Since its founding in 1994 as a simple online book seller, Amazon.com Inc. (AMZN, Financial) has a been a disruptive force in many industries. Not just retail and e-commerce, but also advertising, media and cloud computing. As one of the first trillion-dollar market cap companies, it has recently fallen from its lofty perch with its stock declining 50% in 2022. The question is, will it join other high-tech flyers like Tesla (TSLA, Financial), which declined around 65% in 2022, and Netflix (NFLX, Financial) that was down over 70% at one point last year?
The company’s business model has diversified over the years to beyond being a one-stop e-commerce destination for almost any type of consumer product. Amazon also manufactures and sells electronic devices, including Kindles, Fire tablets, Fire TVs, Rings and Echo. The company’s fast-growing Amazon Web Service (AWS) platform provides computing, storage, database, analytics, machine learning and other technology services. Its membership platform, Prime, provides free shipping of various items as well as access to streaming of music, movies, TV shows and other video content. The company also has a network of over 6 million third-party sellers.
Amazon is expected to generate over $500 billion in revenue this year and currently has a market capitalization of $857 billion.
Cost cutting
Like most large-cap tech companies, Amazon is undergoing cost reductions and efficiency measures. One focus is the so-called “other bet,” in which the company spends in the range of $10 billion to $15 billion annually with no material near-term return on investment. For example, the Alexa business was mentioned as one segment that has operating losses of greater than $5 billion annually. Other money-losing ventures include Kuiper, Zoox, video games and its foray into health care. I do not expect the company to eliminate all of these “other bets” as it needs new products and services for future growth, but any material cut would provide a significant boost to the bottom line. The company also indicated it has stopped hiring incremental new employees.
Financial review
The company continues to put up decent growth rates, at least on the top line. Total sales increased 15% to $127.1 billion in the third quarter, with AWS leading the way with 28% constant currency growth. The North American segment increased 20%, while the International segment decreased 5%.
Operating income results were a different story, with the North American segment reporting a loss of $400 million and the International segment reporting a $2.5 billion loss. AWS was again the stalwart with operating income of $5.4 billion compared to $4.9 billion in the prior-year period. A slowing consumer spending pattern, higher fuel and input costs and the now routine supply chain pressures continue to weigh on the core e-commerce business. It was shocking to many investors that the original business created by Amazon is not making money at this time.
Amazon has also operated at a negative free cash flow position for the past four quarters. Operating cash flow less capital expenditures was -$19.7 billion in the third quarter. For the three prior quarters, free cash flow was -$23.5 billion, -$18.6 billion and -$9 billion. When including debt and lease repayments, the situation is even worse.
The company’s cash and investments position has declined to $58.7 billion from $96 billion at the end of 2021. Long-term debt increased to $58.9 billion from $48.7 billion over the same period.
However, management recently stated they expect free cash flow to flip to positive in 2023 as working capital improves and capital expenditures come down.
Valuation
The company gave fourth-quarter guidance of sales between $140 billion and $148 billion, which is a growth rate of between 2% and 8% compared to the prior-year period. Operating income is expected to be between breakeven and $4 billion, compared to $3.5 billion in fourth-quarter 2021.
The company will not generate positive net income in 2022 on a GAAP basis primarily due to the markdown in equity securities valuation. On a non-GAAP basis, analyst estimates are approximately $1.40 due to the difficult operating environment. Non-GAAP earnings peaked in 2021 at $4.21, so the company is a long way away from full earnings potential.
The 60 price-earnings multiple is a reduction from historical levels, but still seems elevated, particularly for a company whose core e-commerce business is losing money. 2023 consensus estimates are approximately $3.50, which drops the forward price-earnings ratio to a more reasonable 24. However, the GAAP earnings per share estimate drops to $1.50 due to the massive level of stock-based compensation the company still pays its employees.
The GuruFocus discounted cash flow calculator creates a value of $67 per share when using 2023 non-GAAP earnings of $3.50 per share as the starting point and a long-term growth rate of 10%. The current stock level is pricing in a 10-year growth rate of approximately 15%.
Guru trades
Gurus who have purchased Amazon stock recently include Catherine Wood (Trades, Portfolio) and Al Gore (Trades, Portfolio)'s Generation Investment. Those who have reduced or sold out of their positions include Spiros Segalas (Trades, Portfolio), Steven Romick (Trades, Portfolio) and Ray Dalio (Trades, Portfolio)'s Bridgewater Associates.
Summary
Amazon's stock price has likely not fallen enough to create a margin of safety for long-term value investors. The high-margin AWS segment is still just a cloud company with intense competition from Microsoft (MSFT, Financial) and Alphabet (GOOG, Financial). The company needs to prove it can rationalize its cost base and trim money-losing ventures with no hope of near-term returns in order to gain confidence from investors.
