After confirmation that lockdown supercharged the web retailer’s figures, our companies analyst gives his view on the shares.
Despite the wider US market trading nearly 1% weaker yesterday, after a record drop in economic activity, the Nasdaq technology index edged up 0.3% as “FAANGs” - Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOGL) (now Alphabet) - held their sway.
After the close, Amazon.com (NASDAQ:AMZN) showed why there’s such demand for these tech giants, delivering strong beats to second-quarter 2020 consensus targets.
Earnings are $10.30 per share versus the $1.46 expected, on revenue of $88.91 billion versus $81.56 billion forecast. Yes, there is guesswork as to whether this is exceptional due to Covid-19 lockdowns, or if it represents a fundamental shift in buying behaviour. But the lockdowns have certainly pulled forward the digitisation of society by at least a couple of years.
9% revenue beat overcomes supply system strains
Lockdowns have presented a logistics challenge globally, and yet despite delays to Amazon’s usual one to two-day delivery service, its grocery sales have tripled and grocery delivery capacity soared 160%. Consumer demand then shifted usefully to a more normal mix of products – with better margins – than groceries/consumables.
With a second wave of Covid-19 underway (or repression of the first wave lapsed as governments get desperate to revive their economies), it does not appear people will be much confident to resume visiting stores. I am plenty comfortable visiting supermarkets now that masks are mandatory, but I can’t recall when I last entered any other shops. A recent social psychology article cited that once people have altered behaviour for around 80 days then it is ingrained.
Amazon has brought forward capacity it did not anticipate it would require until 2021, and is preparing for the peak shopping season in November – the fourth quarter this year also set to be boosted by Amazon deferring its mid-July Prime Day shopping event.
Slight glitch in the cloud computing growth rate
Revenue for the keenly-watched Amazon Web Services is up 29% like-for-like to $10.81 billion, slightly softer than the first quarter, testing the story about how big tech firms are benefiting from the shift to more people working from home.
It appears the cloud giants have lately run into the dilemma of clients slashing capital expenditure, hence attention will likely fix on what extent of third-quarter recovery is possible. Amazon is guiding for 24% to 33% revenue growth overall, with a wide range also applying to its operating income target range of $2 billion to $5 billion.
Other elements have also posted strong second-quarter growth, particularly advertising, up 41% like-for-like to $4.22 billion, and subscription services, up by 29% to $6.02 billion.
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But does this warrant a PE multiple near 150x?
At around yesterday’s close of $3,052, the stock’s historic price/earnings (PE) ratio was 145x, which capitalises Amazon at over $1.5 trillion. This compares with over 80x when I drew attention as a ‘buy’ at $1,950 at the end of April 2019. Admittedly, I was late to the party, but the tip has still shown a 57% return. Amazon has never paid dividends which, in an equities bull market, may even have accentuated appeal as a “pure” growth play.
My rationale 15 months ago was momentum-based, organically, with first quarter earnings per share (EPS) having beaten consensus by a whopping 54% with a 117% like-for-like uplift.
In particular, the cloud side was billowing after the launch of new products a vigorous expansion of global reach. Large companies were becoming increasingly relying on AWS, potentially quite a moat.
The group was also investing towards artificial intelligence and the smart home, offering “something new” in the story to keep investors teased.
Yes, the stock has advanced 57%, and I concede this is significantly due to ratings expansion, which also raises the long-term risk of mean reversion.
The fear some years ago was that Amazon would suffer once conventional retailers got their act together online, yet here we are today with “buying online” frequently assumed as via Amazon.
Another factor in my ‘buy’ case had been roughly half of online shopping product searches starting on Amazon.com, and the pandemic has probably reinforced this habit.
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What extent of premium is fair
I expect Amazon will remain a juggernaut for online retail, although investors may argue over this for a while, heralding a consolidation phase for the stock.
Amazon still remains unique in its diversification across e-commerce and cloud computing, potentially leading delivery of “the smart home”. It already has a 33% lead position in cloud computing infrastructure ahead of Microsoft and Google. It is projected by eMarketer to gain share in US e-commerce from 37.3% of sales to 38% this year.
Yes, Amazon has lost out temporarily in April to Walmart, which was better positioned to capitalise on the initial Covid-19 related hike in grocery sales. But Amazon’s increased capacity enables it to take share from regular grocers and compete with Walmart’s delivery.
A near-term risk of anti-trust measures
I think consolidation is also likely now that the US Congress has the collars of big tech CEO’s – witness their testifying this week on a charge of monopolists, given their profit margins. In a presidential election year, politicians will want to prove they are standing up for “the little guy”.
Amazon was held to account specifically over its use of third-party seller data in sales decisions, which does not appear so overtly anti-competitive as Facebook’s acquisition of Instagram (in order to neutralise a rival).
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From my own experience, and showing Amazon’s extent of power, I was able to get Dell Direct to cut a mid-teen percentage off the cost of even its reduced price on a new desktop PC, because I cited Amazon re-selling it cheaper and Dell has a price-matching policy. This testifies to Amazon’s buying muscle, to get lowest prices off manufacturers (who will fear losing share if they do not appear in Amazon searches) and compromises their margins.
I expect Congress will virtue-signal some actions and, yes, these could disrupt Amazon stock in the short to medium term. But, as with Facebook and Google (online searches), people have become addicted because these companies deliver services that transform people’s lives, mostly for the better. Politicians face a tricky task reducing their power: in Amazon’s case it would probably require an online sales tax which is under consideration in the UK, but already being criticised as regressive and punishing of consumers.
Amazon’s success is based on having achieved superior product ranges, price and delivery – so if Congress wants to dismantle that, ultimately it is arguing with the basics of capitalism.
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Does history offer any lessons for mean-reversion?
I think the chief risk Amazon holders face is a rating that is now overblown beyond fundamentals; the company has enough on its hands simply to grow into. And what if the monetary environment changes: say a crisis of confidence in Federal Reserve stimulus actually supporting the economy than boosting asset values?
In recent years, a “growth” style of investing (or momentum trading) has hugely out-performed “value” as vigorously as what preceded the tech-stock bubble bursting in 2000.
This time around, growth and tech stocks have soared against a background of falling yields on all financial assets, higher gold prices and equity performance narrowing in the market, giving multiple signs of low confidence.
Manifestly, the tech sector has changed greatly since 2000, especially in terms of earnings maturity and balance sheet risk. Twenty years ago, debt levels were higher and investors were often speculating on loss-makers they hoped would transform.
Amazon, like Netflix, is not altogether an IT company, but its stock is perceptibly grouped in the FAANGs with Apple, Facebook and Alphabet (the holding company for Google). During the Trump years, the US stock market has been driven by these big internet-related stocks which now overall test 50x historic earnings. Yet Cisco Systems, a key market leader in the boom 20 years ago, traded at over 300x earnings.
My hunch is that Congress will come up with measures that do not fundamentally tame these companies, but may disrupt expectations of super-normal profits. So, ratings are due a degree of tempering, even if the tech context has substantially stronger legs than in 2000. It is impossible to say “to where”, and analysts’ “fair value” consensus of $3,100 currently is more a finger in the wind as to social psychology.
Accordingly, if you are wary, then lock in some gains. I would expect buyers of dips still to emerge given Amazon’s evolution as a global power in e-commerce, so broadly: Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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