By Peter Mantas
Amazon.com Inc. (NASDAQ: AMZN) has been on a tear recently with the stock compounding at over 120% CAGR over the last 10 years. That is truly an unbelievable feat for any company, especially a mega cap technology company that is one of the largest in the world. The key question for most investors looking to get into or who are already holding the name is whether this company can continue its meteoric rise.
There is no question we are in the early-to-mid stages of a bull (stock) market as seen by the incredible rise in startup venture capital inflows and many big cap tech names that seem to do no wrong. Most investors may not realize this, but the current market period is eerily reminiscent of the 1996-1998 period, where despite increasing levels of volatility, big cap, small-cap and mid-cap tech names continued their incredible rise which eventually culminated into the tech bubble of 2000. Now, this is not to say that AMZN or the market in general is in “pre-bubble” territory (that in itself is a separate article), that it is not worthy of an investment for the next 10 years or that the company has not done an excellent job of executing and providing consumers and enterprises key services. Rather, I am here to merely to provide a little bit of color and taste as to where we might be while keeping perspective as to the rise of an interesting business.
Overall, I believe that AMZN will continue to outperform the overall market and will be a major player in the mega-cap tech scene. Given the ubiquity of its services, enhanced portfolio, flawless execution, and financial metrics that I believe are under-appreciated, there is no reason why this company should not be worth as much as MSFT (or $500 billion market cap) implying roughly at least a +40% return over the next 3-5 years. Given this conclusion, let’s look at why AMZN will continue to rise as this bull market matures over the next little while.
Over the last 10 years, AMZN has grown revenue by over 10x and in its latest quarter, net sales grew by 23% from the previous year. Free cash flow less principal lease repayments over the last year has grown by from -$99 million to over $3 billion. Operating cash flowgrew 72% over the last year to $9.8 billion and net income was $79 million for the quarter versus a net loss of $437 million the previous year. Despite these impressive, “turning of the switch” type of financial results, what is most underrated about AMZN is actually its gross margin growth. Amazon has been widely criticized due to a significant portion of its revenue on the retailing business which in turn has given the tech giant lower than desirable margins. However, over the last 3 years, AMZN’s margins have grown by over 15% to 31.3% gross margin for its TTM.
Interestingly, the main driver for this margin expansion is none other than the new solutions it is providing as part of its enhanced portfolio, including Amazon Prime and Amazon Web Services (AWS). The latter has really propelled the company’s revenue into a salesforce-esque like trajectory with the only difference being that this segment of Amazon’s business is incredibly profitable. In its latest quarter, AWS has nearly doubled (78% growth over the last year) while operating income has grown 432% year-over-year with YTD net sales reaching $6.9 billion. These are obviously very good numbers but what is key is the operating ratio of this part of Amazon’s business. Operating margin for AWS is at nearly 25% for the latest quarter, up over 3x from 8% a year ago. Although Amazon has had quite the run-up, the story for Amazon is quite clear: anchor the business by offering the most complete retail experience to the consumer despite the lower margins, utilize those cash flows to expand higher margin pieces of their portfolio (i.e. AWS, Prime) and continue to expand those margins which will in turn enhance cash flows to be invested into new services, products and opportunities (which hopefully, have higher margins). Needless to say, it is quite the interesting cycle as Amazon seems to be creating a complete technology solutions provider to attack its higher margin mega cap tech peers like never before.
Of course, there are concerns for Amazon and its strategy. The main issue with Amazon is not only its ability to deliver and execute which is difficult to achieve unless market conditions are in their favor, but Amazon has yet to prove that, at its current market cap, it is a consistent and quality earner that so many investors look for when evaluating shareholder value creation. Amazon has a paltry ROIC and ROE in addition to lackluster free cash flow/sales of 4.56 which is a more important metric when evaluating your typical growing technology company. These concerns, although very valid, would certainly be extinguished if Amazon continues to grow and utilize its cash flows from its peripheral businesses, but only time will tell whether these will be sustainable for a long period of time.
Overall, Amazon has given investors a reason to be long the name over the last decade. Although I’m always weary of mega cap tech due to the fact that they trade in incredibly efficient markets, Amazon is the most interesting name to be in given its unique strategy, FCF growth and strong execution which gives current and would be investors hope over the next little while. Look to get into the name below our $522 “buy” target.
DISCLOSURE: Logos LP has no position in the stock mentioned above.
