Should you buy Amazon now or wait until after the stock split?
It was a difficult time for Amazon.co.uk (AMZN 0.25%) investors. The stock is down 35% for the year and some 43% from its all-time highs. With interest rates rising at the start of the year, high-growth tech stocks sold off sharply. And last week bad retail revenue reports from walmart and Target seemed to confirm investors’ worst fears about the effect of inflation on retail sales. Given that these are the two companies that Amazon dominates, it sold hard.
But with the company’s stock buyback and a stock split on the horizon, is it time to buy when others are scared?
Current issues in the retail segment
Hints at last week’s retail destruction were actually predicted by Amazon in its April first-quarter earnings report. Total sales growth slowed to just 7% from 44% a year ago, despite accelerating cloud growth. Operating profit actually fell from $8.7 billion a year ago to just $3.7 billion. When removing Amazon Web Services (AWS) operating profit, Amazon’s North American and international retail business actually totaled $3.8 billion in operating loss. Keep in mind that includes things like advertising and Prime subscriptions, which can be high-margin, so losses in its pure retail business were likely even worse.
As confirmed by Walmart and Target, Amazon struggled as revenue growth slowed amid economic reopening. At the same time, freight and logistics costs rose sharply due to rising fuel prices. And because Amazon had ramped up capacity so aggressively during the pandemic, it found itself with more capacity and more employees than needed as e-commerce revenue slowed.
As if that weren’t bad enough, management has been geared towards even weaker overall growth in the next quarter of 3% to 7% and for operating income to deteriorate – somewhere between a loss of 1, $0 billion and a gain of $3.0. billion.
But AWS is a bright spot
If investors were looking a little under the hood, they might have been a little more excited about Amazon Web Services, the company’s primary cloud computing platform. Companies generally save money and become more agile when moving to the public cloud rather than building their own data centers. This change should therefore continue even in the event of an economic downturn.
Last quarter, AWS revenue grew 37% from 32% growth in the prior year quarter, while AWS operating profit grew 53% as margins were increasing. The margin expansion was largely due to Amazon extending the useful life of its server hardware, but that should be a permanent change.
Over the past 12 months, AWS alone generated nearly $21 billion in operating revenue, up 43%. For 2022, AWS operating profit could be over $25 billion, or net profit just over $20 billion. Amazon’s market capitalization is currently $1.1 trillion, about 55 times that figure.
Even with higher interest rates today, given AWS’ leadership position and the cloud’s long-term growth prospects, it wouldn’t be a crazy price to pay for AWS alone.
And new innovations could help customers weather inflation
With its inventive culture, Amazon also has many ongoing projects in addition to its e-commerce platform and cloud computing. New initiatives such as the Just Walk Out technology and the Project Kuiper initiative for satellite broadband could help. Just Walk Out, which enables a cashier-less retail experience, has the potential to significantly reduce costs at Amazon Fresh grocery stores and other third-party retailers that adopt the platform.
Lower costs could allow Amazon Fresh stores and other retailers to lower prices, helping to combat inflation and labor shortages for consumers. Ditto for the Kuiper project, which has the potential to bring broadband to underserved communities at a lower cost than traditional solutions.
As these projects do not yet generate material income, they are largely overlooked by investors.
A historically low valuation
Meanwhile, Amazon stock is currently trading at a low valuation, at least relative to its history, both on enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization ) and on sales price measures. While Amazon has traded at a lower price-to-sales ratio for the past 10 years, that was before it broke AWS in its financial results, starting in 2015:
Another indication that Amazon might be undervalued is that management is actually buying back stock, which the company rarely does. The last time it did so was in 2011-2012, during another stock price slump. It turned out to be a good buying opportunity for long-term investors.
It all adds up to a nice buy today
Amazon will split its shares on June 3, which isn’t too far away. Although stock splits generally lead to heightened interest from retail investors, this is anything but a normal time. If the U.S. economy were to plunge into a deep recession, Amazon shares may decline.
However, barring this extreme scenario, a lot of bad news is emerging today. Although the short term is very uncertain, the cloud business alone could be a good buy; in the meantime, I would suspect retail will improve – perhaps as early as Prime Day in Q3 and the holiday shopping season.
Additionally, new innovations like Just Walk Out and Project Kuiper provide investors with potential new ventures to look forward to that are not factored into the current price at all. Add stock buybacks and I suspect investors with a time horizon of five or ten years will feel pretty good about buying Amazon stock at today’s prices. If you have the capital and a long-term horizon, there is no need to wait for the split.