Amazon.com, Inc. (NASDAQ:AMZN) reported yesterday after the market close, beating analysts’ forecasts for topline growth, sending many bulls into a frenzy – with quotes currently showing a sharp rise of >12% in pre-market trading. This is a pretty strong move, accounting for more than 1/4 of the 30-day volatility of the stock:
In my opinion, the company could continue to get a tailwind from the influx of some investors from other less efficient mega-cap techs – like Meta Platforms (META) – but aside from its revenue growth, Amazon has almost nothing to boast about. If we move from a technical to a real recession soon, there is a risk that the company’s fundamentals will suffer even more in the coming quarters, which will impact the stock at its current valuation.
Why do I think so?
Let us take an unbiased look at Amazon’s quarterly report. I know that’s pretty difficult, because of the more than 1.1 million people who follow this company on Seeking Alpha, a significant portion is Amazon shareholders. Nevertheless, we have facts and figures that are hard to disagree with.
The company’s revenue increased by 7%, but that came from a +10% increase in U.S. customers, while the international segment posted a 12% YoY decline. The largest revenue segment, online stores (~42% of total sales), declined 4.33% YoY, which is quite a bit. As we know, retailers need to pass on inflation growth to their customers, which is obviously not happening as the company generates more than 22% of its total sales overseas. The strong dollar affects the rate of revenue growth when the reports from the various segments are consolidated, which is why even modest topline growth triggers such a violent market reaction.
Growth of the most promising revenue segment – AWS – increased by 33.29% year-on-year, while the operating profit margin of this segment remained at about the same level (28.95% in Q2 2022 vs. 28.31% in Q2 2021). Perhaps that was part of the reason for the relief rally we are seeing right now, but keep in mind that AWS only accounts for 16.28% of the company’s total revenue, so the success of AWS is not going to be able to meaningfully turn around financials that have been stagnant for more than the first quarter:
Last year, AWS’ share of total revenue was 3.2% lower than it is now, so the company may need another 5-6 years before this segment becomes the main one (assuming it grows at a steady pace), which I personally do not believe very much. Why?
The cloud business is fiercely competitive, and AWS is losing its dominant market share relative to its like-sized competitors (DigitalOcean’s (DOCN) performance is taken to add additional color from the mid-sized players):
As you can see, AWS had the weakest year-over-year growth in Q2 2022 compared to its large-cap peers. By the way, Amazon’s cloud business segment lost 12.32% of its operating income in absolute terms compared to the previous quarter (Q1 2022).
Therefore, the current depressing situation – caused by the loss of AWS market share and the inability of the main retail segment to convert even inflation rates into sales growth – is likely to continue for the foreseeable future, in my view.
I am also puzzled by management’s policy on self-reward:
In H1 2021, the company generated a net income of nearly $16 billion; now we see that Amazon has essentially lost $21.7 billion of that value, while top executive stock compensation has increased 44% (year over year), more than triple the growth of shareholder’s equity (taking into account all buybacks during the period indicated).
I think such an approach can perhaps be afforded by a fast-growing technology company, but by no means by a mega-cap giant with declining margins and growth rates.
Need I say how this approach to self-compensation correlates with the quality of free cash flow generation?
Investors, regardless of the size of their capital, always try to look into the future when analyzing target companies for purchase. In this article, I have tried to do much the same, but my conclusions may differ from yours, and that’s okay because I tend to believe truth is born in a discussion.
In my opinion, Amazon’s management – without naming specific individuals – is doing a pretty poor job of running this massive behemoth, which has succeeded in every market it has tried to conquer because of its size and financing capacity. Right now, however, AMZN is under intense pressure, both from the development of its cloud service (the risk of continued loss of market share) and from its inability to show an inflation premium in its revenue growth.
No one can say for sure when the company’s shipping problems will be resolved. But given current valuation levels, the market assumes they will be soon. This poses another risk – if the problems are not resolved in the medium term, this could lead to a serious decline in the share price.
Of course, I realize that the jump in pre-market will not be the last if there is an improvement over the next few quarters as investor interest in mega-cap technology stocks increases. As such, I rate AMZN as Neutral until we see a qualitative change in the way the company is run.
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