Last year, for the first time since I originally started to invest in Amazon (AMZN) stock back in 2014, my own sum-of-the-parts (SOTP) valuation exceeded the market price of the shares. If you are wondering why I owned it at any point when that was not the case, well, the company’s growth rate was high enough that I would not have expected it to trade below my SOTP figure - which is based solely on current financial results.
That discount got my attention, as Amazon took a drubbing in 2022 like most high-flying growth companies in the tech space coming off a wind-at-their-backs pandemic. What is most striking is just how much of Amazon’s value sits in its cloud-computing division, AWS. If one takes a moment to strip that out (everybody knows it’s insanely profitable and a complete spin-off in the future would be an enormously bullish catalyst for the stock) and focus on the e-commerce business by itself, the picture becomes a bit murky. More specifically, is that part a good business or not?
We have heard for many years - since the company’s IPO in fact - that management is focused on long-term free cash flow generation and thus does not shy away from reinvesting most/all of its profits in the near-term. But one has to wonder, at what point is “the long-term” finally upon us?
Amazon began breaking out AWS in its financial statements back in 2013, so we now have a full decade’s worth of data to judge how the e-commerce side is coming along. The verdict? Not great actually. Between 2013 and 2022, AMZN’s e-commerce operation had negative operating margins 30% of the time (2014, 2017, and 2022) and in the seven years it made money, those margins never reached 3% of sales. As you might have guessed, they peaked during 2020 at the height of the pandemic at 2.7%.
Now, do low operating margins automatically equate to a poor business? Probably not. Costco (COST), after all, has operating margins only a bit better. The difference is that Costco is a model of consistency and grows margins slowly over time, which indicates just how strong their leadership position is within retail.
For fiscal 2022, COST booked 3.4% margins, up from 2.8% in 2012. During that time they only dropped year-over year one time and even then it was only a 0.1% decline. Compare that with Amazon, which had margins of 0.1% in 2013, negative 2.4% in 2022, and year-over-year margin declines in five of the past ten years. Costco appears to be the better business.
Like many tech businesses that loaded up on employees and infrastructure during the pandemic, only to see demand wane and excess capacity sit idle, Amazon CEO Andy Jassy is focusing 2023 on operating efficiency. They are in the process of laying off extra workers and subleasing office and warehouse space they no longer need.
I think Amazon has a real opportunity to prove to investors that its e-commerce business actually is a good one that should be owned long-term in the public markets. If the company takes this efficiency push seriously, it could come out of the process with an operation that going forward is able to produce consistent profits and a growing margin profile over time with far less volatility than in the past. If that happens, I suspect the stock rallies nicely in the coming years.
If they don’t hit that level of clarity and predictability, but settle back into the old habit of ignoring near-term results and preaching the long-term narrative, I am not sure investors will have much patience. After all, Amazon has now been a public company for more than 25 years and the market wants to finally see the fruits of all that labor pay off on no uncertain terms for more than a few quarters at a time.
Full Disclosure: At the time of writing the author was long shares of AMZN (current price $102) and COST (current price $491) both personally and on behalf of portfolio management clients, but positions may change at any time.