Market, Earnings, and AMZN - October 28, 2023
Market commentary, portfolio company earnings results, and a deeper look into Amazon (AMZN)
Every two weeks we share a review of the market, any earnings results, and a deep dive into one portfolio company. Subscribe now to follow along.
Market
From a technical perspective, the market continues to show deterioration with a series of lower lows. The S&P 500 has given up nearly 9% since the beginning of September, a significant sell off over a 2 month period.
The fundamentals and economic data have not been nearly as bad as the price movement presents. Momentum, however, can build in any direction. The next level of support seems to be 404, a 1.5% decline from the current price.
Year-to-date performance across indices:
Nasdaq +29.6% (down from peak of 45%)
S&P 500 +7.2% (down from a peak of 20%)
Dow Jones -2.2% (down from a peak of 7.5%)
The S&P 500 is essentially flat over the last 30 months – and that does not account for inflation.
Long-duration yields started climbing in July 2023 and have continued relentlessly, recently surpassing 5%. Yields on the short-end have been mostly flat.
The increase in long-term yields is making the US dollar more attractive. The DXY index measures the USD against a basket of global currencies. The dollar has gained over 7% since July 2023.
Inflation seems to be staying in check, with the latest Truflation reading showing 2.3% with a declining trend. Truflation provides a more current and timely look at inflation in comparison to the government’s CPI report.
Sentiment has gone sour, as the market gives up some recent gains. In the most recent AAII investor sentiment survey, bearish sentiment increased from 34.6% to 43.2%.
Does the broad sentiment price movement, or does it follow from price movement?
The Fed seems to be getting what they were looking for: inflation is coming down; the yield curve is normalizing (long-term yields going up, while short-term yields stay the same).
Evidence is building that the Fed may be done with this rate hiking cycle. No more rate increases are expected this year. Cuts are expected in 2024.
While the market has given up some gains recently, and sentiment is down, the end of a rate hiking cycle can be a significant turning point. Cash-producing assets will become more attractive as interest rates begin to decline.
Earnings
Over the last two weeks, 12 portfolio companies reported earnings.
Big tech fared well, with Microsoft (MSFT), Meta (META), ServiceNow (NOW), Amazon (AMZN) posting solid revenue numbers and very strong profitability.
Healthcare is inching along. The environment doesn't seem to be easing up for medtech.
Danaher (DHR) called out weakness in biotech spending (due to constrained funding environment) as well as subdued growth from China.
Edwards Lifesciences (EW) performed well in the quarter, but provided a weaker outlook. EW also showed compression in their gross margin, down to 76% from ~80% a year prior. They attributed it to the forex & the strength in USD. That being said, a common reason for gross margin compression due to heightened competition resulting in discounting – or said another way, a decrease in pricing power.
Amazon (AMZN)
“We seek to be Earth’s most customer-centric company. We are guided by four principles: customer obsession rather than competitor focus, passion for invention, commitment to operational excellence, and long-term thinking”
After leaving his investment banking job, Jeff Bezos founded Amazon in 1994. The online book store sold its first book in 1995. Today, Amazon is often known as the everything store.
Amazon had one of their most formative, critical organizational decisions in 2002 when Jeff Bezos issued his famous API mandate. As preserved by a colleague:
This edict transformed Amazon’s culture, allowing teams to move quickly and leverage all the work that other teams had done.
This service-oriented architecture turned Amazon’s technology into a extensible, programmable platform. Naturally, Amazon built out an ecosystem to support their teams, allowing any team to spin up a server and/or a database.
This internal development suite eventually became Amazon Web Services – the first, revolutionary cloud computing offering.
Amazon is known for their strong culture, shaped by values and practices including Leadership Principles, OP-1 & OP-2, and Working Backwards Press Release.
Jeff Bezos led the company up until a few years ago. Andrew Jassy became CEO in July 2021, after serving as CEO of AWS since 2016.
Amazon reports in 3 segments:
North America (retail) - roughly 60% of revenue & 38% of operating income
International (retail) - roughly 22% of revenue & 0% of operating income
AWS - roughly 16% of revenue & 62% of operating income
With north of $500 billion in revenue today, Amazon continues to invest heavily.
“Our move earlier this year from a single national fulfillment network in the U.S. to eight distinct regions represented one of the most significant changes to our fulfillment network in our history. This change has gone more smoothly and made more impact than we optimistically expected.”
You have likely seen the impact of these changes through increased same-day delivery, more items under same or next day delivery, etc. I know I have.
“Trillion-dollar startup” is a fitting title — they have no issue investing where they see opportunity and then optimizing. In their latest earnings announcement they shared the following slide:
AWS continues to be a huge opportunity. With a $92 billion revenue run rate, Amazon is the largest cloud provider today and growing at 12% y/y. Competitors include:
Microsoft’s Azure: $66 billion in recurring revenue rate, growing 28% y/y
Google Cloud: $34 billion in recurring revenue rate, growing 22% y/y
Although AWS’s growth is lower, it is from a much larger base. Artificial intelligence (AI) represents a huge opportunity for these platforms.
Turning to the financials:
Revenue growth has been impressive and steady. In the last 4 years, revenue has grown from $70 billion to $143 billion (!!). AWS’s $94 billion run rate will continue to push that higher yet. The most recent quarter was strong with 6% growth q/q. Outlook was even better, calling for another 14% q/q growth on top.
Gross margin is moving up, most recently hitting 48%. This is quite the jump from historical levels of ~40%. The TTM gross margin shows the smooth progression upwards.
EBITDA margins of 18% are also showing continued improvement.
FCF margin is at 3%, and showing a positive trend. FCF was negative a few quarters ago, as Amazon invested heavily in their new distribution network and facilities. They now look to be optimizing for FCF.
Balance sheet is strong. They have over $64 billion of cash on hand.
Share count is growing over time at a pace of 1-1.5% per year. This is primarily due to stock-based compensation. At some point it will be nice to see that plateau and even begin to decline. For now, Amazon has proven they are capable of delivering growth even at their massive scale.
In terms of efficiency, EBITDA return on capital (ROC) looks solid at 25%. FCF ROC is quite low, again due to the heavy capex investments they have made. It should continue to improve over time.
Amazon share price has yet to reclaim its recent highs. Like many other technology companies, 2022 brought downward price pressures due to the rapid rate increases. The heavy investments and low FCF did not necessarily help the stock from a fundamental perspective.
Shares saw a strong rally in 2023. The 200-day simple moving average crossed above the 50-day simple moving average in June. This “golden cross” is a bullish sign.
It will be important for shares to stay above the 200-day SMA, currently $117. With their strong earnings, shares bounced back up to high $120s. They should find continued support. There can be continued momentum as shares climb and the 50-day SMA inflects upwards.
As for valuation:
Trading at 2.2x revenue and 11.5x EBITDA, Amazon shares are not very demanding. From a FCF perspective, they look expensive, but again that optimization is underway. For investors that believe the company can continue to grow, this can be a great opportunity.
More concretely, the following table shows possible annualized returns given various scenarios over the next 5 years.
Revenue growth expectations are in the 10-12% range. With a focus on efficiency, EBITDA growth should be higher than revenue growth.
Considering 14-16% EBITDA growth and EBITDA multiple in the range of 10-12x (vs. the current 11.5x), AMZN could produce annualized returns of 10-16% per year.
Fastgraphs provides another perspective.
Looking at operating cash flow per share, shares look quite undervalued. With the current expectations, if shares were to trade at a 25x multiple (roughly the 10 year average), shares could trade as high as $330 in a few years (up from current $127).
Looking at free cash flow per share, shares also look attractive. With the current expectations, if shares were to trade at a 25x multiple on FCF, shares could trade up to $190 by the end of 2025, for an IRR of north of 20%.
Closing thoughts
Amazon is an iconic company. Always focused on the customer, Amazon is known for offering the best prices and fastest delivery.
Their commitment and investment to do so was described very well by Nick Sleep and Qais Zakaria of Nomad Partners. The concept they coined “scale economies shared” is all about driving improvements and passing the benefit on to the end users, further deepening the moat by offering the best value proposition possible.
The last few years have been challenging for investors – with the marketing essentially flat over the last 30 months.
As interest rates peak, they are soon to stabilize, and then decline. Equities are poised to benefit.
At Torre Financial, we remain focused on finding the best investment opportunities at any time. We focus on companies that have high returns on capital, competitive advantages, and durable growth. We focus primarily on fundamentals, and continually reevaluate and rebalance according to what the market is offering.
A few years down the road, scooping up shares of strong companies will inevitably prove to have been a good move
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders – companies with high return on capital, competitive advantages, and durable growth.
Federico Torre
Torre Financial
federico@torrefinancial.com
Disclaimer: This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and all employers and their affiliated persons assume no liability for this information and no obligation to update the information or analysis contained herein in the future.