Amazon (AMZN) presents investors with a highly rewarding opportunity, as it’s priced at just 26x times trailing cash flows. Even though its retail operations are a huge winner in our work-from-home environment, investors are scrambling amidst the uncertainty to quantify the near-term impact on its operations.
Long-term investors looking out further than next twelve months are going to be rewarded at this price point.
Amazon is well-positioned to benefit from our work-from-home environment and has gained further mindshare with consumers as a reliable and efficient brand. The company's retail operations are going to benefit, whereas its AWS business is going to slow down near-term before springing back.
Retails Operations to be a Huge Beneficiary of Unprecedented Ordering
The more consumers get into the habit of navigating Amazon's website and comparing different products, the more challenging a habit it will be to break when the economy opens up again.
What’s more, Amazon’s retail operations benefit tremendously from strong operating leverage the more volume it transacts, from its warehouse efficiency all the way to increased package-density when delivering. In fact, Amazon is designed to be increasingly profitable the more volume goes through its platform, given its huge fixed costs.
A recent update from Amazon states that the surge in customer orders is now so significant that it can not even afford to carry non-Amazon packages. The excess capacity previously available on its network that was being rolled out to compete with United Parcel Service (UPS) and FedEx (FDX) will have to be cut back.
Put another way, no matter how much capacity Amazon had available, it needs even more, as the number of orders continues to increase beyond expectations and the company focuses on shipping essential items.
The Question Mark on AWS
Amazon’s AWS is likely to be hurt by the overall economic slowdown. The bulk of AWS’s customers are small and medium-sized businesses that rather than being focused on their digital transformation journeys, are now focused on survival.
AWS derives a significant portion of its revenue from usage-based operations, as companies use AWS for storage, data transfer or running hours. Although Amazon’s AWS now makes up a relatively small aspect of Amazon’s total revenues, approximately 12%, it made up close to two-thirds of its operating income in 2019.
Having said that, once the economy opens up once again, AWS should spring back up. Undoubtedly, for many cloud-players there’s likely to be the same overall dynamic at play, with two or three quarters of suboptimal financial results before starting to return to a normalized earning profile.
Valuation - Small Downside, Large Upside Potential
Amazon is being priced at 26 times trailing cash flows from operations, and that’s realistically as cheap as this tech juggernaut is likely to get. Amazon is well diversified and led by an insanely competitive and incredibly talented team.
In fact, compared to the previous few years, Amazon’s present cash flow from operations multiple is already trading at a discount to its historical average of 32 times.
The Bottom Line
Investors don't get a cheap investment in a strong well-diversified global tech company such as Amazon when outlooks are extremely positive.
Investors get a cheap stock when the outlook is uncertain. Right now, even if Amazon's AWS segment outlook is temporarily unimpressive, Amazon's retail operations should more than make up the difference. This is a highly compelling investment opportunity, and worth considering.