Amazon Web Services: The Key To Amazon’s Dominance (NASDAQ:AMZN)

Investment Thesis:

As we all know, Amazon (NASDAQ:AMZN) is the biggest e-commerce company in the United States and the leading cloud computing player in the world. The company has seen a drop in its market valuation since it had its eyes set at $2 trillion. The drop has been significant, and the company is now trading at a market valuation of $970 billion, which is attractive as AMZN has a huge market opportunity in global cloud computing. With Amazon Web Services (AWS), the cloud computing segment seeing tremendous growth in the last years. To provide context, the AWS segment has demonstrated substantial revenue growth, with revenues increasing from $17 billion in fiscal year 2017 to $62 billion in fiscal year 2021. Further to this, the AWS segment has a high operating margin, close to 30%. More on this at a later stage. In essence, AMZN is a company with solid fundamentals, a leading e-commerce segment, and a rapidly growing, highly profitable cloud computing segment. Given these attributes, the company represents a compelling investment opportunity and in my opinion a buy.

Business Overview:

AMZN is one of the world’s largest technology companies, operating in various segments, with the company’s business model centered around generating revenue through its North America and International e-commerce segments. As mentioned above, AMZN also has a growing and highly profitable cloud computing business. Finally, the company is close to becoming the most popular streaming video service in the United States. We can expect AMZN to become a global dominant player in this market in the coming years. Let’s jump into the financials!

Financial Overview:

In terms of financial performance, AMZN has trailing twelve months revenues of $502 billion and cash flow from operations of $39.7 billion. These numbers demonstrate the company’s ability to generate massive revenues and cash flow, which is a testament to the effectiveness of its business model. The majority of these revenues come from the company’s North America and International segments, which account for over 87% of total sales during FYE 2021. The remaining revenues come from the rapidly growing AWS segment. AWS revenues are becoming an increasingly larger portion of the company’s total revenues and are the primary source of profits generated by the company.

AMZN competes in the global cloud market with major players such as Microsoft (MSFT), Google (GOOG) (GOOGL), Alibaba (BABA), and Tencent (OTCPK:TCEHY). The competition in this market is intense, with each of these companies offering a range of cloud-based services and trying to gain market share.

AWS has been growing rapidly during the last years and has become a significant contributor to the company’s total revenue, as of the third quarter of FYE 2021 the segment accounted for 16% of total revenues. The table presented below displays the revenue growth for AWS, as evidenced by the FYE 2022 third quarter and prior periods. One can clearly see the substantial growth AWS is experiencing, and with the market continuing to grow, the segment could continue seeing double digit growth rates. It is worth noting that AWS is a very profitable business, with the operating margin constantly being around 25% to 30% of revenues.

To stay competitive, AMZN is investing heavily in research and development to enhance its technological capabilities, including cloud, e-commerce platform, logistics, and others. In the TTM, AMZN spent approximately $66 billion in R&D, which is a significant investment in the company’s future. Fundamentally, AMZN has very strong financials, including a strong balance sheet bolstered by $59 billion in cash and cash equivalents. This cash allows the company to have flexibility to make strategic investments and acquisitions, as well as to whether economic downturns. Although the company’s debt seems large, most of it comes from lease liabilities, which are considered less risky than other forms of debt.

Shareholder Returns

AMZN management announced a share buyback program of $10 billion earlier in 2022, which is likely to be increased in the future. This is a positive sign for shareholders and demonstrates the management confidence in its future prospects.

Management has started buying back shares, with the company spending $6 billion over the previous twelve months. It could very much be that they have finalized the authorized $10 billion in the last quarter of 2022. It will also be interesting to see if management chooses to expand upon this, or what their subsequent decision will be.

Growth Opportunities:

One key area for growth for AMZN is the global cloud computing market, which is projected to grow to $1.2 trillion by 2027. AMZN currently holds over 30% of the total market and can take advantage of this growing market by expanding its cloud services offerings, increasing its presence in new geographical regions, and targeting new industries. As a hypothetical scenario, if AMZN were to retain 20% of this market by 2027, the company could potentially generate approximately $240 billion in revenues from its AWS business. Furthermore, if the business were able to maintain operating margins of 25%, it would yield operating profits of $60 billion annually. It is important to note that this is purely a hypothetical scenario, however it does demonstrate the potential magnitude of the AWS business.

Another key area for growth is the global e-commerce market, which is projected to grow to $5.4 trillion by 2026. AMZN can capitalize on this growth by continuing to expand its e-commerce offerings and increasing its global presence, particularly in emerging markets such as Asia and Africa, where e-commerce is still in its early stages.

The final key area for growth is the streaming video market, where the company’s streaming service, Amazon Prime, is increasingly gaining market share. The streaming video market is rapidly growing, as more and more consumers are shifting away from traditional cable and satellite television to streaming services. AMZN has invested heavily in creating original content for the platform, and this has helped to attract and retain subscribers. As of September 2022, Amazon Prime Video is the second-most popular streaming service in the United States, after Netflix.

Valuation:

As mentioned earlier AMZN has seen a drop on its market valuation since it had its eyes set at $2 trillion, the drop has been significant and is now trading at a market valuation of $970 billion. This puts the company multiples at cash flow to price of 24x and sales at approx. 2x.

For the valuation of the company, I have used the market multiple method, using future forecasted earnings to a 25x multiple. I have obtained the analysts’ revenues forecast from Seeking Alpha data and have applied net profit margin of 7.5%, which is above the average of the previous 3 years at 5.6%. I have done this because I am assuming that management will be able to limit losses from the North America and International segment, and AWS profits will most likely continue increasing with revenues. Using this method, I have arrived at a market valuation for AMZN of $1.5 trillion by FYE 2026.

Risks:

Increased competition: AMZN faces intense competition from both traditional retailers and e-commerce companies, as well as from technology companies that are entering the retail space. This competition can lead to price wars, which can negatively impact AMZN profit margins. To mitigate these risks, management will have to continue to innovate and improve its offerings, by investing in new technologies, improving its logistics and supply chain capabilities, and providing a superior customer experience.

Overreliance on AWS Operating Income: There is a risk of over-reliance on the cloud computing segment for operating profits. The segment currently represents a significant portion of the company’s overall profitability. However, if management does not prioritize profitability in other business segments and if there were to be a technological disruption in the cloud computing market, it could result in a decline in overall company profits. It is crucial for the company to maintain a balanced and diversified stream of profits to mitigate this risk.

Bottom Line:

In conclusion, AMZN has strong financials with a growing AWS business, which is becoming an increasingly larger portion of the company’s total revenues and primary source of profits. The company continues to make significant investments in R&D in order to enhance its technological capabilities and maintain a competitive advantage in its respective markets. With strong fundamentals coupled with the opportunity of being a dominant player in growing markets such as the global cloud computing, video streaming and e-commerce markets, AMZN presents an attractive long-term investment opportunity.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.