Amazon: End of Days or Still “Day One”?


By James Cakmak and Ryan Guttridge

Andy Jassy hasn’t even completed his first year as CEO of Amazon, but he’s already feeling the heat. And so are investors.

Much like the market, Amazon investors have bifurcated into two camps: those who believe this is the beginning of the end and those that project it’s still “Day One” for Amazon. Needless to say, we are in the latter camp.

If you look at Amazon’s 1Q22 results in a vacuum, it was a bad quarter. Moreover, you can’t sugarcoat management missteps in gauging and sizing capacity for demand. The stock is now paying the price for making investments in the face of slowing growth.

But we don’t look at things in a vacuum. Amazon is lapping inflated growth comparisons; a slowdown was mathematically inevitable. Zooming out to the forest from the trees, however, it appears as though growth rates are simply mean reverting back to their longer term averages.

When it comes to labor and capacity, it also appears the company is becoming more nimble in its ability to scale up and down as demand ebbs and flows.

The original promise of the internet was “clicks not bricks”. In other words, the internet would enable businesses to rapidly grow without the burden of physical constraints. Through its logistical prowess and cloud infrastructure, Amazon is now fulfilling the scale free promise.

Peak Uncertainty

No matter which index or sector you look at, the markets have been ugly. It’s no surprise why uncertainty is so elevated when you consider the following:

  1. Supply chain decimated by lockdowns
  2. Climbing inflation
  3. Fed pulls an abrupt 180 with interest rates and its balance sheet
  4. There’s a war going on
  5. Recession fears and risk to S&P earnings mount

It goes beyond these major headlines, however. Much like the Fed, investor sentiment has pulled a 180, especially when it comes to what’s prioritized.

Growth has taken a backseat to profits. Uber CEO Dara Khosrowshahi even had to pen a letter declaring a “seismic shift” in investor expectations.

So what’s changed. In short, “investing” has become a bad word.

Despite companies growing faster and monetizing faster, the lack of earnings is serving as a reason to sell. The cloud infrastructure built by Amazon, Microsoft, and Google facilitates growth opportunities larger than ever before, but “investing” in that growth has become taboo.

This serves as a payday for algorithmic (read: computers) traders who grab onto such moments and reinforce the downward trend. It’s further exacerbated by the fact that fundamental buyers have all but stepped to the sidelines. The market has no bid. And “investing” is exploited on the short side.

We’re in a market where consumer “staples’’ with declining topline figures are rewarded with premium valuations. In contrast, growth assets with eye-popping sales growth are discounted given the earlier stage of their profitability curves.

Secular forces always win over cyclical ones. If you’re willing to invest now, the opportunity is generational.

Amazon In Your Portfolio

Any company with a subscription aspect to their business has seen their stock hammered. Amazon is no exception. To be sure, Amazon is not strictly a subscription business per se, but there’s a growing chorus of negative sentiment around such “discretionary” businesses as recession fears edge higher.

Amazon is not Netflix.

Instead, Amazon is the most valuable subscription in your portfolio of subscriptions. Its entire purpose is to save you time.

Unlike your Netflix subscription, Prime has a positive return on investment. So while discretionary by definition, the ability to “make money” from time savings makes it more essential than not.

We believe saving time is the main purpose of any innovation. Further, it’s a prerequisite for creating sticky customer bases. Think of it this way. Which subscription out of your portfolio of subscriptions would you give up last…one that uses up your time or saves you time?

The Original Cloud-First Company

Retail is not central to the Amazon story at all. Operationally, the retail business serves as a lattice on which its profitable business verticals, such as AWS, rest. Likewise, logistics was an outgrowth of retail, as was advertising.

The financial goal of any company is two-fold: maximize revenue and maximize the return structure.

Revenue is straightforward. Return structure is a function of margins and asset productivity. Increasing revenue for each dollar of assets is the engine for driving returns financially, and, in turn, for shareholders.

While the invention of the assembly line was the best historical example of increasing asset turns, Prime is right up there with it. Prime is at the core of the Amazon story and the conduit to fueling engagement for each customer over time.

Take a look at Amazon’s businesses through the lens of Prime:

Consider what you get from Prime. For $139 per year, Prime members get to fully participate in the Amazon flywheel. Contrast that to Netflix at $120 per year for the most basic plan and the value becomes starkly apparent.

Prime member figures back up this point. Recall, Jeff Bezos stated that Prime members surged to 200 million in February 2021, up from 150 million the year prior, and 100 million in April 2018.

In Andy Jassy’s inaugural investor letter in April 2022, he reiterates that Amazon maintains “over 200 million Prime customers”. This compares to Netflix which has a similarly sized subscriber base and lost customers in the latest March 2022 quarter.

But it’s not just the stickiness, it’s that Amazon can also maximize asset turns by increasing engagement. Jassy writes customers have “started using Amazon for a larger amount of their household purchases”.

Once consumers get a taste of time savings they don’t go back. In a post-Covid world, things will never go back to the way they were.

Amazon’s logistical prowess gives the company an almost insurmountable competitive advantage. Getting things into your home is a big deal.

Tobin’s Q ratio states that a company whose replacement cost is more than its market cap is undervalued. It would likely cost multiple trillions to rebuild Amazon given the virtuous cycle of the Prime flywheel, compared to the current market cap of just over $1T. From this perspective, it’s difficult to conclude Amazon is overvalued.

“Day One” and Revenue Growth

There’s a growing narrative that Amazon is entering the late stages of its company cycle.

The critics are quick to point out the 3% decline in revenue from online stores in 1Q22, albeit this figure was a 1% decline on a constant currency basis. In aggregate, going from 41% growth in 1Q21 to 9% in 2Q22 certainly looks like growth is stalling. Further, the company’s comments around excess capacity reinforces this narrative.

In reality, Amazon is simply lapping difficult comparisons from the prior year and there is nothing to suggest that growth has materially deviated from longer term averages. Jassy’s letter notes that Amazon was able to grow three years of target revenue (2020–2022) in a period of 15 months (1Q20–1Q21), which implies an estimated compound annual revenue growth rate of about 21%.

To be sure, growth rates were trending well ahead of internal targets as Covid pulled forward demand. But the question is if the incremental Covid demand is transitory or not.

This is not Amazon specific. Virtually all of today’s cloud-first companies face the same debate and underappreciation for the persistence and sustainability of their growth rates.

If you believe Jassy’s words about household purchases going up, then that demand is here to stay. Again, Amazon is not Netflix.

Further, with only 13% of retail sales online domestically, which way is this figure likely to go? Secular forces always win over cyclical ones.

It helps to also look at growth on a three-year basis to normalize the impact from Covid. The table below illustrates Amazon three-year compound quarterly growth rates from 1Q15–2Q22E.

As you can see here, Amazon’s three-year compound growth rates consistently hover around 20%. While this figure may ease into the high-teens over the coming years as the revenue base gets larger, the compounding is very real.

The story for Amazon and the stock this year has always been about 2H22 as comparisons normalize. Provided the Covid demand remains sticky, Amazon is on track to to accelerate growth throughout the balance of the year and revert back toward its historical averages.

Below we illustrate the trends in growth rates across all segments from 1Q19–4Q22E. Keep in mind that Prime Day occurred in 2Q21 last year and will take place in 3Q22 this year. This can provide an additional 3%-4% bump to the posted growth rate taking it conceivably over 20% in 3Q22.

Amazon’s growth is not materially slowing. In fact, the long-term averages remain a reliable guide on the growth potential over the next five years. As Andy Jassy said, “Time is your friend when you are compounding gains…It remains Day 1.”

“But Amazon Doesn’t Make Money”

As longtime shareholders, we’ve been grappling with this since day one, pun intended. Amazon has a high P/E. We get it.

But “investing” is bad.

Consider The Coca-Cola Company. Over the last 10 years, the company averaged annual sales decline of 1.4%. What do you get to pay for this awesome revenue trajectory? Well, ~7x sales and ~26x earnings.

You can look at it two ways. First, companies can either stop spending and slow growth despite the massive opportunity ahead, or second, invest to capture that growth.

So yes Coke has earnings, but why would a long term investor choose KO over AMZN? This isn’t to pick on KO (we prefer Coke over Pepsi anyway), it’s simply to show that investing can’t be centered around just one simple metric.

By the way, KO is up 8% year-to-date. And here we thought high P/E stocks should be going down because interest rates are rising.

But we digress…

Due to this fog-filled outlook, we are in a market where complacency and earnings are rewarded and capitalizing on the future is punished.

Foregoing earnings in lieu of growth is a good thing, because it means earnings will be that much bigger in the future. Most of today’s emergent cloud-first companies like Snowflake, and later stage ones like Amazon, are firmly aware of how the math works. It makes sense to invest and would be stupid not to.

We can discuss the excess capacity issue for Amazon ad nauseum. But long story short, they overstaffed for Omicron and have the ability to right-size in one quarter’s time. More importantly, the company is well equipped to service growth as demand picks up for the holidays in 2H22.

A byproduct of Covid was to make Amazon’s operations more nimble. Financially speaking, it’s becoming much more dynamic and predictable in its cost curves.

For the sake of argument, let’s assume that the bear case is right: Amazon is in its final innings of growth and is the Netflix of retail (despite the fact Amazon isn’t losing subscribers). If that proves to be the case, the earnings picture is likely to look starkly different.

If you assume normalized margins across Amazon’s businesses, the company has the ability to deliver upwards of ~$150 EPS in 2022, per below:

This implies Amazon trades at a P/E of about 15x. 15x!

It’s not that Amazon doesn’t want to make money, it’s that the opportunities are so vast it would be a disservice to shareholders not to.

Nobody Reads Proxies

It’s surprising how little attention is paid to proxy statements.

There’s a ton to glean for investors on if the CEO will be compensated for rewarding shareholders. Or if the compensation occurs despite the stock performance.

Amazon’s management compensation program is one of the best out there. It perfectly aligns management with shareholder interests. The C-suite doesn’t earn meaningful cash salaries or bonuses based on operating targets. Instead, their only significant source of compensation comes from restricted stock units.

For instance, CEO Andrew Jassy was given 61,000 shares in conjunction with his promotion. These shares vest over a 10-year period, with 80% vesting in years five to 10.

Per the 2022 Amazon Proxy:

“Represents a special grant in connection with Mr. Jassy’s promotion to President and CEO. This award vests over 10 years, with more than 80% of the shares scheduled to vest between 5 and 10 years after grant, and is expected to represent most of Mr. Jassy’s compensation for the coming years.”

You don’t think Mr. Jassy is thinking about the long-term stock price to maximize his wealth? We doubt he took the job just for fun.

Also consider this nugget from the proxy: “Simply put, with the number of shares vesting from his previous stock awards and 2021 stock award declining by 23% from 2021 through 2025 and holding flat through 2030, unless we create value for all shareholders over the 10-year vesting period for his 2021 stock award, Mr. Jassy cannot increase, or even hold constant, the realized value of his 2021 stock award.” (emphasis ours)

If the stock doesn’t perform, management doesn’t get paid. Try to find that in any other place in the market. This says something about management’s conviction regarding a company that “doesn’t make money”.

As for Mr. Bezos, he hasn’t taken a salary in years. Instead, he is content in being Amazon’s largest shareholder and continues to own approximately 13% of the company. That’s not a small number.

Amazon’s Intrinsic Value

Sum-of-the-parts (SOTP) analysis can provide a useful sanity check. This is true even in cases where the assets are symbiotic and spinoffs are not truly in the cards. However, they are especially relevant in cases where management is explicitly compensated to build shareholder value.

Below is our estimation of Amazon’s SOTP:

Simply taking current multiple multiples helps achieve a market capitalization for Amazon north of $2.3T, or more than double its current value. At current prices, you’re getting all these businesses for essentially 50 cents on the dollar.

There’s a lot of value trapped in Amazon that’s not getting any credit. Again, if Amazon were to post that $150 EPS number this year with a GDP-esque topline, how would today’s market value it compared to how it does now? Because of the sticky customer base does it get a KO multiple, or above market multiple at least?

The Bottom Line For Amazon

Only 1% of global retail is online, and just 13% domestically, per the Census Bureau. As such, nearly nine out of 10 transactions are still conducted offline in the United States. The runway is very long.

Let’s not forget the stock split either. There’s likely a reason why Amazon announced the 20:1 share split six months in advance, it coincidently aligns with the mean reversion of growth rates in 2H22 and the Prime Day kicker. Obviously this is not an economic event but it does make it more accessible to investors while making the stock easier to hedge in absolute dollar terms.

By our estimation, Amazon is undervalued by every measure. Which means if you missed investing in Amazon in the past, this is perhaps the best opportunity to enter the stock or average down since the Great Financial Crisis.

While Amazon press releases are notoriously self promotional, management is generally very austere in their commentary.

In an unusually candid moment on the 1Q22 earnings call, CFO Brian Olsavsky said on the earnings call: “But I wouldn’t be fooled by the revenue growth rates in this difficult comp period”.

Amazon is closer to Day One than Day Last.

Clockwise Capital is an asset management firm with a private equity approach to the public markets. We focus on the meaning of time and the role it plays in people’s lives. We believe the essence of a great investment resides in the ability of a company to either save their customers time, or improve its quality. We understand how technology evolves to drive these two factors, which we believe define human progress. As a result, we search for securities with cyclically depressed valuations whose companies save time, thus using secularly advantaged industries to build a concentrated portfolio. With each series of investments our goal is to optimize edge, maximize return, while also minimizing correlation. This allows our portfolio to maintain a liquid, low duration fixed income balance, ready to capitalize on market volatility, while still generating market beating performance.