Internet giant Amazon Inc. (NASDAQ:AMZN) was started by Jeff Bezos in his garage and went public in 1997. Under his leadership, Amazon has grown its revenues from $147 million to $88,990 million. The lifetime sales growth makes for a compound annual growth rate (or CAGR) of 45.7%. Impressive growth! Amazon is one of the few companies that grew during both the tech bubble and the Great Recession of 2008.
This article presents my sales expectations for Amazon. The goal is to estimate sales growth for fiscal-year 2015 (and beyond) under different economic scenarios. The article presents a top-down approach for sales forecasting, where the key indicator of sales growth will be the retail e-commerce industry. After forecasting sales, the article uses a forward P/S ratio to gauge the potential price movement of the stock after the announcement of 4Q results.
Global Retail E-commerce Projected Sales
Online retail sales are expected to continue growing worldwide. Since Amazon is one of the global leaders in e-commerce, it is reasonable to expect that Amazon sales will continue growing. According to data from E-marketer, global e-commerce sales are expected to amount to $3 trillion by 2018. Amazon sales were $0.089 trillion (or $89 billion) last year. Based on these numbers, there is substantial growth potential for Amazon sales.
According to these expectations, the worldwide e-commerce retail sales is expected to grow at a CAGR of 17.6% for the next five years. The 17.6% growth rate is key in this analysis, because it represents the market growth rate. See table below.
Why using global retail e-commerce sales as the key market growth rate?
Because Amazon continues to derive most of its business and revenue from the sale of inventory products and service revenues from third party sellers on its websites. Despite the fact that Amazon Web Services (or AWS for short) is a fast-growing segment of the entire business, it contributed just 8% of revenue as of Q3 2015. The rest of Amazon's revenue came from products and services related to retail sales. Also, Amazon is a global company.
Furthermore, the retail e-commerce sales also takes into consideration intangible products that are delivered through the internet. For example, an intangible product delivered through the internet is Amazon Prime Video Services.
For those reasons, I find it reasonable to use the growth rate of global retail e-commerce sales as the key metric to determine Amazon's growth rates in sales going forward.
A quick overview of Amazon's historical sales
As mentioned before, Amazon is one of the few companies that was able to grow sales during the global financial crisis of 2008. The following chart plots Amazon sales from 2004 to 2014 (11 years of data).
Source: Amazon Annual Report, Chart from Author
There are two key aspects of Amazon's historical sales that need to be highlighted.
First, the growth that Amazon has achieved over the past 11 years is impressive. Amazon grew at an average rate of 30% and CAGR of 27%. Second, the growth in Amazon sales have been decelerating since 2011. The steep decline in the growth line on the chart shows the deceleration in sales since 2011. However, growth is still healthy.
Forecasting sales under five scenarios
In my opinion, forecasting under different scenarios is important because it gives the forecaster an opportunity to account for different possible outcomes. In order to form an unbiased long-term outlook, Amazon sales were forecasted under five different scenarios as follows:
1) Emphasized Bull Scenario: Under the emphasized bull scenario, Amazon will continue to dominate the global retail e-commerce market. Furthermore, Amazon services (Prime and others) will continue to be most preferred services for consumers. Under this scenario, Amazon growth is neither accelerating nor decelerating. The 11-year CAGR of Amazon sales is 26.6%, so sales will continue to grow at that rate for the next three years. This growth is above the industry growth rate of 17.6%, which means that Amazon will continue to increase market share.
2) Bull Case Scenario: Under the bull scenario, Amazon will continue to dominate in the global retail e-commerce. Amazon services will be widely accepted, but competition will take a portion of the market. The bull case makes the assumption that Amazon will continue to grow faster than worldwide e-commerce industry. Since the industry growth rate is 17.6%, Amazon would grow faster than that. Last year, Amazon grew rates by 19.5%, so this rate seems fair for a bull case. Given the fact that Amazon sales have been decelerating since 2011, the bull case scenario builds in a deceleration of 0.5% per year.
3) Base Case Scenario: Under the base case, Amazon will continue to grow simply because it operates in high growth industry. The base case does not assume extraordinary growth for Amazon. The base case makes the simple assumption that Amazon will grow at the industry rate of 17.6% per year.
4) Bear Case Scenario: Under the bear case, sales will continue to grow but competitors will take a larger portion of the market than Amazon. In this case, Amazon will lose some market share. Amazon sales will continue to grow but the deceleration will be larger. Amazon growth will decelerate by 2% every year, slowing to a 12% Y/Y growth by 2018. Amazon will grow slower than the key e-commerce industry rate.
5) Emphasized Bear Scenario: Under the emphasized bear scenario, Amazon will find itself in trouble to maintain its market share. This could happen for a variety of reasons such as bad press or other unforeseen event. Amazon will simply grow because of inflation and industry growth. Amazon sales will underperform e-commerce industry growth and will decelerate by 5% ever year. Furthermore, Q4 sales will be flat from last year. Y/Y growth in 2018 will be just 2.6%. Amazon will lose substantial market share to competitors.
(Note: Only Q4 2015 was estimated for FY 2015 because Amazon already reported three quarters of sales)
Each scenario results are presented in the table below. All estimates are calculated based on the explanations above.
Source: Author Estimates
Using P/S instead of price-to-earnings (P/E) as a gauge of potential stock price reaction to sales results
One of the most interesting behaviors of AMZN is how useless the popular P/E ratio is. From 2006 to 2015, the P/E ratio has fluctuated from 2000x to -2000x (yes, I said two thousand). The wide fluctuations in P/E is simply because the market gives Amazon a very high stock price for its low EPS (earnings per share). In fiscal-year 2014, Amazon reported a loss of 52 cents per share, but the stock price was approximately $300 after the announcement.
Because the P/E ratio is highly volatile, a better measure of relative valuation is the P/S ratio. At the current price of $663, Amazon trades at a P/S of 3.1x, which happens to be the highest P/S ratio in the past 5 years. See chart below:
Considering the fact that the 5-year average P/S of Amazon is approximately 2.1x, we can see that AMZN stock is priced for high expectations. The table below shows the projected P/S ratios based on the sales expectations above.
Under the most optimistic scenario, the P/S of Amazon will approach the average at the end of fiscal-year 2016. It seems that the market is expecting Amazon to continue growing at much higher pace than the industry.
If Amazon maintained a P/S ratio of 2.1x for the past 5 years, then it appears that the current P/S is based on high expectations of sales.
Investor takeaways from the forecast and P/S analysis
There are a number of conclusions that can be made from the analysis and forecast of Amazon sales.
First, Amazon will probably surpass $100 billion in sales for the first time ever, even under the most bearish scenario. This is a huge milestone not only for Amazon, but for any business. Despite the fact that the market already expects this milestone, reaching $100 billion in revenue speaks about the popularity of Amazon's business.
Second, the industry growth of retail e-commerce is expected to be high in the future. Despite its current popularity, e-commerce has more room to grow.
Third and more importantly, it appears that the current price of Amazon is already reflecting very high expectations of sales growth. A forward P/S of 2.2x for 2016 indicates that the market already sees a bright future in Amazon. In other words, the share prices might suffer if the most optimistic expectations are not achieved. Whereas if the most optimistic expectations are simply met, AMZN shares might not shoot upwards because that was already expected.
Fourth, the law of averages suggests that Amazon P/S will revert back to its mean of 2.1x. This reversion can happen either when Amazon stock price decreases or when Amazon sales increase. Amazon stock price is already building high expectations. Therefore, one way of reverting to average, that does not include a downturn in the stock price, is by reporting extremely good sales numbers. Under the most optimistic case scenario, Amazon P/S will revert to mean at the end of 2016 (which gets reported around January 2017).
At this point, all the good expectations of Amazon appear to be already built into the price. Based on the sales number, I see more downside risk than upside potential in AMZN at a price of ~$660 going into the next earnings release.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.