Amazon AMZN released its fourth-quarter earnings report on Feb. 1. Here’s Morningstar’s take on Amazon’s earnings and stock.
Key Morningstar Metrics for Amazon
- Fair Value Estimate: $185.00
- Morningstar Rating: 3 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: High
What We Thought of Amazon’s Q4 Earnings
- Amazon’s results were better than we expected. We raised our margin assumptions based on continued strong results over the last several quarters and the guidance for the first quarter of 2024, so we assume there is a little more upside over the long term. Overall results are consistent with our long-term thesis for AWS, advertising, and e-commerce leadership, along with our wide moat rating.
- Shares have run sharply, so we see the stock as fairly valued. We see tension between the good results and a mixed macro picture, and we are not willing to assume conditions are rosy enough for enterprises to aggressively expand workloads on AWS and consumers to happily spend on discretionary items in the near term.
Fair Value Estimate for Amazon
With its 3-star rating, we believe Amazon’s stock is fairly valued compared with our long-term fair value estimate.
Over the long term, we expect e-commerce to continue to take share from brick-and-mortar retailers. We further expect Amazon to gain share online. We believe that over the medium term, COVID-19 pulled forward some demand by changing consumer behavior and better penetrating some retail categories that had not previously gained as much traction online, such as groceries, pharmacy, and luxury goods. We think Prime subscriptions and their accompanying benefits, combined with selection, price, and convenience, continue to drive the retail story. We also see international as a longer-term opportunity within retail. We model total retail-related revenue growing at a 9% compound annual growth rate, or CAGR, over the next five years.
We believe the critical growth drivers over the medium term will be AWS and advertising. Since these segments earn materially higher margins than the rest of the business, we also expect them to drive margins higher over time. Over the next five years, we project AWS revenue growing at a 15% CAGR and advertising revenue growing at a 19% CAGR. In total, Amazon should grow at an 11% CAGR through 2027. We model GAAP operating margin expanding from 2% (actual) in 2022 to the low double digits in 2027 as the company grows into its expanded footprint and optimizes its substantial investment in transportation.
Economic Moat Rating
We assign Amazon a wide moat based on network effects, cost advantages, intangible assets, and switching costs. The firm has been disrupting the traditional retail industry for more than two decades while emerging as the leading infrastructure-as-a-service provider via AWS. Consumers have embraced this disruption, which has driven change across the entire industry, as traditional retailers have invested heavily in technology to keep pace. COVID-19 has accelerated this change. Given the company’s technological prowess, massive scale, and relationship with consumers, we think Amazon has widened its lead, which we believe will result in economic returns well over its cost of capital for years to come.
We believe Amazon’s retail business enjoys a wide moat supported by cost advantages, intangible assets, and network effects, based on a combination of online stores, third-party seller services, subscription services, and physical stores. Given its massive scale, Amazon has created cost advantages, including buying power, economies of scope, route density, and research and development. From a total gross merchandise value perspective, with approximately $580 billion in 2021, it finally surpassed Walmart WMT. Additionally, the company has become more vertically integrated over time, and most recently has built out its transportation network. Size dictates certain scales of efficiency, but we think Amazon is the definition of operational excellence.
Risk and Uncertainty
We believe Amazon sees a high amount of uncertainty, and that despite being an e-commerce leader, it faces a variety of risks.
Amazon must protect its leading online retail position, which can be challenging as consumer preferences change (especially since the COVID-19 pandemic, as they may revert to prior behaviors) and traditional retailers bolster their online presence. Maintaining an e-commerce edge has pushed the company to make investments in nontraditional areas, such as producing content for Prime Video and building out its transportation network.
Similarly, the company must maintain an attractive value proposition for its third-party sellers. Some of these investment areas have raised investor questions in the past, and we expect management to continue to invest according to its strategy, despite periodic margin pressure from increased spending.
The company must also continue to invest in new offerings. AWS, transportation, and physical stores (both Amazon-branded and Whole Foods) are three notable investment areas. These decisions require capital allocation and management focus, and they may play out over years rather than quarters.
AMZN Bulls Say
- Amazon is the clear leader in e-commerce and enjoys unrivaled scale to continue to invest in growth opportunities and drive the very best customer experience.
- High-margin advertising and AWS are growing faster than the corporate average, which should continue to boost profitability over the next several years.
- Amazon Prime memberships help attract and retain customers who spend more with Amazon. This reinforces a powerful network effect while bringing in recurring and high-margin revenue.
AMZN Bears Say
- Regulatory concerns are rising for large technology firms, including Amazon. Further, the firm may face increasing regulatory and compliance issues as it expands internationally.
- New investments—notably in fulfillment, delivery, and AWS—should dampen free cash flow growth. Also, Amazon’s penetration into some countries might be harder than in the United States due to inferior logistic networks.
- Amazon may not be as successful in penetrating new retail categories like luxury goods due to consumer preferences and an improved e-commerce experience from larger retailers.
This article was compiled by Frank Lee.
The author or authors own shares in one or more securities mentioned in this article. Find out about Morningstar’s editorial policies.