Amazon Stock: Far from Fair Value After YTD Bounce (NASDAQ:AMZN)

Introduction and paper

Amazon (NASDAQ: AMZN) Stocks ended 2022 with a 50% correction (almost the same rate of decline from the peak) – one of the worst years in stocks history, if you don’t count the drama of the 2000s.

When I last reviewed Amazon in late July 2022, I concluded that the stock was still trading fairly high and there were some red flags to consider. The article is outdated since then.

I’m updating my paper today, but changing my previous rating from Neutral to Buying. Amazon has focused on cost control while growing its market share in e-commerce. Additionally, AWS continues to expand aggressively, and the company’s overall valuation is currently at its lowest level in years. This was not found six months ago and is not visible today.

Cost optimization, e-commerce and cloud

The first thing I would like to draw your attention to is that management is stepping up its cost optimization efforts by increasing layoffs to 18,000 (an estimated 5.5% of the company’s workforce). annually), Amazon Stores, People, Experience, and Technology Group.

According to Reuters, this is one of the biggest layoffs in the tech sector in terms of absolute numbers of employees.

However, unlike Twitter, Peloton (PTON), or Better.com, Amazon has laid off relatively few employees. Apparently, management decided to sacrifice the prospects of the less profitable, highly risky segments and focus on building market share in the existing highly profitable segments.

Bank of America analysts said in a Jan. 9 note that Amazon’s U.S. retail spending growth in the third quarter of 2022 outpaced both U.S. Census data and bank card spending data, prompting AMZN to overtake the e-commerce industry. pointed out that it continues to gain share in

Wells Fargo’s Brian Fitzgerald points out that the census data shows the same trend. For the better part of the last decade, e-commerce sales have increased about 15% nationwide, and returning to the long-term trend line, Amazon’s Q4 guidance is his 2%-8% sales growth rate. seems too conservative.

As the absolute leader in the Western e-commerce market, Amazon has a good chance of riding the 27% CAGR that ReportLinker’s analysts forecast for this market. [2023 to 2027]According to their calculations, this global market will reach almost $13 trillion by 2027, which is a lot for Amazon too.

According to Statista, Amazon held about 13% of the global e-commerce market in 2021. Given that it’s actually $13 trillion, his current AMZN market cap is only 7.7%.

In terms of potential upside, even if Amazon’s share doesn’t grow from here, I think there’s a lot to consider. The company already has the trenches and safety margins needed for future margin expansion.

Amazon definitely has a moat and technology edge in its cloud segment. According to Statista, Amazon’s share of the global cloud infrastructure market in the third quarter of 2022 is 34%, still ahead of the combined market share of its two biggest competitors, Microsoft Azure and Google Cloud.

Amazon Web Services (AWS) remains strong in growth and margins, but both revenue growth and margins disappointed investors in the last quarter. 16% of revenue), up 27% year-over-year and 4% quarter-over-quarter. AWS EBIT was $5.4 billion, down from $5.72 billion in Q2 2022 and up 11% from $4.88 billion a year ago. AWS EBIT margin was 26.3% in 3Q22, up from 29.0% in 2Q22 and 30.3% a year ago. AWS, which currently delivers more than $80 billion in annual revenue, is likely to face tougher comparisons in the coming quarters, which could challenge revenue growth, analysts at Argus Research said. pointing out.

I agree with these conclusions. The higher the bar of comparison, the harder it is for a company to keep achieving growth above his 20%. Expanding to the cloud in 2023, or already starting to do so, especially against the backdrop of a shrinking market in anticipation of difficult times). However, long-term growth is never out of the question. Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) technologies need to be implemented, and Amazon has about 55% share of the total market. , according to BofA, will only grow in the next five to ten years.

Grandview Research values ​​the global PaaS market size at $60.12 billion in 2021, with a CAGR of 19.3% from 2022 to 2028. The Business Research Company has calculated that his IaaS market size worldwide will grow from his $81.16 billion in 2022 to $96.93 billion in 2023. A compound annual growth rate CAGR of 19.4% despite all the challenges in the world. Research and Markets sees a long-term CAGR of 27.2% for IaaS.

So while 2023 is likely to be tougher than the highs of 2021-22, growth is unlikely to stop even then. market.

Amazon’s DCF and Relative Ratings

Thinking about the future always makes me feel relaxed and gives me warm hope for the best that every investor needs. However, in such moments it is best to wake up and approach the evaluation as calmly as possible, since much depends on it.

Assume that AMZN’s revenue declines 8% YoY in E2023 and increases at a CAGR of 14.65% until E2026. Assume that the EBITDA margin declines to a positive 9% in E2023 (with an EBIT margin of only 2%), but then the EBIT margin is 6.8%, increasing gradually to 14% by E2026. This doesn’t look very optimistic. For example, in FY2020 he already had an EBITDA margin of 12.5%, and in FY2020 he reached an EBIT margin of 5.93%.

D&A as a percentage of total sales is expected to fluctuate between 6.5% and 6.9% each year. The ratio of receivables to sales is 7.3% in E2023 and decreases to 6.5% in E2024. This reflects the company’s improved operations. It remains constant at 7% for the remaining forecast years. The inventory to sales ratio increases to 8% in E2023, reflecting difficult times (increased inventory is mostly a problem in retail). However, after E2024, this ratio will gradually decline to reach 6.9%, reflecting the greater weight of the cloud. A segment of Amazon’s business. Accounts payable increased slightly to his 8% of sales, and that trend will continue into fiscal 2020 and beyond — I think management will look to improve the cash conversion cycle. However, from 2024, we expect this ratio to decline gradually from 8% to 6.9%.

CAPEX as a % of revenue declines by about 140 billion years. Based on my calculations, it’s only 7% for E2023. Looking at past historical periods, we can see that as Amazon has grown, its capital expenditures have increased and decreased through various investment cycles. This cycle has peaked since 2020 as capital costs are fairly low. AMZN was able to invest up to 13% with near-free project financing. [as of its revenues] – Just like in the 2000s:

My assumption of 7% holds true for E2024, then it will gradually rise to 7.8% by E2026. This is because the company’s business structure (which is in many ways different than it was 20 years ago) does not allow the cost of innovation to rise significantly. reduction.

Discount rate – [WACC] – The one I use for the DCF model I’m describing has the following inputs:

• 3.5% risk-free rate;
• 4% debt cost;
• 13% tax rate;
• Beta version of 1.2.
• Market risk premium of 4.7%.

In the output we get the following free cash flow data:

Assuming Amazon continues to grow at a rate of 4% over the forecast period, the fair value per share today is $129.1. This is about 31.5% upside From the closing price of the last trading day.

Assuming the stock trades at 12x EBITDA by the end of 2026 (which itself is very conservative), its fair value is $123.2 per share (~25.6% upside potential at the current stock price).

Last year’s stock performance made Amazon stock a prime example of undervaluation that not everyone understands or recognizes.

After reading some very exciting and undeniably good investment books by Peter Lynch and his followers, some investors are skeptical of price-to-earnings ratios (or similar Make investment decisions based solely on well-known multiples).

Amazon PER [FWD] 60x according to YCharts data. This is so many that it scares many retail investors. But remember, it doesn’t matter how a retailer makes money (offline or online). It’s retail first and foremost. The industry is characterized by fairly low profit margins, and when the crisis begins, the volatility of profit margins increases sharply. Of course, it’s not the best direction for business. If the business cycle moves in the opposite direction, it stabilizes again just as quickly. Therefore, PER is no longer representative in this situation. More important for companies in this sector are multiples related to earnings. This is because it is the revenue dynamics that indicates the stability of the business model. Looking at the multiples associated with this metric, and adding other equally important EV/EBITDA and price-to-book ratios, we can see that AMZN stock is trading near the local lows of the relative valuation range.

Compared to long-term historical multiples, AMZN stock appears to be 24-57% undervalued, depending on the selected ratio. These results broadly support what my DCF model shows.

Conclusion

I acknowledge that my conclusions and the buy rating itself carry some fairly significant risks. beginningas I mentioned in my articleHow to Position Your Portfolio for 2023“We are entering a period of turmoil that is likely to continue through 2023, and we will be in recession midway through the year.

In this article, we can add that betting on quality bonds in 2023 looks much more attractive as the bottom of this asset class has already been reached and the bottom of the stock market still looks far away. can.

Second risk Relevant to my paper is the sensitivity of my DCF output to some underlying assumptions.For example, if WACC is increased to 10% [by increasing the MRP to 6.1%], with a fair value of $92.6 per share. In this case, we have to talk about overestimation, not underestimation.

Or, for example, if the company doesn’t quickly return to positive earnings growth in E2024, what will happen to its stock valuation? Assuming a CAGR of 8.6% instead of 14.65%, AMZN’s fair value per A drop to $107 severely limits upside potential.

In the event of a large sale or sustained earnings downgrade, I believe this is very likely across the tech sector.

But despite that, I think Amazon stock is already in oversold and overvalued territory. Literally last week the stock took advantage of the accumulated divergence and broke through the downtrend channel – a classic triangle pattern:

The volume during this move was very good – if the risk-on rally continues and (SPY) doesn’t bounce off the next resistance, AMZN will see an increase in vertical volume and a chance to ‘lift’ to the previous level It seems to me that there is .

the closest target 20-25% of current priceThis should be my medium-term price target.

thank you for reading!