Amazon (AMZN) stock is down more than 7% since reporting earnings on August 1. While the stock is still up 12.4% in 2024, shares have fallen nearly 12% in the third quarter. With the selloff, the stock is trading in undervalued territory, based on Morningstar's fair value estimate
Amazon reported a solid quarter, with revenue above the midpoint of guidance but below consensus and profitability well ahead of its outlook. However, guidance for the third quarter was light on both the top and bottom lines versus the pre-call consensus. Shares dropped from $184 (£139.68) to $168 the day after earnings, and with the stock's 15% upside to our fair value estimate and a wide moat rating, we view it as attractive.
Amazon remains the clear leader in e-commerce, and efforts to improve operations have paid dividends. The company is also the leader in public cloud services and well-positioned for all things AI – and these are all secular trends.
We weren't quite as aggressive in the near term as the street, so results and guidance were a little more in line with our thinking. Our fair value estimate went up $2 to $195 based largely on the time value of money within our model. We don't think the long-term story has changed, and we view quarterly results more as noise.
E-commerce drove the weakness in the quarter, which seems obvious, given the pressure the consumers are under with inflation. AWS was strong and continues accelerating, with new workloads moving to the cloud and generative AI driving relative strength. Advertising remains another bright spot, outpacing advertising growth at Meta Platforms (META) and Alphabet (GOOGL).
The following are highlights of Dan Romanoff's current outlook for Amazon and its stock. The full report and more of his coverage of Amazon are available here.
Key Morningstar Metrics for Amazon Shares
• Fair Value Estimate: $195.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium
Fair Value Estimate for Amazon Shares
With its 4-star rating, we believe Amazon's stock is undervalued compared with our long-term fair value estimate of $195 per share, which implies a 2024 enterprise value to sales multiple of 3 times and a 2% free cash flow yield. We think multiples are a little less meaningful for Amazon, given the ongoing heavy investment and rapid scaling that depresses financial performance. However, we expect the company to significantly grow its free cash flow as it matures.
Over the long term, we expect e-commerce to continue to take share from brick-and-mortar retailers. We further expect Amazon to gain share online. We believe that over the medium term, covid-19 pulled forward some demand by changing consumer behavior and better penetrating some retail categories that previously had not gained as much traction online, such as groceries, pharmacy, and luxury goods. We think Prime subscriptions and their accompanying benefits, along with selection, price, and convenience, continue to drive the retail story. We also see international as a longer-term opportunity within retail. We model total retail-related revenue growing at an 8% compound annual growth rate over the next five years.
Read more about Amazon's fair value estimate
Economic Moat Rating
We assign Amazon a wide moat based on network effects, cost advantages, intangible assets, and switching costs. The company has been disrupting the retail industry for more than two decades while emerging as the leading infrastructure-as-a-service provider via Amazon Web Services. This disruption has been embraced by consumers, driving change across the industry as traditional retailers have invested heavily in technology to keep pace. Covid accelerated this change, and given the company's technological prowess, massive scale, and relationship with consumers, we think Amazon has widened its lead, which we believe will result in economic returns well over its cost of capital for years to come.
We believe Amazon's retail business has a wide moat. It has network effects associated with its marketplace, whereby its many buyers and sellers continually attract more buyers and sellers. It has a cost advantage tied to purchasing power, logistics, vertical integration (proprietary brands, owned delivery, and so on), and a negative cash conversion cycle. And the business possesses intangible assets associated with technology and branding.
We also believe AWS is a wide-moat business. It has high customer switching costs, a cost advantage associated with economies of scale whereby few competitors can keep up with Amazon's investment pace, intangible assets arising from semiconductor and facility development, and a network effect associated with a marketplace for software created to make AWS work better.
Amazon's burgeoning advertising business has a narrow moat, in our view, based on intangible assets from its proprietary data on hundreds of millions of users, as well as a network effect again focusing on buyers and sellers meeting in the largest available venues.
Read more about Amazon's economic moat
Financial Strength
We believe Amazon is financially sound. Revenue is growing rapidly, margins are expanding, the company has an unrivaled scale, and its balance sheet is in great shape. In our view, the company's marketplace will remain attractive to third-party sellers, as Prime continues to tightly weave in consumers. We also see AWS and advertising driving overall corporate growth and continued margin expansion.
Read more about Amazon's financial strength
Risk and Uncertainty
Amazon's uncertainty rating is high. Despite being an e-commerce leader, the company faces a variety of risks.
Amazon must protect its leading online retailing position, which can be challenging as consumer preferences change (especially in the wake of covid, as they may revert to prior behaviors) and traditional retailers bolster their online presence. Maintaining an e-commerce edge has pushed the company to make investments in nontraditional areas, such as producing content for Prime Video and building out its transportation network. Similarly, the company must maintain an attractive value proposition for its third-party sellers. Some of these investment areas have raised investor questions in the past, and we expect management to continue to invest according to its strategy, despite periodic margin pressure from increased spending.
Read more about Amazon's risk and uncertainty
AMZN Bulls Say
Amazon is the clear leader in e-commerce and enjoys unrivaled scale to continue to invest in growth opportunities and drive the very best customer experience.
High-margin advertising and AWS are growing faster than the corporate average, which should continue to boost profitability over the next several years.
Amazon Prime memberships help attract and retain customers who spend more with Amazon. This reinforces a powerful network effect while bringing in recurring and high-margin revenue.
AMZN Bears Say
Regulatory concerns are rising for large technology firms, including Amazon. Further, the firm may face increasing regulatory and compliance issues as it expands internationally.
New investments – notably in fulfillment, delivery, and AWS – should dampen free cash flow growth. Also, Amazon's penetration into some countries might be harder than in the United States due to inferior logistical networks.
Amazon may not be as successful in penetrating new retail categories, such as luxury goods, due to consumer preferences and an improved e-commerce experience from larger retailers.
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