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Elevator Pitch
I continue to have a Buy rating assigned to Amazon.com, Inc.’s (NASDAQ:AMZN) shares.
In my earlier write-up for Amazon published on August 5, 2022, I focused specifically on analyzing AMZN’s acquisition of One Medical and how this will affect its positioning in the healthcare industry. My attention turns to Amazon’s financial forecasts and business outlook for next year with this latest update.
I continue to believe that Amazon warrants a Buy rating. Amazon currently trades at an appealing mid-teens forward EV/EBITDA multiple, and the current consensus fiscal 2023 operating income forecast for AMZN is too conservative implying a good chance of an operating earnings beat next year.
AMZN Stock Key Metrics
Before I touch on Amazon’s 2023 prospects, I will highlight certain forward-looking metrics released as part of AMZN’s most recent Q3 2022 results.
Amazon released its financial results for the third quarter of 2022 on October 27, 2022 after trading hours, and AMZN’s stock price dropped by -7% to close at $103.41 on the next day. Amazon’s shares declined by an additional -1% to close at $102.44 at the end of the October 31, 2022 trading day.
The market’s negative reaction to AMZN’s Q3 2022 financial results is likely attributable to the company’s below-expectations fourth quarter top line and operating profit guidance.
Amazon expects to achieve total revenue of $144 billion in Q4 2022 based on the mid-point of its guidance, which was approximately -7% below the Wall Street’s consensus top line projection of $155.4 billion. Separately, AMZN provided a Q4 2022 operating income guidance of $0-$4 billion. In comparison, the sell-side analysts had earlier (prior to the issuance of Q4 guidance) anticipated that Amazon will record an operating profit of around $4.7 billion in the final quarter of this year, as per S&P Capital IQ data.
I think investors should look beyond AMZN’s 2022 financial performance and focus on the company’s outlook for the following year which is the subject of the subsequent section.
Where Will Amazon Stock Head In 2023?
I see Amazon generating significantly higher and better than expected operating profit in 2023.
It is important to look at Amazon’s incremental margins for Q4 2022 as implied by its management guidance, rather than focus on the expected financial figures in absolute terms.
Deutsche Bank’s (DB) October 28, 2022 research report (not publicly available) titled “Batten Down The Hatches” noted that AMZN’s “incremental margins at the high end of the 4Q (2022 management) guide are >7%, which would be the third strongest 4Q incremental margins of the last 17 years.”
Incremental operating income margin is calculated by the change in operating profit between two financial periods divided by the change in top line in the same time frame. In other words, Amazon’s relatively high incremental margin guidance for Q4 2022 (as compared to history) implies that the company thinks it can realize much higher incremental operating profit for every additional dollar of revenue it achieves going forward.
In my view, this bodes well for Amazon’s FY 2023 profitability and operating income outlook. Specifically, productivity and capital expenditures are two key areas where there is room to expand the company’s profit margins.
At the company’s recent Q3 2022 earnings call on October 27, 2022, AMZN emphasized that it wants to be in a position to have “a fast start on a lot of (productivity) initiatives in Q1 of next year”, considering that “there’s still a lot of opportunity to continue to improve productivity and drive cost efficiencies.”
Separately, Amazon revealed at its third quarter investor briefing that it has “taken steps to alter our forward plan and take CapEx (Capital Expenditures) out, and noted that it “probably cut about one-third of our (capital expenditures) budget from what we originally thought for 2022.”
Morgan Stanley (MS) previously published a report (not publicly available) titled “The Fulfillment Network: Built Through ’24” on September 21, 2022, which highlighted that Amazon “has enough (warehouse) capacity to handle its volumes until” the fourth quarter of 2024 based on its analysis. MS’s research provides support for the view that AMZN’s capital expenditures and fulfillment expenses (on a per unit-basis) should be significantly lower in 2023.
In summary, Amazon should head into 2023 with a substantial increase in operating income and expansion in profit margins.
What Are Amazon Catalysts To Watch For In 2023?
I am of the view that there are two re-rating catalysts for Amazon that investors should watch for next year.
One of the catalysts is Amazon beating market expectations with its actual operating profit for fiscal 2023.
According to consensus financial forecasts obtained from S&P Capital IQ, the market currently expects Amazon’s EBIT to grow by +104% to $24.7 billion and expand its EBIT margin by +100 basis points to 4.3% in FY 2023. Notably, AMZN’s consensus numbers for 2023 are still below the company’s actual FY 2021 EBIT of $24.9 billion and EBIT margin of 5.3%.
As I mentioned in the preceding section, I am of the opinion that AMZN is well-positioned to generate higher-than-expected operating income in the following year. My FY 2023 operating profit and operating income margin estimates for Amazon are $27 billion and 4.7%, respectively.
The other catalyst is the return of share repurchases for AMZN.
As revealed in its Q3 2022 10-Q filing, Amazon spent roughly $6.0 billion on share buybacks in the first six months of the current year, but it didn’t repurchase any shares in the third quarter. As of September 30, 2022, AMZN still has around $6.1 billion left from its current share repurchase authorization.
Following the recent share price correction, Amazon trades at a consensus forward next twelve months’ EV/EBITDA multiple of 14.7 times as per S&P Capital IQ valuation data. As a comparison, AMZN’s 10-year trough EV/EBITDA multiple is just slightly lower at 14.3 times, while its 10-year mean EV/EBITDA ratio is much higher at 22.2 times. Therefore, it is reasonable to predict that Amazon is likely to accelerate its pace of share repurchases in Q4 2022 and into 2023, as long as AMZN’s valuations remain sufficiently attractive for buybacks to take place.
If Amazon does execute on share repurchases in the fourth quarter of 2022, this will be revealed as part of AMZN’s FY 2022 results and 10-K filing that are expected to be released in February 2023. This will serve as a catalyst for Amazon, as share buybacks will send a strong signal to the market indicating that AMZN’s shares are undervalued.
What Is The Long-Term Prediction For Amazon?
There is still room for Amazon to continue growing in the long run, notwithstanding its size in absolute terms and market leadership in the e-commerce space.
AMZN’s revenue is expected to grow by a CAGR of +12.6% for the FY 2023-2026 period according to S&P Capital IQ. I hold the view that Amazon should be able to meet or even exceed the market consensus’ long-term growth expectations.
One key thing to note that e-commerce penetration isn’t that high. Based on a June 2022 research report issued by Morgan Stanley, the current penetration rate of e-commerce on a worldwide basis is just 22%, and there is the potential for the e-commerce penetration to rise further to 27% in the next four years. As such, I have a reasonably positive view of AMZN’s growth prospects for the long run.
Is AMZN Stock A Buy, Sell, or Hold?
AMZN stock stays as a Buy-rated stock for me. Amazon’s shares are inexpensive based on the forward EV/EBITDA valuation metric, and I think that there are re-rating catalysts in place for AMZN like higher-than-expected operating profit and the resumption of share repurchases.
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