Amazon In Risk Zone

|
About: Amazon.com, Inc. (AMZN), Includes: AAPL, FB, GOOG, GOOGL, MSFT
by: Oleh Kombaiev
Summary

Within the bounds of my DCF model, even the most optimistic scenario for Amazon’s development does not indicate that the company’s share is undervalued because of the high WACC.

The current WACC of Amazon exceeds 12% and the key reason for this has been the record high Beta coefficient.

Beta is a risk multiple, therefore, such a situation potentially means trouble.

Having updated my DCF model for Amazon (AMZN), I have come to the conclusions that contrast with my series of positive articles devoted to Amazon.

Amazon - is actually three almost separate companies: North America e-commerce, International e-commerce, and Amazon Web Services. So, in order to build a qualitative DCF model, we need three separate forecasts for both revenue and margin.

North America

According to the model based on Statista forecast, the retail e-commerce sales in the United States will be growing at a CAGR of 6.8% in the next 10 years:

I believe Amazon will continue its aggressive policy aimed at conquering the market share and accordingly I forecast that Amazon's revenue in North America will be growing at a CAGR of 8.5% in the next 10 years:

Amazon revenue forecast

Let’s talk about the margin of this segment.

In 2018, the operating income of the North America segment increased by 2.5 times. At my glance, last but not least, the company’s initiatives in the digital advertising market have affected this result:

Top 5 Companies, Ranked by US Net Digital Ad Revenue Share, 2018 & 2019 (% of total digital ad spending)

So, I expect that the margin of this segment will increase steadily from 5.1% in 2018 and gradually will grow up to 13% by 2028:

International segment

In accordance with the Statista forecast, by 2021, retail e-commerce sales worldwide will rise to $4,878 bln. If the trend will continue, by 2028, the global e-commerce market will rise to $9,494 bln and the CAGR will amount to almost 13%:

In the global e-commerce market, Amazon will have to compete fiercely with local players, which will slow down the growth of revenue and profitability of this segment of the company. I think the 10% CAGR for the International revenue segment is an acceptable baseline scenario for the next 10 years:

Also, I expect this segment to remain unprofitable for at least 5 more years:

Amazon Web Services

According to various forecasts (Forbes, Wikibon, IDC), global enterprise cloud spending will be growing at a CAGR of about 20% during the next 10 years. So, I believe that AWS revenue growth at a CAGR of 17% is the baseline scenario for the next 10 years:

The cloud market is becoming more competitive and I expect that the operating profitability of this segment will decrease from the current 25% to 16% in a terminal year:

Eventually, I got the following total revenue forecast for Amazon:

The internal revenue structure will be as follows:

According to my forecast, Amazon's revenue will amount to $279 bln in 2019 (+20 YOY), and to $325.7 bln in 2019 (+16.7 YOY). It is noteworthy that these figures almost match the average analysts' expectations:

And here is the total operating income forecast:

But the main surprise was waiting for me when I calculated the WACC:

The current WACC of Amazon exceeds 12% and the key reason for this has been the record high Beta coefficient:

I have calculated Beta for other companies from the FAAMG list and haven’t found a similar Beta coefficient value.

Facebook (FB):

Facebook Apple (AAPL):Apple Microsoft (MSFT):

Alphabet (GOOGL) (GOOG):

Beta is not stable and prone to cyclical change. Therefore, I proceed from the assumption that Amazon's beta coefficient will tend to the industry average in the long term, thereby reducing the WACC.

And here is the model itself:

As you can see, the model does not imply potential for the rise of Amazon's share. Moreover, I changed such parameters of the model as revenue growth, profitability, CAPEX, etc., over a wide range, but this did not have a strong impact on the result. Within the bounds of the model, even the most optimistic scenario for Amazon’s development does not indicate that the company’s share is undervalued because of the high WACC.

This is what I think about it all...

High Beta indicates an increased speculative interest to the company’s shares on the part of short-term investors who tend to buy shares in a rising market and sell in a falling market. In any case, high Beta means high volatility or high risk. In this case, higher than in any other company on the FAAMG list. In my opinion, this bodes no good for Amazon in the near future.

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.