inc. (WBD) 98 million. In the U.S., Prime Video has 22% market share, Netflix 21%, Disney 12%, Warner Brothers Discovery 15%, and Apple TV 7%. With respect to ball-parking potential revenues for Prime Video, during 2023, Netflix generated $33.6 billion in streaming revenues, and $5.5 billion in net income.
Saving the best for last, AMZN’s advertising segment. During 2023, the category accounted for ~8% of AMZN’s total revenues, and expanded 24.3% to $46.9 billion. In addition, over the fourth quarter, AMZN revenues associated with the advertisement segment accelerated 27% to $14.7 billion. Comparatively, Meta Platform, Inc.’s (META) advertisement revenues advanced by 24% to $38.7 billion, and GOOG’s advertisement revenues expanded 11% to $65.5 billion. The digital advertisement industry is anticipated to expand at a CAGR of 11% to $432 billion by 2029. Projected 2023 digital advertisement market share for AMZN is 7%, META 18%, and GOOG 39%.
During the December quarter, AMZN introduced Sponsored TV in the U.S., a self-service solution for promoters to generate streaming TV campaigns to reach viewers across AMZN’s streaming services, including AMZN Prime. Given that statistical data demonstrates that 56% of North American customers initiate their purchase journey by searching for products on Amazon.com, undoubtedly, over time, advertisers are likely to seek out AMZN as a primary website for promoting their products.
With respect to profits, AMZN’s earnings will multiply significantly based on revenue leverage from strong sales growth, across the breadth of the business, as fixed costs associated with advertisement, technology, and corporate overhead are distributed across dramatically higher figures. However, additional margin expansion is likely on cards, due to continued deceleration in cost-to-serve owing to decline in spending related to inbound processes and inbound network as well as regionalization, along with leverage derived from deflationary tailwinds associated with fuel and transport.
Given the above-described narrative, AMZN appears locked and loaded to deliver significant revenues and earnings expansion, over the following three years, and beyond.
Bottom Line
Our love affair with AMZN continues, as established through our previous three articles on the company. It’s not our fault, the company is just that awesome. AMZN’s shares have rallied 104% since our first article on the firm, 71% since the second, and 40% since the third. AMZN’s 2023 financial outperformance was just the tip of the iceberg. All the company’s segments have more growth ahead of them, than behind. In addition, AMZN’s other high-margin segments (advertisements, subscriptions, and third-party seller services) are coming into their own and will drive an upside in margins.
Further, the world economy appears poised for an elongated expansion, with global GDP expected to double by 2050. Most of the growth is expected to be derived from geographies where AMZN’s budding businesses are located, implying that the firm’s growth potential is far from tapped. Undoubtedly, with a large international presence, AMZN will be subject to geopolitical and economic risks. However, considering that the businesses AMZN dabbles in are more normal than luxury, the pullback in growth will be relatively marginal.
Given AMZN’s potential for increasing revenues and earnings streams, and the relative stability of the company, Amazon.com, Inc. stock is a must Buy, despite the run-up. Better late than never.
