Amazon is a great investment opportunity. It has a higher pricing power and a better revenue mix, which leads to greater profitability. Investors can also expect lower capital expenditures moving forward.
Amzn shares can have both positive and negative aspects. There is stiff competition in the online e-commerce market and difficulty in expanding into new markets.
My Amazon Hold rating is unchanged. Amazon has both pros and disadvantages and its valuations aren’t attractive enough to warrant a Buy rating.
I am continuing to assign a Hold Amazon.com, Inc.’s shares (NASDAQ:AMZN). In a previous article published on December 17, 20,21, I wrote about AMZN’s 2022 outlook.
My latest article examines the pros and cons associated with investing in Amazon’s shares. My Hold rating is justified because I conclude that Amazon’s risk/reward ratio is more evenly balanced. AMZN is able to price Prime in its home market. This makes it a strong competitor. Also, the reduction of capital expenditures and shift in revenue mix should help Amazon’s future profitability. Amazon might have difficulty competing in new growth areas or geographical markets, but there are plenty of competition in its core ecommerce business.
AMZN Stock Key Metrics
Before I go into detail about the pros and disadvantages of Amazon investing, I’ll review the company’s Q4 2021 financial results.
AMZN’s fourth quarter 2020 revenue rose by 9.4% to $125.6 billion, compared to the previous quarter which saw $137.4 billion. Amazon’s Q4 2021 bottom line was mostly in line market expectations. Amazon’s quarterly revenue was only -0.13% less than the consensus market revenue forecast.
Amazon’s operating profit decreased by 49.7% YoY to $6,873million in Q4 2020 and $3,460million Q4 2021. This was +44.2% higher than Wall Street analysts consensus estimate of $2.4 billion. AMZN’s Q4-2021 operating profit was also at the higher end of its prior operating income guidance, which was “between $0 & $3.0 Billion.”
AMZN’s outlook is mixed.
Amazon’s Q1-2022 revenue guidance of $112.0 billion to $117.0 billion and operating income guidance between $3.0billion and $6.0billion, as stated in its fourth-quarter earnings report, suggest that the company expects to generate operating margins of between 2.7%-5.1% for the current quarter.
In other words, AMZN should see a significant increase in its operating margin in Q1 2022 compared to its Q4 2021 margin of 2.5%. In my December 17, 2021 update, I raised concerns that Amazon’s actual 2022 earnings may fall short of expectations as a result of higher labor expenses than anticipated. There seems to be less of an issue with a shortage in workers than previously thought. Amazon mentioned specifically that “the labor problem is not as severe in Q1 (2022), as in Q3 and Qu4 (2021).
Amazon’s Q1-2022 revenue guidance for $114.5 Billion was negative. This is -5.4% less than the consensus top line forecast by sell-side analysts of around $121B.
In my December 2021 article, “it is very probable that e-commerce growth will gradually normalize closer pre-pandemic levels”, which “will translate to a slower pace retail revenue growth moving forward.” AMZN’s revenue guidance was weaker than anticipated for the first quarter. This supports my views.
After I’ve discussed AMZNs key financial metrics, I’ll touch on the pros/cons of investing in Amazon in the two following sections.
Pros Of Buying Amazon Stock
I believe that AMZN has the most important investment merits. This includes its pricing power in relation US Prime membership, more favorable revenue mix with higher margin businesses growing faster, and a moderate reduction in capital expenditures moving forward.
Amazon revealed in its Q4 2021 earnings press release that it would increase the cost of Prime memberships in America. The monthly fee will go from $12.99 up to $14.99 (+15%) and the annual membership will go from $119 up to $139 (+17 %).”).
Amzn has not raised the price of Amazon Prime in America for the first time. Amazon Prime memberships costing $79 to $99 per year were increased by +25% in 2014. Amazon also introduced a monthly Prime subscription option in 2016, priced at $10.99. Amazon Prime Prime monthly subscriptions were priced at $10.99 in 2016.
Amazon highlighted in its Q4-2021 results briefing that it welcomed millions of new Prime members, and had “consistently low member renewal rates” for the latest quarter.
Amazon’s Prime membership is “sticky” in a simple way. The high retention rate of current members, highlighted above, shows that the company has significant pricing power.
More Favorable Revenue Mix
The company’s FY 2021 10-K filing shows that Amazon’s AWS (Amazon Web Services revenue) increased by +39.5% to $12.7 billion in Quarter 2020 and $17.8billion in Quarter 2021. Meanwhile, its other (advertising revenues) increased by +32.2% to $7.4billion to $9.7billion over the same period. AMZN’s retail sales increased only by 4.1% YoY in the most recent quarter.
Gartner (IT), which published recent research in February 2022, forecasted that more than half the “enterprise IT spend” in the “application software, infrastructure software and system services markets” will shift towards “public cloud computing” by 2020. This means that AWS should maintain its strong growth momentum over the next few year. Amazon’s advertising revenue is forecast to continue growing rapidly in the near future. Apple’s (AAPL), iOS privacy updates are a tailwind in favor of AMZN, but a headwind in favor of other internet advertising companies that depend on third party data. CNBC reported that Amazon “holds an enormous amount in-depth consumer information” and this “will likely become more rare and valuable for marketers.”
I wrote in December 2021 about AMZN that Amazon would benefit from a favorable Revenue Mix (which is good for profitability). As the revenue contribution of higher-margin AWSs and advertising businesses (as well as retail business with lower margins), grows, The same views are still held by me.
Expectations Of Lower Capital Expenditures
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According to S&P Capital IQ Data, Amazon’s capital expenses are expected to fall from $61.1 million in fiscal 2021 down to $55.8billion, $54.6billion and $49.7billion for FY 2022 and FY 2023 respectively. This is in line with the comments of the company management at their Q4 2021 results presentation.
Amazon said that capital expenditures for the “fulfillment centre side” are “moderating”, and will probably match growth of our “underlying businesses” in 2022. This was when Amazon was asked about when AMZN would “emerge” from the investment cycle.
Summarising, I’m positive about Amazon’s ability to raise Prime members’ prices. An improved revenue mix and lower capital expenses could result in higher profitability for AMZN over the intermediate term. This is also a key investment merit for the stock.
I will now discuss the negatives and risks associated with investing in Amazon.
Cons of buying Amazon stock
In my opinion, the key risk factors or negatives associated with an investment in AMZN’s shares include stiffer-than-expected competition in e-commerce, and the challenges linked to expansion in new geographies and new product categories.
E-Commerce Space Competition
Amazon’s Q4-2021 retail or online revenue growth was slow and its overall guidance for Q1 2022 revenue was below expectations, as we discussed earlier in this article. AMZN faces increased competition in the online e-commerce market. This is a critical factor.
AMZN is under greater competition from both niche ecommerce platforms and social media companies.
The lines blurring between ecommerce platform operators, social media companies, and social media companies is a sign of the times. Meta Platforms’ (FB) introduction of Facebook Shops was in the middle 2020. It describes this new initiative as allowing companies to create an “easy-to-use online store on Facebook” and Instagram “freely”. This is a focus on a “mobile first shopping experience.” Snap (SNAP), meanwhile, is betting on augmented and virtual reality or AR ecommerce. Bloomberg’s January 26th 2022 article stated that SNAP has partnered with “businesses” to offer products through camera overlays within its Snapchat app. Users can then digitally try out a new lipstick shade, or a new shoe style.
Amazon has to compete with niche players when it comes to e-commerce. AMZN used to be a niche book seller before it became the retail giant it is today. Despite Amazon’s dominance in the market, niche companies such as Etsy and Wayfair have been able create their own niches. These niche players may not take Amazon’s retail market share, but they could limit AMZN’s future expansion into specific product segments. Amazon hasn’t been able compete with ETSY in the handcrafted product category, for instance.
The Foreign Market Expansion is Tough
The company’s fiscal 2020 10-K filing shows that Amazon’s split between domestic (North America), and foreign revenue is still around 2:1.
AMZN’s international competitiveness speaks volumes when the company responds to a question on whether Amazon Prime pricing could rise in international markets. Amazon responded to a Q4 2021 results question by saying that they consider the relative price of Prime membership compared to its cost and how customers use it. This could be interpreted as Amazon’s relative lower pricing power in international market where it is less established or faces formidable local competitors.
Conclusion: It may be too optimistic for Amazon to project faster growth in international markets that will more than offset its slowing home market growth over the long term.
It is possible that expansion into new growth areas may not prove to be successful
Amazon’s chance to expand into new growth areas like healthcare and financing is exciting to some investors. This could lead to Amazon achieving similar success to its core e-commerce business or AWS. However, Amazon’s growth plans might not prove to be as profitable as investors expect.
The grocery sector is an example. Amazon currently has a single-digit market share of the US grocery market, even though AMZN bought Whole Foods Markets and spent a lot of money building this business for years. This may be because Amazon has no competitive advantage or clear edge in these new areas where there is fierce competition.
Amazon’s core business in e-commerce faces significant competition. This means that the company may not be able achieve its potential for growth in new markets or other areas.
Amazon Stock: Is it worth investing in?
Stocks that have more advantages than disadvantages and are priced well are worth considering. Amazon is not an exception to this rule.
The market currently values Amazon at a consensus forward twelve-month’s EV/EBITDA multiple value of 19.2x, according to S&P CapitalIQ data. This is lower that AMZN’s 10-year average forward EV/EBITDA (22.9).
AMZN is still a worthy trade, even though it trades below its average historical EBITDA/EV multiple. There are also expectations that the company will experience slower revenue growth over the medium term. Amazon’s revenue CAGR was +27.2% during the FY 2016-2019, but it is predicted to have a slower revenue CAGR (+14.9%) for the FY 2022-2025 time period, based on consensus forecasts by S&P Kapital IQ. However, AMZN’s slowing top line growth over the next few year is balanced by an increase in profitability. Market consensus predicts that Amazon’s EBITDA margin in FY 2025 will rise from 15.3% to 18.2%.
Amazon is a Hold as I see both headwinds, and tailwinds in the future for the company. AMZN’s valuations at the moment are not too high, but they are not cheap either. This makes a Hold rating fair.