Amazon: It Truly Is Day One
Business sometimes echoes sports. It’s often clear when a hockey player is on a breakaway that no one is going to catch up. Such is the case with Amazon.com, Inc. (NYSE:AMZN). Simply put, Amazon is so far ahead in both cloud computing and e-commerce that no one is going to catch it, in our view.
While we believe Amazon’s stock is pricey at the current time (~90x 2018 price/earnings), we would look to buy if the stock fell somewhat based on our belief that Amazon’s earnings are set to dramatically increase in the near-to-medium term. As a result, the stock may be less expensive than it appears at first blush.
Insurmountable Cost and Market Position Advantage
Amazon has a massive advantage in both e-commerce and cloud computing services due to economies of scale. Consider the following:
- Amazon has almost 50% market share of US e-commerce sales according to a report on CNBC credited to eMarketer, while the closest general retailer, Walmart , is at just 4%. Moreover, Morgan Stanley believes approximately half of US households are Prime subscribers. From a logistics standpoint alone, Amazon has a huge advantage because of the density of delivery zones. The simple reality is that Walmart, Target, and other general retailers do not have the economies of scale to compete (at least profitably) with Amazon in ecommerce.
- According to a report posted on ZDNet, Jeffries expects AWS’ market share to be more than 60% in 2019 . While Microsoft and Google are gaining some traction, Amazon remains the clear leader in the space. Amazon is using its leadership position to persistently increase AWS functionality while decreasing price.
Sticky Service Offerings Imbue Amazon with Utility-Like Qualities
Amazon’s AWS offering essentially provides utility computing services. Customers typically utilize several AWS services that are deeply ingrained in their development process. As a result, it’s incredibly difficult to switch cloud providers without redeveloping most (or all) of an application at high cost and potential disruption. What’s more, Amazon is obsessive about delivering a very strong value proposition for its customers, so the likelihood that a customer would switch to an alternative cloud provider for a lower price is quite low, in our view.
In the e-commerce business Amazon has developed the Prime service. Benefits of the program include free shipping (sometimes as fast as 2-hour delivery at no charge), Prime Video and Music, Prime Reading, and savings at Whole Foods. Paid Prime memberships now exceed 100 million, providing Amazon with a huge and loyal customer base. Amazon continues to roll-out new Prime benefits (including a large amount of video content) and features to limit program churn. In our view, these subscribers are likely to remain loyal Amazon customers for the long-term, making it very difficult for competitors to gain market share. Prime customers will continue to shop on Amazon to take advantage of the free shipping and convenience of the offering. In addition, Amazon is now so well recognized for its ecommerce leadership that customers simply go to its website first – aside from niche products, it’s hard to imagine how a competitor could make inroads against Amazon.
Leadership Position in Huge and Growing Markets
The cloud computing, e-commerce, online advertising, and general retailing markets that Amazon is targeting are huge and generally fast-growing. Moreover, in our view, Amazon will grow substantially faster than these markets as it hoovers up market share and re-invests earnings to further strengthen its business.
In particular, the cloud computing market is poised to grow at a strong pace for an extended period driven by (i) the shift from on-premise computing infrastructure to cloud-based systems; and (ii) growth in new software offerings that leverage the power of cloud-based computing and artificial intelligence. Amazon is likely to roll-out increasingly powerful and low-cost services in the future that capture a significant proportion of the growth in this market.
The e-commerce market should continue to grow strongly in North America over the next several years as customers increasingly opt for the convenience of having products (including food and perishables) delivered.
Amazon is also looking to expand its ecommerce offerings into business supplies/products, automotive parts, other segments of retail, as well as to deepen its penetration in International markets.
In addition, Amazon appears poised to substantially grow its physical store presence, most notably in groceries (Whole Foods expansion and, as reported by the Wall Street Journal, possibly through stores unrelated to Whole Foods) and convenience stores (through its Amazon Go concept ). These stores will further entrench Amazon in consumers’ lives.
Operating Leverage Inflection Point, Revenue Growth Should Drive Meaningfully Higher Earnings
Amazon’s AWS and North American retail businesses have both reached an inflection point, with little additional fixed cost needed to support meaningfully higher revenue. Accordingly, we believe Amazon will experience strong margin expansion in the coming years – a phenomenon that occurred in 2018:
We believe the AWS segment will continue to exhibit strong revenue growth on a sustained basis, leading to margin expansion and substantially higher earnings. While it is difficult to forecast revenue/expense growth over the long-term for this segment, we believe it should generate substantial operating earnings as margins expands. Indeed, based on the assumptions below, we think it could generate in excess of US$35 billion in operating earnings a decade from now:
Opportunity to Build a Highly Profitable Advertising Business
Amazon is leveraging its dominant e-commerce position to build a large and profitable advertising business. In 2018 revenues in the product group that houses this service more than doubled to US$10.8 billion. Amazon is building out its advertising business in two ways:
- Charging product sellers and manufacturers for placement at the top of search results. Searches on Amazon now bring up several “sponsored” products as the top results. We believe it will be increasingly important for sellers to pay product placement fees to ensure their products rank well in Amazon’s product search engine.
- Utilizing customer order data to determine optimal targeted advertising to run on third-party websites (banner ads, etc.). According to The New York Times, this advertising has proven immensely effective for advertisers because Amazon has a good sense of what customers are looking to buy or have bought in the past.
Culture of Winning Under Jeff Bezos
Jeff Bezos, Amazon’s Founder and CEO, has built an incredibly customer-focused culture at the company. It is abundantly clear that Mr. Bezos has laid the groundwork for a corporate culture that is obsessive about putting the customer first in everything that Amazon does. Low prices, incredible convenience, ever-improving delivery speed – these are the hallmarks of Amazon’s relentless pursuit and that is why it wins so consistently – customers truly enjoy doing business with Amazon.
Mr. Bezos has displayed this customer obsession since his original letter to shareholders, published in 1997. Amazon’s customer-focus has paid off in spades and will likely continue to accrue benefits long into the future because it is the company’s cultural imperative – Amazon’s modus operandi.
Summing It Up
We believe Amazon is set to lead in multiple markets, most notably e-commerce and cloud computing infrastructure, while expanding in other large sectors such as offline retail and Internet advertising. With continued growth, Amazon should experience meaningful margin expansion which, in turn, should lead to substantially higher earnings. While the stock is pricey, in our view, we believe the long-term outlook for Amazon is very favorable. We would be buyers on weakness.
To see other stocks we’re interested in, please head to our home page.