Summary
Amazon has many advantages, including its pricing power, favorable revenue mix that results in improved profitability, and the expectation of lower capital expenses going forward.
AMZN shares have some negatives and pros. They face stiff competition from e-commerce and are difficult to expand into new markets.
My Amazon Hold rating has not changed; there are pros and con to investing in AMZN, and its valuations do not support a Buy rating.
Elevator Pitch
I continue to assign Hold status to Amazon.com, Inc.’s (NASDAQ.AMZN) shares. I previously wrote about AMZN’s 2022 outlook in an article published December 17, 2021.
My latest article discusses specifically the pros and disadvantages of investing with Amazon shares. My Hold rating is based upon the conclusion that Amazon’s risk-reward balance is more or lesser equal. AMZN does have pricing power in its domestic market, which is in line with Prime. I believe that the decrease in capital expenses and the shift to a revenue mix will be beneficial for Amazon’s future financial viability. Amazon might not be able compete in new growth markets or geographic markets. However, there are many competitors in its core business of e-commerce.
Key Metrics of AMZN Stock
Before I explain the pros and con’s associated with an Amazon investment, I review the company’s most recent financial metrics (Q4 2021 financial reports).
AMZN saw an increase in revenue of +9.4% YoY. It went from $125.6 Billion in the fourth quarter 2020 to $137.4 Billion in the most recent quarter. Amazon’s Q4-2021 top line was broadly in line with market expectations. Amazon’s quarterly sales were only 0.13 percent lower than the consensus revenue forecast.
Amazon’s operating revenue decreased by -49.7% YoY (from $6,873 million Q4 2020 to $2,460 million Q4 2021), but this was +44.2% above the Wall Street analysts consensus estimate at approximately $2.4 Billion. AMZN’s fourth quarter operating profit of $3,460 million in Q4 2021 was also above the prior guidance of between $0 and 3.0 billion.
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AMZN’s guidance for the future is mixed.
Amazon’s Q1 2022 revenue guidance for “between $112.0 million and $117.0 trillion” and operating profit guidance of “between 3.0 billion and $6.0 Billion”, as per its fourth-quarter earnings releases, indicate that the company is likely to earn operating income margins between 2.7% and 5.1% in this quarter.
In other words AMZN’s Q1 2022 operating margin should increase significantly compared with its Q4-2021 operating margin, which was 2.5%. In my earlier update on AMZN’s December 17, 2021, I stated my concern that Amazon could lose out on its 2022 earnings due to an increase in labor costs. The threat of a shortage or workers seems less severe than we had previously feared. Amazon explicitly stated at the Q4 2021 earnings call that “the labor issue is not as big in Q1 (2022),”
Amazon’s Q1-2022 revenue guidance was $114.5B, which is 5.4% below the consensus top line forecast from the sell-side analyst of around $121B.
In my December 2021 Article, I mentioned that “it seems very likely that online sales growth will gradually normalize closer towards pre-pandemic level” which will “translate into a slower pace for retail revenue growth in the future.” AMZN’s revenue guidance this quarter was weaker that I anticipated.
After discussing AMZN’s financial metrics, I will now discuss the pros and disadvantages of becoming an Amazon investor.
Pros Of Buying Amazon Stock
The key investment benefits for AMZN, according to me, are its pricing power in relation US Prime Membership, a more favorable revenue mixture with higher-margin business growing faster, as well as a moderated pace in capital expenditures.
Pricing Power
Amazon stated in its Q4-2021 earnings media release, that it would raise the price of Prime memberships in the U.S. by increasing the monthly membership fee from $12.99 (+15%) and annual membership fees from $119 (+17 %).”).
It is not the first occasion that AMZN has increased the price of Amazon Prime US. Amazon Prime membership prices increased by +25%, from $79 to $99. In 2014, the annual subscription cost was $79 to $99. Amazon then introduced a monthly Prime subscription at $10.99 in 2016. Amazon Prime Prime was launched at $10.99 per month in 2016 and the price of its monthly and yearly subscription plans increased by +18%, +20%, to $12.99/ $119, respectively.
Amazon further stated that in its Q4-2021 results briefing it “welcomed million of new Prime Members” and had “consistently higher member renewal rates in the recent quarter.”
Amazon’s Prime membership base has a “sticky” feel, as shown by the high number of existing members kept, which gives it significant pricing power.
More Favorable Revenue Mix
According to the company’s FY 2021 10-K filings, Amazon’s AWS (Amazon Web Services), revenue increased by +39.5%, going from $12.7 Billion in Q4 2020, to $17.8 Billion in Q4 2021. However, its other (advertising) revenues increased by +32.2%, rising from $7.4 to $9.7B over the same period. AMZN’s retail revenue increased by only 4.1% YoY over the last quarter.
Gartner (IT), a recent research firm, has forecasted that over half of all “enterprise IT” spending in the “application, infrastructure and market services” markets will be shift towards “public clouds computing” by 2025. This suggests that AWS’ strong growth momentum must be maintained over the next few decades. Amazon’s advertising revenues are also expected to increase rapidly over the next few years. Apple’s (AAPL), iOS privacy modifications are a tailwind and a headwind respectively for AMZN and other internet advertising businesses that rely on third parties data. CNBC published a May 6, 2021 CNBC article stating that Amazon has “an enormous amount of consumer data”, which “will likely be a more scarce and valuable commodity to marketers.”
In my earlier December 2021 AMZN article I mentioned that Amazon will see a favorable revenue mixture (which is positive to profitability) as the revenue contribution (as compared with retail businesses with lower margins) of AWS and advertising business grows. The same views remain.
Expectations Of Lower Capital Expenditures
According to S&P Capital IQ, Amazon’s capital expenditures will decline from $61.1billion in fiscal 2021, to $55.8billion, $54.6billion, and $49.7billion respectively for FY 2022/23 and FY 20204, respectively. This is consistent with company management’s remarks at the Q4-2021 results briefing.
Amazon indicated that capital spendings related to “fulfillment center” are “moderating” which “will likely now match growth in our underlying businesses.” This was when AMZN was asked when AMZN “emerges from this investment cicle” during the earnings call.
Overall, I feel positive about Amazon’s ability raise Prime member prices. Higher profitability and a better revenue mix could mean that AMZN will be more profitable in the long-term, which is also important for investors.
In the next section, I’ll discuss the risks and downsides associated with Amazon investments.
Cons of Buying Amazon Stock
In my opinion, the key risk factors or negatives associated with an investment in AMZN’s shares include stiffer-than-expected competition in e-commerce, and the challenges linked to expansion in new geographies and new product categories.
E-Commerce Space Competition
Amazon’s Q4-2021 retail revenue growth or ecommerce revenue has been slow. Its Q1-2022 overall revenue guidance was also below expectations, as previously discussed in this article. AMZN is experiencing increased competition in e-commerce.
AMZN faces greater competition from niche ecommerce platforms as well as social media companies.
The lines between social media platforms and e-commerce platform owners are blurring. Meta Platforms introduced Facebook Shops at the beginning of 2020. This new initiative allowed companies to easily create an Instagram and Facebook store for free. It is focused on a mobile-first buying experience. Snap (SNAP), meanwhile is betting on augmented truth or AR ecommerce. Bloomberg published a January 26, 2022 Bloomberg article highlighting that SNAP is working closely with “businesses to present products via camera overlays on its Snapchat app. So users can digitally test out a new shade of lipstick, or a brand-new shoe style.”
Amazon, on the other hand must compete with niche players within e-commerce. AMZN, before becoming the retail giant that is it today, was a niche bookstore seller. This business model later expanded to other retail verticals. Amazon’s dominance is not the only reason why companies like Etsy, Wayfair, and Wayfair (W), are able to make a niche in their specific areas. These niche players won’t be able take over Amazon’s entire retail market, but they may limit AMZN from expanding in certain product categories. Amazon has not succeeded in challenging ETSY’s hand made product category.
The foreign market expansion is hard
Amazon has been venturing abroad for years, and the division between their domestic (North America) revenues and foreign revenues remains at about 2:1, according to its fiscal 2021 10-K filing.
AMZN’s ability to compete in foreign markets is evident in the company’s response to a question regarding Amazon Prime pricing increases in international markets. Amazon said that the company considers “the relative price to customer versus our cost of supply that and the usage and the value we’re creating to customers” when deciding whether or not to raise the Prime membership’s price in particular markets. This would indicate that Amazon has lower pricing power than its competitors in certain markets.
It is possible to be optimistic about faster growth in international market to offset the slower growth in Amazon’s domestic market over time.
Failure to expand into new growth areas could be detrimental
Amazon’s ability to expand into areas of growth such as lending and healthcare is something that certain investors are excited about. In the end, Amazon will be able to achieve similar success in these areas to AWS or its core business of e-commerce. Amazon’s new growth initiatives may not be as successful for investors as they hope.
One example is the grocery market. Amazon currently holds a small single-digit share of the US grocery industry despite having bought Whole Foods Markets from Amazon in 2017. This could reflect the fact that Amazon lacks a competitive edge in these new segments, where competition is fierce.
Amazon’s core E-commerce business faces considerable competition. It may not live up to its potential in new markets, or areas of growth.
Amazon Stock is it worth investing in
If the stock has more value than its cons, or if valuations are high, then it’s worth investing in. Amazon doesn’t seem to think so.
According to S&P CapitalIQ data Amazon is currently valued by market at a consensus forward 12 months’ EV/EBITDA multiple 19.2 times. This is lower then AMZN’s 10-year forward mean EV/EBITDA 22.9.
AMZN deserves to trade below its historical EV/EBITDA multiple because there are concerns about slowing revenue growth. Amazon saw a +27.2% revenue growth for the FY 2016-19 period. However, the consensus forecasts of S&P CapitalIQ show that it will see a slower revenue growth of +14.9% over the FY 2022-2025 period. The upside is that AMZN will see a slowdown in its top line growth in the next few decades, but it will be compensated by increased profitability. Market consensus is that Amazon’s EBITDA margin should increase from 15.3% for FY 2021 to 18.2% for FY 2025.
Bottom Line
Amazon is a hold, because I see both tailwinds as well as headwinds for it in the coming years. AMZN’s current valuations may not be expensive, but they don’t come cheap. Therefore, a Hold rating seems fair.