A Deep Look At Amazon

The internet has impacted every sphere of life and it has proven to be particularly disruptive for the retail sector due to the enablement of and growth E-commerce. E-commerce has grown at an unprecedented rate all over the world and it is expected to become the largest retail channel in the world by 2021. Within the U.S., the online sales of physical goods in 2018 amounted to $ 504.6 billion and it is projected that online sales will surpass $735 billion in 2023. Much of the revolution in eCommerce can be attributed to Amazon (AMZN), a pioneering company that has emerged as a market leader in the digital retail space. Originally founded as an online bookstore in 1995, Seattle-based AMZN has now evolved into a complex multi-faceted company that sells a wide variety of products, media, and services on its E-commerce platform. 

Amazon’s share of online retail sales

Since its inception, AMZN has achieved unprecedented growth to become not only the largest online marketplace and a global media company but also the most successful cloud service provider. It is projected that AMZN will account for more than half of online retail sales in the U.S. and about 14% of worldwide online retail sales in 2019.

Source: www.emarketer.com

The company has also started focusing on the brick-and-mortar retail business by launching Amazon Books across the US and by acquiring Whole Foods Market. It has been ranked amongst the most innovative companies and it is one of the top five largest companies in the U.S. by market capitalization. At the time of this writing, Amazon has a market capitalization of more than $900 billion dollars and its stock price has grown six-fold in the last five years.

Source: www.google.com

AMZN serves a variety of customer segments that include retail consumers, sellers, enterprises, developers and content creators.The company also manufactures and sells electronic devices that include Kindle e-reader, Fire tablets, Fire TV’s and Echo smart speaker devices.  In addition, the company helps sellers to improve their product sales by providing advertising services.  The company also offers its products and services through Amazon Prime, a subscription-based program that entitles customers to receive benefits. Further, the company enables content creation and publishing through its two arms namely, Amazon Studios and Amazon Publishing.

AMZN has organized its business operations into three segments namely, North America, International and Amazon Web Services (AWS). AWS specifically caters to small-scale businesses, enterprises and developers who wish to launch their respective cloud-based or internet-based software applications and services. As a cloud service provider, AMZN offers a wide range of global computer, storage and database and other service offerings. AWS also provides cloud-based tools to allow authors, musicians, filmmakers to publish and sell content. In recent years, AMZN launched Alexa, its cloud-based voice service that is powered by Artificial Intelligence (AI) and machine learning.  The service can also be used in conjunction with third-party automation devices.

Business Strategy

AMZN strives to be a customer-centric company that has a passion for invention and a commitment to operational excellence. Since its inception, the company’s goal is to garner market share by offering its customers the lowest prices possible through low everyday product pricing strategy and shipping offers. AMZN has adopted a two-pronged strategy to achieve growth. Firstly, it reinvests a considerable portion of its profits back into business to scale its infrastructure and operations for achieving operational efficiency. The economies of scale help AMZN to keep prices low and achieve competitive advantage. Secondly, AMZN not only scales its infrastructure to build operational efficiencies but also offers its infrastructure services to other enterprises and users. Thus, AMZN’s two-pronged strategy enables the company to grow and diversify into related and unrelated businesses.

Initially, AMZN depended completely on third-party logistics companies for fulfilling its logistics needs. After reinvesting in its business to create its own warehouses, AMZN relentlessly focussed on automating its warehouses and to build a fulfilment center network. The company started offering its order fulfilment services to third-party sellers when its fulfilment center network grew to a point where it could handle additional capacity. AMZN made its fulfilment business even more competitive by investing back into infrastructure to lower costs. Similarly, AMZN began offering its AWS cloud services when its internal IT infrastructure and applications scaled up in such a way that they could be offered to those businesses who wanted to migrate their IT services to the cloud.

To gain more control over its cost structure, AMZN is now aiming to build a downstream supply chain infrastructure for shipping directly from its fulfillment centers to customers. By taking control over the downstream supply chain, AMZN aims to launch last-mile delivery programs like Amazon Prime Now that promises to speed up delivery time. The company is now handling its own shipping for 26 percent of online orders. The company has also expanded its capability by launching its own cargo airline and it is now in a position to offer logistics services to third parties. At the end of Q4 2018, AMZN’s air fleet consisted of 50 cargo aircrafts.

Besides reinvesting in growth, AMZN is also plowing back its profits into innovation. The company’s research and development efforts have led to the creation of many popular products and solutions like Kindle, Fire TV, Fire Tablet, Echo smart speakers and the voice-activated Alexa virtual assistant. The company has always been among the top U.S. companies in terms of number of patents granted and it is now exploring new technologies like drone delivery as a last-mile solution. Due to its rapid evolution and broad market offerings, AMZN faces intense competition from different industry sectors around the world. Despite the competition, AMZN continues to remain a customer-focused company rather than a competitor-focused company.

Growth through Acquisitions

Until recent years, AMZN has been sporadically acquiring companies that supported the growth of its E-commerce platform. However, the company’s acquisition strategy is now being driven by its goal to enhance the capabilities of its AWS platform and Alexa virtual-assistant as well. Moreover, AMZN is now acquiring companies at a faster rate than in the past. To gain an edge over its competitors, AMZN has recently acquired companies that will enhance the AI and productivity-based capabilities of its AWS platform. To date, AMZN has acquired Harvest.ai, Thinkbox software, GameSparks, Goo Technologies, Do.com, CloudEndure and TSO Logic to beef up the productivity of AWS. By acquiring Harvest.ai, AMZN is building AI-based data security tools for its AWS platform. Thinkbox offers content creation tools, while GameSparks and Goo Technologies offer tools for cloud-based game development. Additionally, Do.com offers online meeting productivity tools while CloudEndure and TSO Logic are cloud-based workload management tools. AMZN’s acquisition of Graphiq, Blink Home, Ring and Eero are the company’s attempts to build an ecosystem of voice-enabled devices around its Alexa virtual assistant system. By interfacing Graphiq with Alexa, users can use voice commands to generate interactive data-driven infographics. Blink Home, Ring and Eero offer smart home automation devices that can be integrated with Alexa to improve customer convenience.

To expand its E-commerce platform AMZN is making acquisitions to enter new business areas and geographies where it hasn’t had a strong presence.  For instance, AMZN’s acquisition of Souq.com and Wing.ae is solidifying its position in the Middle East and North Africa (MENA) region, the next big growth market in E-commerce. Souq.com is the largest E-commerce platform in the MENA region while Wing.ae is an online delivery booking service that speeds up deliveries within the UAE. Through these acquisitions, AMZN is eyeing to become a dominant E-commerce player in the MENA region. In a major move to diversify in an unrelated sector, AMZN acquired PillPack, an online pharmacy store, in 2018. By entering the healthcare space, AMZN has now achieved the capability of shipping prescription drugs around the U.S.  AMZN’s acquisition of Body Labs is yet another example of the company’s attempt to innovate its E-commerce platform. Body Labs is an AI-based 3D-body scanning and modelling software that will enable AMZN customers to virtually try fashion outfits.

Besides making acquisitions to enhance its digital capabilities, AMZN is also boosting its omni-channel retailing strategy by acquiring physical retail stores and last-mile delivery technologies. In 2017, AMZN made a foray into the brick-and-store retail market by acquiring Whole Foods Market. By entering into the grocery market, AMZN has been positioned as a market challenger to leading retailers like Walmart, Kroger and Costco. Moreover, the acquisition has enabled the company to create an omni-channel ecosystem that consists of online grocery ordering and physical delivery stores located nationwide. In 2017, AMZN acquired Dispatch, a robotics company that created an AI platform for local delivery by a fleet of autonomous vehicles. The acquisition helped AMZN to gain the technical know-how to create Amazon Scout, a recently launched fully electric system that manages last-mile delivery using robots.

Key Growth Areas

AMZN’s subscription service business continued to grow in Q4 2018. During the holiday season, a very large number of customers worldwide started Prime free trials or began paid memberships. Additionally, more customers reportedly subscribed to Prime services worldwide in 2018 than ever before. In 2018, AMZN expanded its Prime Free Same-Day Delivery and Prime Free One-Day Shipping to more than 10,000 cities and towns in the U.S.  In Q4 2018, AMZN enabled its customers to speed up free grocery delivery and pickup from Whole Foods Market through the usage of Prime Now app. AMZN’s Prime subscription service isn’t the only growth driver for the company. In next several years, AMZN will continue to explore growth opportunities in domains that are outside the traditional retail and consumer market. Besides catering to its retail customers, AMZN is increasing its focus on its consumer-facing AI services and market-leading AWS cloud services.  Both, the AI systems as well as the public cloud services, markets are high-growth sectors having compounded annual growth rates (OTCPK:CAGR) of 38% and 12.6% respectively.

Source: Gartner 2019

It has been forecasted that the AI systems market will reach $79.2 billion in 2022 and the public cloud service market will grow to$331.2 billion in 2022. AMZN will also be taking advantage of the rapid growth of the global smart speakers market which is growing at a CAGR of 36%.

Smart Speakers Market Growth 2018-2022

Source: www.abnewswire.com

In Q4 2018, AMZN increased smart home automation features for Alexa. The Alexa system is now compatible with more than 28,000 smart home devices. The number of Alexa-compatible devices has more than doubled in 2018. By integrating these smart home devices with Alexa, AMZN is introducing new ways for customers to control and monitor their homes. AMZN has also introduced features which will help customers integrate Alexa into their car.  The company is expanding its Alexa services to Italy, Spain and Mexico by offering a wide selection of locally relevant services in the region.  Further, AMZN has implemented self-learning capabilities in Alexa and it has also introduced new tools for Alexa developers to build engaging skills.

In 2018, the company continued to invest efficiently in its AWS platform to enhance customer experience. During the year, AMZN continued to expand its AWS infrastructure by launching AWS GovCloud (U.S. East) and AWS Europe (Stockholm) Regions. In Q4 2018, AMZN attracted new enterprise customers for its AWS services. These customers include Ellie Mae, Korean Air, Santander’s Openbank, and Pac-12. In addition, Amgen has decided to leverage AWS for the vast majority of its cloud infrastructure and National Australia Bank has chosen AWS as its long-term strategic cloud provider.

During Q4 2018, AMZN not only launched two machine learning chips but also added significant capabilities to its AWS platform to enable developers to build, train and run machine learning models and algorithms.  Further, AMZN launched four new services in Q4 2018 that provide automation and prescriptive guidance to help customers manage their workloads on AWS.  In the same quarter, AMZN also introduced a service that helps customers to create and manage scalable blockchain networks using the AWS platform.

Apart from benefitting from its AI and cloud services, AMZN is also poised to benefit from its digital advertising business. In 2018, the revenue from company’s advertising business soared more than 70% and it is expected that ad revenue will grow by 50% in 2019 to over $11 billion. In terms of U.S. digital ad sales in 2018, AMZN now occupies third place behind Google and Facebook.

Financials and Guidance

For the trailing twelve months (TTM) that ended on December 31, 2018, AMZN’s operating cash flow increased to $30.7 billion which is a 67% increment in comparison with the cash flow of $18.4 billion that was reported for the TTM period that ended on December 31, 2017.In addition, the company’s free cash flow increased to $19.4 billion in comparison with the $8.3 billion that was reported for the TTM period that ended on December 31, 2017. Further, free cash flow less lease principal repayments increased to $11.6 billion in comparison with $3.3 billion reported for the TTM period that ended on December 31, 2017.

Source: Amazon Q4 2018 Financial Results presentation

For 2018, the free cash flow less lease principal repayments increased to an inflow of $8.4 billion as compared with an outflow of $1.5 billion for the TTM period that ended on December 31, 2017. At the end of FY 2018, the common shares outstanding plus shares underlying stock-based awards totaled 507 million as compared with 504 million a year ago.

Source: Amazon Q4 2018 Financial Results presentation

For Q4 2018, AMZN’s net sales were reported as $72.4 billion which is a 20% increment in comparison with the net sales of $60.5 billion that were reported in Q4 2017.  Further, the growth has been reported as 21% after excluding the unfavorable impact of $801 million due to y-o-y changes in foreign exchange rates throughout the quarter. In Q4 2018 the company’s net sales increased by 21% in comparison with Q4 2017.

Source: Amazon Q4 2018 Financial Results presentation

In Q4 2018, AMZN’s operating income increased to $3.8 billion in comparison to the operating income of $2.1 billion that was reported in Q4 2017. Additionally, the company’s net income increased to $3 billion as compared with the operating income of $1.9 billion that was reported in Q4 2017. Segmentwise, AMZN’s AWS was the top-performing segment in Q4 2019 as the segment’s net sales increased by 45% to $7.4 billion in comparison to the same period of last year. AWS accounted for about 10 percent of AMZN’s total revenue for the fourth quarter.

Source: Amazon Q4 2018 Earnings Release

For FY 2018, net sales increased to $232.9 billion which is a 31% increment as compared to the net sales of $177.9 that were reported in 2017. The growth reported was 30% after excluding the $1.3 billion favorable impact from y-o-y changes in foreign exchange rates throughout the year. In 2018, the company’s operating income increased to $12.4 billion in comparison to the operating income of $4.1 billion that was reported in 2017. The net income in 2018 increased to $10.1 billion as compared to the net income of $3 billion that was reported in 2017.

For Q1 2019, AMZN expects net sales to be between $56 billion and $60 billion which is a growth rate between 10% and 18% in comparison to Q1 2018. The guidance is based on the anticipation that the foreign exchange rates will have an unfavourable impact of approximately 210 basis points. The company expects its operating income to be between $2.3 billion and $3.3 billion, in comparison to the $1.9 billion operating income that was reported in Q1 2018.

My Take

For many years, Amazon was criticized for growing at all costs – and those costs were extremely high. Well, any investors who stayed on the sideline until profits were more robust missed out on some serious price appreciation. Fortunately, we’re still very bullish on the stock. At a recent price of $1864, we believe the stock has a 30% upside to roughly $2450. Unfortunately, it still and will likely not pay a dividend for quite a long time. This stock is for growth-oriented investors and, can be quite volatile as well. It was as low as $1340 in December 2018 before starting on its slow buy steady ascent.

At a price/FCF multiple of 44, the stock might look overvalued, but we urge investors to take a closer look at FCF growth potential. While I don’t see the multiple expansion, the stock price should appreciate along with the growth in FCF, which is expected to be 74% higher in 2019 than 2018, and then grow another 30% growth in 2020.

If you missed the pullback in December, don’t despair, it’s still not too late.

Disclosure: I am/we are long AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It does not provide individualized advice or recommendations for any specific reader. Also note that we may not cover all relevant risks related to the ideas presented in this article. Readers should conduct their own due diligence and carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances.