Amazon Is No Longer A Strong Growth Story

News that Amazon (AMZN) - Get Report is overvalued should not be particularly shocking to anyone. However, news that Amazon's growth is meaningfully slowing down is insightful, particularly going into the company's all-important Q4 2018 earning results in less than one month's time. This should make investors question whether now might be the best time to exit this investment.

Hope vs. Reality

Amazon's share price has in the past couple of months been highly volatile. However, many investors are now looking towards its earnings call for a positive update from Amazon's newest business opportunity -- advertising.

Moreover, although Amazon did tremendously well in disrupting both the retail industry as well as instigating the cloud sector towards explosive growth, it is my strong contention that the advertising tech-giant Alphabet (GOOGL) - Get Report will not be as permissive of Amazon's encroachment into this space. Let's look at the facts.

As the table above highlights, out of Amazon's $57 billion of revenue generated in the last quarter, 4% came from its Other category, which includes but is not limited to its advertising revenue. Said another way, should investors really be putting their hopes for a rewarding positive investment when less than 5% of the business is being discussed?

On the other hand, credit should certainly be given to Amazon. It was highly innovative of Amazon to sell advertising space to consumer-branded companies at a time when consumers are most likely to execute their purchase. Furthermore, although Amazon has been relatively opaque on quantitative disclosures for this business unit, one can surmise that this segment promises consumer-branded companies a very high return on investment, thus promising a high level of repeat customers.

Does Advertising Actually Matter?

However, here is the crux of the argument: Amazon's Q4 2018 is a vitally important quarter this retailer. Looking ahead, Amazon's Q4 guidance is pointing towards its top line growing between 10% to 20%. Consequently, even if we assume, generously, that this all-important quarter will grow at 17% year-over-year, this level of growth is not sustainable of Amazon as a growth story investment.

Said another way, even if Amazon's advertising revenue was over the near and medium-term to succeed in growing at 100% year-over-year, given that advertising sales start from such a small base relative to Amazon's consolidated revenue, it becomes a non-factor.

In essence, for a very long time, Amazon has been the poster boy for strong growth in the mid-20% range. In fact, both Amazon's three- and ten-year compounded annual growth rates (CAGR) are very roughly equal at 26%-28%, respectively. This has led many investors to believe that Amazon could grow to the sky. But Amazon can't grow to the sky -- and it won't.

Financial Position -- Frail At Best

Further complicating an investment in Amazon is the fact that its financial position for fiscal 2019 is looking particularly stretched. Although Amazon can boast of having $30 billion of cash and equivalents on its balance sheet, what investors should be keeping a close eye on are its upcoming capital lease obligations.

For fiscal 2019, Amazon has close to $7 billion due for capital lease obligations, including interest, plus unconditional purchase obligations which reach $3.8 billion. Altogether, fiscal 2019 looks to be a bulge year for cash outgoings for Amazon, at a time when its top line growth appears to slowing down. All of which brings up the question -- are Amazon investors investing with an adequate margin of safety?

Fundamentally Overvalued

As the above table highlights, while Amazon's tech peers have seen their valuations come down in the past several months and offer clear-cut, positive investment bargains, Amazon's die-hard investor fan-base, continues to passionately clamor for Amazon. However, my argument has been to drive home the message that not only is Amazon overvalued, but its growth is slowing down at a rapid clip.

Fiscal 2019 is unlikely to see Amazon's top line growing at mid-20%, while its valuation is evidently still pricing in this level of growth. Yet, for now, its cash flows are still being valued at 30.7x, which is evidence that Amazon remains very much overvalued.

Takeaway

Going into Amazon's Q4 2018 earnings, shareholders are not sufficiently pricing in the fact that Amazon's strong growth days are now over. Furthermore, investors hoping that advertising sales will turn out to be a big driver of top line growth are likely to face disappointment.  

The author does not own any stocks in any companies mentioned in the article.