Global Equity: Is the market grossly undervaluing Amazon?
EPIC Global Equity Fund
We are convinced that Amazon, a core holding in the EPIC Global Equity Fund, represents a once in a decade opportunity.
Amazon has not traded at such a low price to sales ratio since 2014 and is materially below its 10-year average.
Source: https://www.macrotrends.net/stocks/charts/AMZN/amazon/price-sales
Since 2014, Amazon’s gross margin has increased 1250 bps. All other things being equal, Amazon’s P/S ratio should have trended higher.
Source: Amazon financial reports and Morningstar
In 2022, Amazon’s share price halved. The costs of its retail business have always concerned investors, but high Inflation amplified pressures, increasing shipping, fulfilment, and logistic costs on one hand and lowering discretionary income on the other. As we embark on 2023, Amazon’s shares are now trading at 2018 levels.
Source: finance.yahoo.com
Yet Amazon today is a very different company, with revenues having more than doubled since 2018 from $233 billion to $470 billion.
Many market participants are concerned that Amazon’s top line growth does not trickle down to the bottom line due to ever increasing costs.
Amazon’s cash from operations has increased nearly seven-fold since 2014 and over 50% from 2018 levels. This is even more impressive than it seems as 2021 figures are depressed due to one-off exceptional increases in accounts receivable and inventory which will normalise in 2022.
Source: Amazon financial reports and Morningstar
The sceptics point out that in order to fuel growth, Amazon has to deploy increasing amounts of capital, particularly with today’s increasing cost of capital. Questions on shareholder value creation are raised as Amazon is perceived as a low margin, low return business.
However, return on adjusted invested capital has more than doubled since 2014.
Source: Amazon financial reports and Morningstar
Many market participants have yet to acknowledge the fact that over the past few years Amazon is becoming far more profitable.
What makes Amazon special?
In the US retail market, Amazon is larger than the next 14 biggest digital retailers combined. The company is over five times as large as its second-largest competitor Walmart.
The average Amazon buyer’s annual household income is tilted towards the middle to upper income cohorts. Its consumers are less impacted from inflationary pressures.
Today nearly fifty cents of every dollar spent online on ecommerce in the United States is at Amazon. Its customer-centric approach is allowing Amazon to hugely outperform the competition, winning approximately 3-4% US ecommerce market share annually, equating to 11% in just the last three years.
Source: Amazon financial reports, Morningstar estimates and US Census Bureau
Amazon is a world-class innovator with a proven track record of creating multi-billion dollar, high margin businesses
Amazon Prime was launched in 2005 to fuel growth in Amazon’s e-commerce business, The strategy worked, according to Statista, with Prime members spend an average of $1,400 on the e-commerce platform annually, compared to $600 spent by non-Prime members.
Amazon’s annual subscription revenue is larger than McDonalds, KFC and Domino’s Pizza annual revenues combined.
Source: Amazon financial reports and https://www.investing.com/
More recently, Amazon has built its advertising operation from a standing start into a business with a current run rate of c.$40 billion.
That is roughly the annual revenue of Mastercard and beverage alcohol giant Diageo combined today.
Bucking the trend of the current economic environment, Amazon’s advertising business grew 30% year-on-year in the last quarterly reporting season.
Source: Insider Intelligence
Amazon advertising wins because:
"Advertisers are looking for effective advertising. And our advertising is at the point where consumers are ready to spend" Brian Olsavsky, Amazon CFO.
Amazon Web Service is the company’s crown jewel.
In the latest quarter AWS grew 28% year-on-year. With an annual revenue run rate of c.$70 billion it generates as much revenue as Coca Cola and Nvidia combined.
Source: Amazon financial reports and https://www.investing.com/
Amazon’s latest quarterly report notes that AWS currently has $104 billion of committed revenue. At a ballpark operating margin of 30%, that equates to over $30 billion of committed operating profit, which is broadly the annual operating profit of LVMH, Pepsi and Starbucks combined.
Research company Gartner recognised AWS as a leader in cloud infrastructure and platform services for the 12th consecutive year.
Source: Amazon financial reports
In 2014, AWS accounted for 5.22% of Amazon’s revenue, in 2021, 13.26% of revenue is derived from AWS. Revenues from high margin business such as AWS and digital advertising are worth far more than low margin ecommerce. The market is not pricing this in.
Furthermore, with the cloud computing market expected to grow at 16% annually to $1.6 trillion by 2030 there is a long runway for growth ahead.
Amazon has a 33% market share position in this high margin, high growth, highly lucrative space.
Conclusion
We believe that short-term market headwinds are creating an excellent time arbitrage opportunity in Amazon.
Amazon’s ecommerce business should return to profitability once inflationary pressures subside. Notwithstanding these pressures, Amazon’s scale means it will likely keep on winning market share in the online retail space.
The higher margin, faster growing AWS and advertising businesses will keep on improving long term profitability. These businesses are exceptionally well-positioned in huge markets, both of which are expected to comfortably break the trillion-dollar mark by 2030.
Market participants are focused on the current headwinds but are not looking at the improving fundamentals of the overall Amazon business.
Investors are grossly underestimating what Amazon will realistically generate in cashflows over the next five to ten years.
In investing, money is made when you buy, not when you sell.
Seeds sown during bear markets will most likely yield the highest rewards.
Amazon is just one of many opportunities prevailing market conditions have created.
The EPIC Global Equity fund is ideally positioned and actively managed to take advantage of such opportunities.
Malcolm Schembri
Fund Manager, EPIC Global Equity Fund