- E-commerce is challenged by slower growth and inflation.
- The Rivian bet is doing more harm than good.
- On the bright side, AWS remains the most meaningful value driver.
- Advertising is the icing on the cake.
- At $2,000, investors can pick up AWS and Advertising at a fair price, while getting the retail business virtually for free.
Amazon (NASDAQ:AMZN) reported disappointing 1Q22 earnings with inline revenue of $116 billion (+7% YoY), an operating margin of 3% vs. 5% consensus, and a whooping net loss of $3.8 billion as a result of higher inflationary pressure and a $7.6 billion pretax loss from an 18% stake in Rivian (RIVN). The stock has lost 26% year-to-date, and the outlook for the core online business does not look so rosy. However, Amazon's AWS and advertising business remain highly lucrative. Should shares ever reach $2,000, I believe investors could pick up these two highly attractive segments while getting Amazon's retail business virtually for free.
E-commerce is challenged by slower growth and inflation
Like many businesses that benefited from the pandemic, Amazon is grappling with lower sales growth and expects 2Q22 revenue of $118.5 billion at midpoint vs. $125 billion consensus. This implies roughly 5% YoY growth vs. 27% in 2Q21 when demand for online shopping surged.
Margin-wise, Amazon guided 2Q22 operating income of -$1 to $3 billion and OPI margin of 0.84% at midpoint vs. 5.5% consensus and 7% in 2Q21. Per management, this is a result of higher stock based compensation ($6 billion for full year 2022) and higher operating costs from internal and external factors ($4 billion).
In 1Q22, Amazon noted inflationary pressure of $6 billion including higher shipping costs and wages ($2B), lower labor productivity as a result of over-hiring ($2B), and fixed cost deleveraging from excess fulfillment and transportation capacity ($2B). Management believes 2/3 of the $6 billion higher costs can be controlled internally.
Although it's encouraging to see container costs trending lower, the Russia-Ukraine war and Covid restrictions in China still put upward pressure on inflation.
Amazon is currently in excess capacity after expansion in 2020 and early 2021 to keep up with strong e-commerce demand. With online sales now slowing, management thinks demand will grow into capacity during busier times such as Prime Day (moved to 3Q22 vs. 2Q21) and the holiday seasons. However, investors should treat this view with skepticism as consumers are now more comfortable shopping in-store and spending will likely lean towards services (eg. traveling) vs. products as the pandemic is now in the past.
The Rivian bet is doing more harm than good
Rivian is a classic attempt of major corporations taking on strategic diversification (I call it "diworsification") by going into something completely irrelevant to the core business (see an example of how tobacco giant Altria (MO) "diworsified" itself into trouble). From 4Q21 to 1Q22, the fair value of Amazon's stake in Rivian dropped almost 50% from $15.6 billion to $8 billion. The $7.6 billion loss was a major reason why 1Q22 bottom-line was deep in the red.
To investors, this shouldn't come as a surprise because Rivian's valuation is based on thin air and analysts are clearly still in la la land with an average price target of $70 vs. $30 as of writing. In 2021, Rivian had revenue of just $55 million, negative gross profit of $465 million and a net loss of $4.7 billion. In 2022, management expects to produce an adj. EBITDA loss of $4.75 billion. While one can argue that Rivian is investing for the future as EV is still in the early stage of mass adoption, recouping almost $10 billion in losses seems like an uphill battle. As a result, I'd expect the stock to experience nothing but pressure under a new interest rate regime.
On the bright side, AWS remains the most meaningful value driver
AWS remains the bright spot with 1Q22 revenue of $18.4 billion (+37% YoY) and a backlog of $88.9 billion as of 1Q22 (+68% YoY). Operating Income margin of 35.3% was the highest level ever, although it benefited from a change in estimated useful lives of servers and network equipment. Further, management noted that 50% of 2022 Capex ($60B consensus vs. $61B in 2021) will be spent on infrastructure to support AWS.
To date, AWS has launched the first 16 Local Zones in the US and has plans to launch new Local Zones in 32 cities in 26 countries across the world. Local Zones allow AWS to provide services at the edge of the cloud, or run locally near large population. This means fasting computing and lower latency for AWS customers.
Despite competition from Microsoft (MSFT) (+46% cloud revenue growth in 1Q22) and Alphabet (GOOG) (+44% in 1Q21), Amazon remains a highly competitive name in the global IaaS and PaaS market poised to grow at a 29% CAGR from 2021 to 2025 ($400 billion). At this rate, AWS should be a $100 billion business by 2023.
For valuation, I model AWS growth similar to the industry at a 2-year CAGR of 29%, with revenue reaching roughly $104 billion in 2023. Assuming 2023 operating margin of 32% and a target EV/EBIT multiple of 25x (roughly inline with Microsoft), AWS should have an enterprise value of ~$834 billion by 2023.
Advertising is the icing on the cake
Although management never disclosed margins from the advertising segment, one can bet that it's a high-margin business given the Amazon's highly valuable ad inventories including Amazon.com, Fire TV, IMDb TV, Twitch and live sports.
Like Google, Amazon advertising rests in the most well-protected part of the marketing funnel as the majority of ads being run have clear commercial intents where users are already in the purchase consideration stage. From an advertiser's perspective, conversion-led campaigns are usually the least likely budgets to be cut.
Valuation-wise, I model a 20% CAGR from 2021 to 2023 and a target EV/sales multiple of 4.5x (inline with peers such as Google and Meta). This should lead to a 2023 enterprise value of ~$204 billion.
At $2,000, investors can pick up AWS and Advertising at a fair price, while getting the retail business virtually for free
Using a SOTP approach, we arrive at a 2023 market value of a little over $1 trillion and roughly $2,000 a share for both the AWS and advertising segment. Should the stock fall by another 20% to reach this level, investors can expect to pay a fair price for these two highly lucrative businesses and get Amazon's retail empire at no additional costs. Risks to my thesis include (1) slower-than-expected AWS and advertising growth, (2) lower than expected AWS margin, and (3) worsening market conditions putting a lower ceiling on the target valuation multiples.
Amazon is hardly a growth stock in a post-pandemic world, therefore investors should identify potential entry points from a value-oriented perspective. While the online business is challenged by slower growth and severe inflation, both AWS and advertising are doing incredibly well. As a result, I believe Amazon's the risk/reward profile should become quite compelling when the stock reaches $2,000 a share.
This article was written by
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