georgeclerk
Elevator Pitch
My investment rating for Amazon.com, Inc.’s (NASDAQ:AMZN) stock stays as a Buy.
I highlighted my expectations of AMZN reporting above-expectations operating income and resuming share buybacks this year in my prior November 1, 2022 article.
In the current write-up, I take a longer term view of Amazon’s shares. I see Amazon growing its free cash flow and expanding its operating margins in five years’ time. This provides justification for my Buy rating assigned to Amazon.
Where Will Amazon Stock Be In 5 Years?
I expect Amazon to be more profitable and generate a higher level of free cash flow in the medium term. My view of Amazon’s intermediate term outlook is aligned with the Wall Street analysts’ consensus financial estimates for the stock.
As per S&P Capital IQ’s consensus data, the sell-side sees Amazon’s EBIT margin and free cash flow rising to above 10% and in excess of $100 billion, respectively in fiscal 2027. This represents a significant improvement from AMZN’s pre-COVID FY 2020 operating margin of 5.9% and free cash flow amounting to $31 billion.
In my opinion, the growing share of revenue derived from higher-margin businesses, Amazon Web Services (or AWS) and advertising services, will be the key driver of AMZN’s higher operating profit margins and stronger free cash flow in the next five years. AWS and advertising services accounted for 16% and 7% of Amazon’s revenue for the first nine months of 2022, respectively. AWS achieved an operating margin of 30% for full-year 2021, and the advertising services business is even more profitable than AWS based on research analyst Benedict Evans’ estimates.
There is certainly room for advertising services and AWS to contribute a larger proportion of AMZN’s top line going forward.
Amazon hosted its annual AWS re:Invent event between late-November and early-December last year. BofA Securities published a research report (not publicly available) on November 30, 2022 titled “Ecosystem Remains Strong”, outlining takeaways from AWS’ CEO presentation at the 2022 AWS re:Invent event.
This BofA Securities’ report highlights certain metrics disclosed by AWS’ CEO which suggests that AWS continues to gain significant traction with existing and new clients. Specifically, nine out of 10 companies on Forbes’ Cloud 100 list, a ranking of the leading private cloud companies globally, are users of AWS.
Also, AWS is securing more new customers and winning new projects with existing ones in the financials sector, according to AWS’ CEO as per the BofA Securities’ report. A key win for AWS in the financials sector is that the Nasdaq MRX option exchange is now hosted on AWS since December 2022. AWS’ CEO also revealed the names of some of its clients which are leading players in their respective industries, such as Samsung (OTCPK:SSNLF) (OTCPK:SSNNF), Airbnb (ABNB), and Expedia (EXPE).
Separately, the public sector also continues to be a significant source of new business opportunities for AWS. Seeking Alpha News reported earlier on December 7, 2022 that AWS shared “Pentagon’s $9B cloud awards” relating to “the Joint Warfighter Cloud Capability contract” with three other major technology companies.
The growth outlook for AWS in the mid term is excellent, taking into account the company’s backlog and industry forecasts. Amazon revealed at its most recent Q3 2022 earnings briefing that AWS’ backlog expanded by +57% YoY to $104 billion as of September 30, 2022. On the other hand, Forrester (FORR) estimates that the size of the worldwide public cloud market could be as large as $1 trillion in 2026.
Amazon’s advertising services business is the other major growth driver for the company.
Advertising services only contributed a high single-digit percentage of Amazon’s top line in 9M 2022, and I predict that the advertising services business could potentially grow to represent as much as 10% of AMZN’s revenue by 2027. My bullish view of the advertising services business’ growth prospects is supported by market forecasts and channel checks.
Based on media research firm GroupM’s forecasts, the worldwide retail media market is projected to expand by +58% in the subsequent five years from $101 billion for 2022 to $160 billion in 2027. The industry is expected to grow fast, and Amazon’s advertising services business is well-positioned to grab a bigger share of the market.
According to Deutsche Bank’s (DB) November 1, 2022 research report (not publicly available) titled “Key Takeaways From unBoxed 2022”, AMZN’s advertising services business has been gaining market share. The DB analysts’ conversations with advertisers at a recent industry summit suggest that “platforms like Amazon with large high-intent customer bases that are capable of providing comprehensive ad campaign effectiveness” are taking a larger slice of advertisers’ budgets.
In a nutshell, I have a positive view of Amazon’s five year outlook, and I see the company registering robust free cash flow and healthy profitability in the future.
What Is The Short-Term Prediction?
Analysts are bearish on AMZN’s near-term financial performance.
Based on the consensus financial figures drawn from S&P Capital IQ, the short-term prediction is that Amazon will experience slower growth and weaker profitability. Specifically, Wall Street forecasts that AMZN’s top line growth will slow from +14.7% YoY in Q3 2022 to +6.2% YoY for Q4 2022, and the sell-side sees Amazon’s EBIT margin contracting from 2.0% to 1.8% over the same time frame. In other words, Amazon’s upcoming quarterly financial results release at the end of January won’t be pretty.
But this has created a buying opportunity for Amazon’s shares, as highlighted in the next section.
AMZN Stock Key Metrics
Amazon’s valuation metrics imply that the stock’s valuations have become very appealing now.
The market currently values AMZN at 12.6 times consensus forward next twelve months’ EV/EBITDA according to data sourced from S&P Capital IQ. Amazon’s current EV/EBITDA ratio is at a 44% discount to its 15-year average EV/EBITDA metric of 22.5 times. It is worth noting that the last time Amazon’s forward EV/EBITDA valuation multiple dropped below 13 times was during the 2008-2009 Global Financial Crisis.
In the subsequent section, I focus on potential short-term catalysts for AMZN.
What Are Catalysts To Watch For?
The major catalysts for Amazon in the near term will be potential earnings beats in subsequent quarters.
Given that the global economy remains weak, above-expectations financial results for AMZN will be dependent on more aggressive cost management rather than positive revenue growth surprises.
A recent January 4, 2023 Seeking Alpha News article noted that AMZN has plans to “lay off over 18,000 employees.” This makes it more likely that short-term catalysts for Amazon relating to lower-than-expected expenses and better-than-expected profitability can be realized.
Is AMZN Stock A Buy, Sell, Or Hold?
I retain my Buy rating for AMZN. Higher profit margins and stronger cash flow in the future should eventually bring about a positive re-rating of Amazon’s valuations.
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