It is a manmade creation that has so far defied the laws of finance. The share price return of 199,908% since it IPO-ed in 1997 (from a split adjusted share price of $1.50 to $3,000), equating to 39% compound annual return, is only part of the story. The stock has had an outsized influence on the global stock market; over the last ten years it has contributed 3% to the MSCI World Index total return (MSCI World returned 100% for ten years to end of March), behind only Apple and Microsoft and that due to their larger starting weights (0.95% and 1.05% respectively, versus 0.21% for Amazon). The average stock contribution to the Index was 4bps .
What is truly wonderous is the consistent revenue growth. In the 2000s the company grew at 29% per annum so that by March 2010 it had annual revenues of $27b. At this point we normally expect the fade in growth to kick in. Not so Amazon – in the 2010s it has generated revenue growth of 27% p.a.! The quarter to March 2020 witnessed a 26.4% growth rate over the first quarter in 2019, no sign of slowing in the headline numbers.
Another wonder is the valuation. In the last 12 months (end of March) Amazon made $21 of earnings per share, putting it on a historic price-earnings ratio of over 143 times and trades on 5.1 times price to sales. It currently earns a group EBIT margin of around 5%, within this it earns 2.2% for its non-cloud businesses. The dream might be to pivot from growth to a mature business with expanded margins, if growth becomes challenging. However, if ex-cloud margins doubled to 4.5%, like Walmart’s, it would get EPS to $40, a price earnings ratio of 75 times. EPS would have to double again to bring valuations down to earth like levels. Of course, doubling margins would impact growth and competitive position, which we discuss below.
Amazon, in growth rates and valuation, is behaving like a start-up. A recent Briefing article in The Economist (And on the second day…) quoted Jeff Bezos insisting that the company “must forever behave like a feisty start up: innovate aggressively and expand relentlessly.” So far, he has succeeded. However, can this phenomenal growth rate continue?
The Economist article lists several headwinds. Firstly, competition from other retailers. In China, Amazon has been defeated by Alibaba. In the US, rivals like Walmart and Target have upped their online game. In Canada, Shopify offers retailers a way to get online and is taking market share and the company will become the backend for Facebook’s e-commerce venture. While in India and Latin America its offering is struggling to get traction and faces other challenges, such as the nationalist policies of the Indian government. Secondly, the markets the company is doing well in are low growth, such as western Europe, whilst in the US the market for prime customers is pretty much satisfied. A third challenge is a political one, both Republicans and Democrats have spoken about breaking up Amazon, antitrust claims are gaining traction in the US and Europe, while labour relations are poor.
The big hope to keep the growth story going is AWS, the cloud platform. The business has grown revenues at 50% p.a. over the past five years. While only 14% of total revenues, it contributed a quarter of revenue growth for the entire company in 2019. It is also the most profitable, with 26% operating margins. The Economist valuation for this cloud business at $500b appears excessive (it would become the 6th largest company in the MSCI World Index), but another year at current growth rates and applying 10x sales as standard in this market for a tech company, gets us there (not quite a value stock!).
Amazon must decide to either keep AWS to try to maintain the overall growth trajectory or spin it to make both more agile and potentially mitigate some of the challenges mentioned above.
The great test for Amazon is to prove the laws of finance truly do not apply to it within retail. Bernstein did a study comparing the market share of incumbents in various industries in 1964, versus what they retained in 2004. Consumer packaged goods companies (Coca-Cola, P&G, Colgate etc) retained 80% of their market share. Retailer incumbents, on the other hand, retained only 10%. The dominant retailer of 1964, Sears Roebucks, was leap frogged by Kmart, which in turn was leap frogged by Walmart, which has been leap frogged by Amazon. Sears Roebuck’s highly popular multi-storey department stores gave way to a cheaper Kmart format, which substituted store clerks for a shopping trolley and put everything on one floor. Kmart was dominant until Walmart introduced the out of town, big box format, adding in a food store. The out of town formula offered a nicer shopping experience and cheaper goods. Meanwhile, Sears Roebuck and Kmart have tried to revive their fortunes by combining; this has failed, and Sears filed for Chapter 11 in 2018. Amazon is now in the seat, can it retain this dominant position, which would truly be incredible. Jeff Bezos is fully aware of retailer incumbents’ history. In a letter to his shareholders in 1997 he said “Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1”. At 143 times earnings, with so many wishing its downfall, with history against it, this is a fantastic case study. One that if the trajectory continues would truly make Amazon the eighth wonder of the world. For investors, I think it is one safer watched from the side lines.