Is Amazon Stock a Buy After Earnings?

Amazon.com AMZN released its first-quarter earnings report on April 27. Here’s Morningstar’s take on the company’s earnings and stock.

Amazon Stock at a Glance

• Fair Value Estimate: $137
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Amazon’s Q1 Earnings

1. The results themselves were good, with all segments in line with or ahead of our expectations. E-commerce was the strongest segment, driven largely by third-party seller services. Advertising was nicely ahead of estimates, while Amazon Web Services was in line with them. Amazon’s advertising clearly outperformed ad-based internet companies, such as Facebook META and Alphabet GOOG. AWS decelerated another 500 basis points in April as customer optimization continued. Cost-cutting is showing results, helping profitability come in better than expected. Revenue guidance overall was in line with expectations, even though AWS is probably slightly lighter than expected, as is the outlook for operating income.

Overall, Amazon is progressing on its cost containment and profitability.

2. These results support our case that Amazon is the leader in e-commerce by a wide margin. Its advertising business is extremely valuable, given its proximity to purchasing decisions and actual commerce, while AWS continues to hold its lead in public cloud computing. AWS is still seeing the same trends as Microsoft’s MSFT Azure, the other clear leader in public cloud services. We think the deceleration in growth seen by both AWS and Azure has been driven more by macro factors than underlying demand.

So the thesis remains intact for long-term investors, but the short-term challenges remain: Amazon’s moat hasn’t changed, profitability is already improving, and AWS should begin to accelerate later this year.

Fair Value Estimate for Amazon Stock

At a 4-star rating, we believe Amazon stock is undervalued compared with our fair value estimate.

Our fair value estimate for Amazon is $137 per share, which implies a 2022 enterprise value/sales multiple of 3 times and a 1.7% free cash flow yield. 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, the critical growth drivers 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.

Read more about Amazon’s fair value estimate.

Economic Moat Rating

We assign a wide moat rating to Amazon based on network effects, cost advantages, intangible assets, and switching costs. The network effects are tied to its marketplace, where the growing number of buyers and sellers continually makes it attractive for additional prospective buyers and sellers. The company’s cost advantage comes from its purchasing power, logistics, vertical integration (proprietary brands, owned delivery, and so on), and negative cash conversion cycle. Amazon’s intangible assets are associated with technology and branding. Prime memberships generate high cash flow that can be reinvested to improve the user experience on multiple fronts. Advertising is tangentially related to retail operations, as it takes place on the company’s own online properties. That segment is growing rapidly and likely has the highest operating margins in Amazon’s portfolio.

Read more about Amazon’s moat rating.

Risk and Uncertainty

We believe the uncertainty for Amazon is high. Despite being an e-commerce leader, the company faces a variety of risks. Amazon must protect its lead position, which can be challenging as consumer preferences change. In the wake of the COVID-19 emergency, consumers may revert to prior behaviors. Additionally, traditional retailers continue to bolster their online presence. The company must also continue to invest in new offerings. Three notable areas of investment are AWS, transportation, and physical stores (both Amazon-branded locations and Whole Foods). Continued international expansion will likely require similar investment and management attention while also increasing exposure to different regulatory environments. From an environmental, social, and governance perspective, data breaches and service outages are a concern for any cloud-services provider.

Read more about Amazon’s risk and uncertainty.

AMZN Stock Bulls Say

• Amazon is the clear leader in e-commerce and enjoys unrivaled scale to continue investing in growth opportunities and driving the 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 Stock Bears Say

• Regulatory concerns are rising for large technology firms. Further, Amazon may face more 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 it has been in the United States because of inferior logistic networks.
• Amazon may not be as successful at 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 Maggie Guidici.

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