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Investment Thesis

Since I first invested in Amazon (NASDAQ:AMZN) stock in 2015, there have always been an unusually high number of skeptics about the company’s future. The company would hardly make any profits, the P/E ratio was far too high, growth was slowing, and the stock was massively overvalued. The critics quieted down when the company was able to increase sales by 37.8% in 2020 and by 21.5% in 2021 to 470 billion and achieve an EBIT of almost USD 25 billion, putting it on a strong growth path with increasing profitability.

The picture changed again with the presentation of the Q4 21 figures. Although net income was unusually high thanks to the partial sale of the Rivian stake, revenues grew by just 9.5% year-over-year, and operating profit had slumped by almost 50%. Looking at the current operating metrics, which I will discuss in more detail in the next section, the picture is similar. So is the stock rightly trading 37% below its all-time high? If one were to judge only the performance of the retail business and that from a short-term perspective, then possibly yes.

But with AWS and advertising, Amazon has two fast-growing segments that are also very high-margin and currently receive far too little attention. I believe that as long as these two segments deliver strong results, the development of the e-commerce business is completely irrelevant.

Q1 2022 Summary

I’ll start by reviewing the Q1 results and indeed, at first glance, the results don’t read particularly well. Sales rose by a meager 7% to USD 116.4 billion, while operating profit slumped by 56% to USD 3.9 billion. Including the loss on the Rivian stake, the company posted a loss of $3.8 billion, or -$7.55 per share, which further alarmed many investors.

To make matters worse, operating cash flow was negative and free cash flow was 17.7 billion. The revenue outlook of 118.5 billion (5% y/y) versus the consensus of 125 billion and the possibility of a loss in operating profit, caused the stock to collapse 15% the next day. In detail, the segments performed as follows:

Online Store: 51.129 (-3% y/y)

Physical Stores: 4,591 (17%)

Third-Party Seller Services: 25,335 (7%)

Subscription Services: 8,410 (11%)

Amazon Web Services: 18,441 (37%)

Advertising: 7,877 (23%)

In fact, aside from the stable growth rates of AWS and Advertising, there’s not much positive to be found here either (I don’t count Physical Stores among them). Especially the 3% decline in Online Stores and the low growth in Third-Party Seller Services gives pause for thought. Subscription revenues have also grown weakly, considering the Prime price increase. But there is a simple reason for these numbers: 2020 and 2021 have anticipated a lot of growth.

It’s no secret that the pandemic has given many companies a growth boost that would otherwise have been spread evenly over many years. 2022 is now mostly back under normal conditions, which makes a direct comparison with 2021 and 2020 not particularly fair. For clarity, I have again compared the growth of 2019 with 2020 in the following table.

Segment Q1 19 Y/Y Q2 Q3 Q4 FJ Q1 20 Q2 Q3 Q4 FJ
Online Stores 12% 16% 22% 15% 16% 24% 48% 38% 46% 39%
Third-Party Seller Services 23% 25% 28% 31% 27% 31% 52% 55% 57% 49%
Subscription Services 42% 39% 35% 32% 37% 28% 29% 33% 35% 31%
AWS 42% 37% 35% 32% 37% 29% 29% 29% 28% 29%
Advertising 36% 37% 45% 41% 40% 44% 41% 51% 66% 51%
Total Revenue Growth 20% 40%

Source: Amazon Annual Report 2019/2020

From the table, it is clear what a significant impact the pandemic had on the revenue growth of the e-commerce business. The growth in online stores and Third-Party Seller Services was slightly double that of the previous year, which would never have been possible on its own. It was clear that there would be this one year where the pandemic growth boost would be consolidated before resuming to the normal growth path next year.

After all, it’s not an Amazon problem that e-commerce numbers will be rather mediocre in 2022; it affects the entire industry. Other online retailers such as Etsy (ETSY) are also struggling with weak growth, especially in the first two quarters of 2022. Even the repeatedly mentioned competitor Walmart (WMT) recorded a 1% decline in e-commerce sales in Q4 2021 just like Amazon.

In Q3 and Q4, the year-on-year comparisons should be more appropriate again and growth should at least be back towards 16-18%, so revenue growth in 2022 should be around 12%, which is not bad at all given Amazon’s size. In 2023, I even think growth rates of just under 20% are realistic again.

So I don’t think we are doing ourselves any favors by comparing Q1 e-commerce sales to last year and complaining about the slight decline. Amazon is still on a growth course.

Is Profitability Becoming A Problem Again?

Since 2015, Amazon has managed to operate consistently profitable and improve margins almost continuously. Obviously, AWS played a significant role in this, which was able to compensate for the losses or marginal profits in the international business with an operating margin of 35% and was able to steadily increase the company’s overall margin due to its strong growth.

Meanwhile, Advertising should also contribute quite a bit to profits, but that is not yet reported separately by Amazon. Since Q1 2021, however, the operating profit has been declining quarter by quarter. At the same time, the gross margin even reached a new record value of 42% recently. Thus, the problem obviously lies in the operating costs, which have reduced the profit so much in the last few quarters.

Amazon is of course aware of this problem and addressed it in the earnings call. In the short term, Amazon has to fight very hard against inflation. Logistics costs in particular have risen at an above-average rate in view of delivery bottlenecks or lockdowns in China. The cost of transporting freight containers has more than doubled since the start of the pandemic. Fuel costs have also risen by almost 50%.

As a result, about 2 billion additional costs have been incurred compared to last year. Another $2 billion, according to the company, is due to decreased productivity in the labor force, where they were surprisingly overstaffed due to the Omicron variant slowdown and thus could not operate as efficiently as in the past. These costs should slowly fall away in the coming quarter. Another problem is the massive investment in new premises and infrastructure to meet the extraordinary demand. Now that demand is slowing down again, these additional costs will of course still be incurred.

This overcapacity has led to further costs of 2 billion compared with the previous year. Accordingly, a total of USD 6 billion in additional costs have been incurred, of which about two-thirds will be controllable and short-term, according to Amazon. Adding this 6 billion to the EBIT of 3.9 billion would be 11% above the previous year’s figure. Especially since the investments in logistics and infrastructure would have been necessary anyway due to the expected increase in demand, but just spread over a longer period of time.

Accordingly, Amazon could even save some costs there in the next few years. In the short term, it does not look good for Amazon operationally and it will probably remain so in the current year, but I think in the next few years we can expect profits to rise again sustainably.

The Relevance Of The E-commerce Business Is Overestimated

As I already wrote in the investment thesis, I believe that the market is far too focused on the revenue development of the e-commerce business. As is often the case, this business alone is probably responsible for the missed expectations in the outlook. A miss of 8 billion sounds like a lot at first, but how much is this 8 billion actually worth?

Amazon’s original core business is notorious for being very capital intensive and very low margin. That’s why Amazon used to rarely carry an EV/sales higher than 2. Assuming Amazon achieves a 4% profit margin in e-commerce in the medium term, the 8 billion would equate to a profit of $320 million. That’s enough for AWS to add a billion in sales and the profit has been offset.

What I’m saying is that it’s not uncommon for Amazon’s revenue outlook to miss consensus, as analysts often have too high expectations here. However, the miss hardly matters for the valuation of the stock as long as the other segments are doing well. I have presented the whole thesis in a sum-of-the-parts model.



In this model, I go through Amazon’s individual segments and value them individually in terms of growth and margin. The sum of these values then gives the fair value of the company.

Online Stores: As mentioned above, despite its growth, the business is not particularly highly valued due to very weak margins. A fair multiple here is likely to be between 1 and 1.5.

Physical Stores: A nice bonus to appeal to brick-and-mortar customers as well, but since it is also very capital intensive, I only put a P/S of 1 here.

Third-Party Seller Services: This is already a bit more attractive than the pure sales business, as Amazon gets a nice merchant commission here. Growth has slowed recently, so I assume a value of 2-2.5.

Subscription Services: The Prime offering is already much more attractive as a subscription model than the other segments. A comparison to the Netflix (NFLX) rating is helpful here to get an idea of the potential. Netflix has long traded between 7-10 times revenue. I’m a bit more conservative due to weaker growth despite higher fees and am putting a multiple of 5.

Amazon Web Services: The fillet piece of Amazon’s segments and the undisputed leader in cloud computing. In this SaaS business, I consider an operating margin of 40% realistic in the medium term. Growth has continued to accelerate recently. On average, the market assigns a revenue multiple of around 11 to SaaS companies such as Adobe (ADBE) , ServiceNow (NOW) , Salesforce (CRM) or Microsoft (MSFT) . I use a value of 10 for my model, but think that even a value of 12 would still be appropriate.

Advertising: This segment has recently been reported separately and is no longer listed under “Others”. With 45% growth in 2021 and 52% in 2020, it was Amazon’s fastest-growing business segment. Again, high margins are possible when looking at competitors like Facebook, Alphabet or TheTradeDesk. As long as growth remains intact, I think a P/S of 8 is reasonable.

I have summarized the values once again in the table:

Segment Total Revenues TTM Fair Price/Sales Value
Online Stores 202.303 1 202.303
Physical Stores 17.746 1 17.746
Third-Party Seller Services 104.992 2 209.984
Subscription Services 32.598 5 228.186
Amazon Web Services 67.140 10 671.400
Advertising 32.656 8 261.248
Other 2.313 5 11.565
Sum 477.748 1.620.432
Current Market Cap. 1.216.000 +33%

It turns out that despite the more conservative assumptions throughout, Amazon’s fair value based on this model is 1,620 billion, which is 33% more than its current market cap. It is clear that while “Online Stores” is nominally the largest contributor in terms of revenue, it is not even a third of AWS in terms of valuation.

From there, the performance of Online Stores is hardly relevant to the valuation. Even if I were to value Online Stores and Third Party Seller Services at 0, I would still have the current market cap. So you can say that if you buy Amazon shares at the current level you get the e-commerce business for free.

To have an indicator for a mid-term price target, I take the 2023 revenue estimate of 46 analysts. These assume a turnover of 616 billion USD. I allocate this to the individual segments in the following.

2023 Forecast

Segment Revenue Estimate 2023 Fair Price/Sales Value
Online Stores 247.200 1 247.200
Physical Stores 18.900 1 18.900
Third-Party Seller Services 130.800 2 261.600
Subscription Services 45.667 5 319.666
Amazon Web Services 109.077 10 1.090.774
Advertising 60.762 8 486.096
Others 4.337 5 21.684
Sum 616.743 2.445.920
Current Market Cap. 1.216.000 +41,7% p.a.

This gives us a potential market capitalization of $2,445 billion, which would roughly correspond to a share price of $4650. That’s a margin of safety not really seen in a large-cap. It confirms the impression that the sell-off in the shares is unjustified.

The Bottom Line

Amazon has lost favor with investors in recent months with mixed quarterly results. The stock is valued as cheaply as it was in 2016, but the sentiment is extremely negative given the reported loss and weak growth rates in the e-commerce business.

The pandemic has caused some cost centers to rise disproportionately, which is currently being felt as demand normalizes. However, cost structures should return to normal in the medium term. The continued strength of AWS and Advertising is currently ignored by many market participants, which makes the current share price very attractive for entry.

The sum-of-the-parts analysis illustrates the high relevance of these two segments. With Amazon, it is very important not only to pay attention to the absolute sales, but also to consider the origin and value of the sales. I give Amazon a Strong Buy rating.