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Amazon (NASDAQ:AMZN) saw strong share price weakness on the back of weaker-than-expected earnings. As we discussed just a few weeks ago, we believe Amazon is at several times fair value, with a fair target price of roughly $1,000/share (pre-split). As we’ll see throughout this article, Amazon’s recent earnings reaffirm the thesis.
Amazon saw growth rates decrease significantly in the most recent quarter.
Amazon Sales – Amazon Investor Presentation
The company saw $477 billion in TTM net sales up 2% QoQ and ~12% YoY. The company saw international sales slow down slightly while AWS and North American sales both continued to remain strong. That financial performance turned into almost $30 billion in negative cash flow expanding significantly QoQ.
The company is currently trading at an annualized -2% cash flow yield, and so far, that shows no indication of slowing down.
Amazon has substantial headwinds worth paying close attention to.
(1) Rising Expenses
(3) Customer Concern
Amazon has 3 headwinds that in our view all work together to place substantial pressure on the company. The first is raising expenses. Inflation is pressuring the company’s free-shipping and other expenses, however, customers aren’t ready to eat all those costs. The company didn’t lower prices when crude prices dropped from COVID so it doesn’t have the room to increase them.
The company’s competition has continued to grow. Walmart (WMT) is rapidly expanding its online offerings, matching a strong physical footprint. Numerous other companies, such as Macy’s (M) and Gap (GPS) are expanding their e-commerce businesses rather than working through Amazon. That’s partially due to the increased value of customer data and trends, which Amazon has access to when you sell with them. With the company already having a dominant market position, competition will hurt future earnings.
Last is customer concerns. Americans are concerned about inflation, and Amazon has never had the cheapest prices. It’s always been a convenience offering. We expect that in a difficult environment, customers will increasingly look towards maximum savings, causing them to move away from Amazon.
Amazon, in our view, is making the same mistake we’ve discussed about with Netflix (NFLX). The company clearly defined an industry, arguably it defined two industries with online shopping and AWS (cloud computing). However, defining that industry, if that industry doesn’t have an insurmountable bar to entry, can only generate rewards for so long.
Amazon and Netflix shareholders are both starting to realize that. Amazon is “flexing” its pricing power by increasing the price of the Amazon Prime subscription. However, as discussed with the headwinds above, customers are looking closer at their wallets, and Amazon never offered the lowest prices or anything similar.
Similarly in AWS, the company has an impressive business. However, Google Cloud (GOOG) (GOOGL) and Microsoft Azure (MSFT) are also growing rapidly. The company is facing new competition here. We expect the company’s market dominance will continue to be pressured, which at minimum, will continue to put pressure on its margins.
Another going concern for Amazon is the company’s continued shareholder dilution.
Amazon Dilution – Amazon Investor Presentation
Despite repurchasing ~1 million shares for ~$3 billion in 1Q 2022, the company still saw its YoY outstanding share count increase by 4 million shares. Given continued stock-based awards, we expect the company to continue adding roughly 4-5 million shares annually, or almost $15 billion in annual dilution expenses.
It’s also worth noting that in their new employee offers, Amazon has consistently assumed 15% annualized stock growth. In a tough job market, the company was forced to more than double its maximum base compensated to employees. Given weak stock price performance (the company’s share price is down YoY), we expect this 15% assumption will soon be challenged.
That’ll result in increased share awards, which means even more dilution.
Our view is that Amazon continues to struggle. The company’s margins will continue to be compressed by competition, pushing FCF to negative levels. The company will continue to have enormous capital obligations to fulfill its commitments to shareholders. New competition will hurt its ability to successfully raise prices in the same way for Netflix.
More so, Amazon’s core offering has continued to be a commitment to customers. In a high inflationary environment, that loses importance over customers looking to protect their pocketbooks, which could stress Amazon’s sales and explain why they’re slowing down. The company doesn’t offer pricing matching versus competitors like Walmart that do.
That means in a price competitive environment, the company is less competitive.
The largest risk to our thesis is Amazon continues to have a dominant market position with pricing power. So far there’s no indication that the Prime price raise has caused massive amounts of customers to leave. If the company can reduce costs and focus on improving its margins, it has the ability to provide reasonable and potentially growing shareholder returns.
Amazon defined an industry the same way as Netflix. Arguably, the company defined two industries, becoming synonymous with both online shopping and cloud computing. However, despite that, competition is increasing significantly in both sectors of the company’s business and its revenue growth is slowing down.
The company’s costs are going up and it still has significant dilution effects from its employee costs. Amazon has seen strong negative FCF with substantial capital spending, and with no sign of that ending, we expect the company to have a poor ability to generate continued shareholder returns.
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