Last year’s spectacular 3-quarter market run propelled Amazon (NASDAQ:AMZN) (green-red bars) to a 66% YTD gain, breaking briefly through the $1 trillion threshold in market capitalization in the first week in September. Equally spectacular was the company’s fall from grace after peaking in late August, succumbing to a 4th quarter market plunge that caromed the stock deep into bear territory, down just over 26% through the end of the year. It was the company’s worst quarterly market performance in over a decade. The market was oversold in the closing months of the year. Amazon bore much of the brunt of this end-of-year profit taking. Now down over 18% since its August peak, Amazon is poised to add about 20% to its current share price for a target of $2,000 by the end of the year.
US GDP in the 4th quarter grew at an annualized rate of 2.6%. The post was a significant climb-down from the heady 4.2% 2nd quarter, artificially goosed by a $1.5 trillion tax cut in this the tenth year of the current bull run. The 2nd quarter output was the best post since the 3rd quarter 2014. GDP growth in the 4th quarter was up 2.88% YOY. While 4th quarter numbers point to a slowing economy, the deceleration could have been much worse, particularly given the market pullback in the 4th quarter. Consumer spending at 2.8% slowed from its 3.5% pace of the 3rd quarter and decelerated even more from the year’s peak 3.8% pace through the end of the 2nd quarter. Nonetheless, consumer spending remained on a firm footing by the close of the year. While housing fell for the fourth consecutive quarter and in six of the past seven quarters, exports rebounded from contraction in the 3rd quarter. Still, the dampened demand for US cars, auto parts and agricultural commodities in Asian markets continued. US-China trade tensions applied further supply chain stress while importers were forced during the period to replenish their wares and pay punitive duties on their purchases. The replenishment of inventory stock was a driving force behind total output in both the 3rd and again in the 4th quarters, additions to GDP growth that likely will fall out of 1st quarter tabulations. While corporate tangible investment indeed bounced back in the final three months of the year with strong spending on inventory and equipment purchases, it was intangible investment that drove corporate spending during the period. The category posted its strongest year since 1999.
This is important. Amazon’s real growth not only comes from technological efficiencies it employs in the marketing and delivery goods to disparate online consumers worldwide. As with other big-data companies like Alphabet (GOOG) (GOOGL), Facebook (FB), Microsoft (MSFT) and kindred companies, the sheer mass of data that Amazon’s servers collect, analyzes and synthesizes provides the revenue generating targeted advertisements that completes the circle for the future sale of goods to the ever-expanding online markets the company creates across the globe. Online advertising will be yet another revenue boon for Amazon in the years ahead, a market that is currently dominated by Google and Facebook in the US and Alibaba (BABA) in China.
Figure 1: Amazon and the S&P 500
Amazon fortunes reversed slowly to the upside by Friday’s market close, up over 8% on the year (green shaded area), a sizable deceleration from the 22% gain through the end of February YOY. Amazon still comes up short some 18 percentage points from its brush with bear territory in December and about 3 percentage points shy of the S&P 500 (black dotted line) on the year (see Figure 1, above).
Market sentiment on retail remains telling as the well-publicized financial difficulties of JC Penney, Sears, Payless ShoeSource, Gymboree, L Brands and Macy’s have colored the sector in broad negative strokes. SPDR S&P Retail (XRT), which tracks the S&P’s equal weighted Retail Select Industry index, fell into bear territory by year’s close with a 21% plunge. This year, XRT has recovered some of last year’s losses putting 8% to the upside on the board YTD. Still, the index is down 14% from its August peak. With 24.5 million shares shorted through mid-February, XRT remains one of the most shorted ETFs on any exchange. At least some of that short interest has migrated to Amazon shares with some 4.89 million shares shorted through the end of February, a 13% increase on January’s total. This negative investor sentiment toward retail clearly carries over to Amazon shares given the 53% retail component to the company’s total revenue picture. Another 18% of Amazon’s total revenue derives from 3rd party retail sales. The XRT connection, however, has its limits: Amazon is not among XRT’s top holdings through the end of February.
There was little surprise in Amazon’s earnings per share rocketing skyward during the course of the year in the wake of the largest corporate tax cut since the 1980s. The 1st quarter saw EPS rise 128% YOY only to be buried by a 1,167% YOY gain in the 2nd quarter as the full impact of the company’s tax savings hit the balance sheet. EPS growth settled slightly in the 3rd quarter at 1,006% YOY before crashing back to earth with a 61% YOY gain in the 4th quarter. The Trump tax cut provided a $789 million direct tax benefit coming from the recalculation of federal net deferred tax liabilities resulting from the corporate tax rate falling from 35% to 21%, less the one-off tax on accumulated earnings of foreign subsidiaries. For the year, the cumulative tax benefit from tax savings came to $1.2 billion.
Such outsized YOY EPS gains are clearly one-off events. Annualized EPS growth since 2015 has been 48.26% against annualized outstanding shares growing at 0.67% with 490 million diluted shares outstanding through the end of 2018. In February 2016, the Board of Directors authorized an open-ended stock buyback program of up to $5 billion. Since the announcement, there have been no repurchases of shares. In fact, the last time Amazon bought its own shares was back in the 1st quarter of 2012 when it paid $960 million, retiring 5.3 million shares.
Yet while WalMart’s (WMT) net sales rose 3% over a nine month period through the end of October and Costco (COST) reported a 10% increase in net sales over the past 12 months through November, Amazon’s net sales through the end of 2018, consolidated net sales were up 31% YOY and 21% annualized since 2013. Operating income was up 203% to $12.42 billion while net income was up just over 203% YOY over the same period. Net income rose threefold YOY to $10.1 billion and 82% annualized since 2013.
Across sectors, Amazon’s online stores were up 13% through the end of 2018. Since 2015, net sales in online stores have grown at an annualized rate of 12.47%. Physical stores, which includes the August 2017 purchase of Whole Foods, jumped to just under 7% of total sales and posted an annualized growth rate of 197% with the inclusion. Revenue from third party sellers on Amazon’s platform, which includes fulfillment and shipping fees and services, rose 34% on the year. Annualized growth since 2015 breached 28%. Subscription services, which includes Prime memberships and all other non-AWS subscription services, increased 46% YOY and comprised about 6% of total revenue for the year. Annualized growth since 2015 comes to 33%. Amazon Web Services continued to post outsized gains with a 47% YOY gain in the 4th quarter, which comes to a cumulative annualized rate of growth of just over 42% since 2013. AWS now comprises just over 11% of total revenue, up from 4% in 2013, an increase of total revenue share of some 35% since 2015. And the latest growth engine comes from and continuing breakout of advertising services. While the smallest segment of revenue at 4% of total, advertising services came in at $8.2 billion in 2018 while marking an annualized growth rate of 117%. Amazon now claims a distant third in 2019 projections for digital ad revenue at $9.1 billion in the US market after Google at $102 billion and Facebook at $67.2 billion. Annualized growth of the category comes to 48%.
First quarter guidance sees net sales increasing between $56 billion and $60 billion, which if realized comprises net gains of between 10% and 18% YOY. Since 2014, 1st quarter net sales have an annualized growth rate of just under 21% which is above and slightly beyond the high end of the company’s conservative growth range. The annual growth between 2017 and 2018 was an exuberant 42%.
A forward share price target of $2,000 by year’s end is reasonable given Amazon’s 21% annualized net sales growth over the past five years. In fact, the target is likely on the conservative side, given Amazon’s many paths to outsized growth. With the Federal Reserve’s new-found forward guidance embracing patience on further rate increases, the policy shift has provided much of the backdrop for market gains to date. With little evidence of inflation in the data and market volatility measures in retreat, despite current unemployment rates at 50-year lows, the Fed is likely to sit on the sidelines for the foreseeable future until such time when inflation clearly rears its head. Both headline and core PCE inflation for the greater economy appear locked at 2.1% through the end of 2020. GDP growth also comes in at 2.1% while the unemployment rate remains steady at 3.8%. The low inflation environment drives the demand for risk assets as the yield on the 10-year Treasury closes in on its YTD high of 2.786% set on the 18th of January. Friday’s market close saw the benchmark yield at 2.754%, its highest post since the closing days of January.
True, the 35-day partial government shutdown came too late to negatively impact 4th quarter results. That said, the shutdown’s impact on the greater economy will likely pose a significant drag on 1st quarter growth. The latest projection of 1st quarter GDP growth from the Federal Reserve Bank of Atlanta is a paltry 0.3%. The forecasting company Macroeconomic Advisors projects 1st quarter GDP growth a little higher at 1.1%. Further, as fiscal stimulus washes out of YOY comparisons, the impact of continuing tariff regimes will likely intensify. Economic uncertainty remains part of the question on both the economic and political fronts over the short and intermediate terms. Market volatility will likely increase. But overall, the low interest environment and the absence of notable inflation provides a fecund space for risk assets and further market growth.
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Disclosure: I am/we are long AMZN. 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.