Amazon Amazon Amazon

Amazon set for lowest growth in 20 years

PG
Peter Garnry

Head of Equity Strategy

Summary:  While most companies get punished for guiding lower revenue than estimates, Amazon shares somehow felt the love from investors in what we believe is a misguided interpretation of the Q4 earnings. The market is often right, but in this case we believe the market is overestimating growth and underestimating the risks to its operations from higher wage and logistics costs on top of an overhang from massive investments during the pandemic. Amazon is set for its lowest growth in 20 years which could suddenly put downward pressure on its equity valuation which is still at a steep premium to the US technology sector.


Overnight Amazon spike set to fade as growth is overestimated

Following yesterday’s carnage in Meta shares, Amazon turned sentiment with its Q4 earnings release with its shares up 11% in pre-market trading. While the price action is positive the underlying dynamics are not being appreciated in our view. The market is a big voting machine and mostly right, but we believe the market is potentially getting Amazon wrong.

First the figures. Amazon delivered Q4 EPS of $27.75 vs est. $3.77 which was mainly driven by recognizing $11.8 in non-operating income with the majority coming from gains on its Rivian ownership. With Rivian down 42% this non-operating asset is already worth a lot less and with recent comments from the Mercedes-Benz CEO that growth of electric vehicles will be increasingly constrained by lack of ressources, we believe Rivian will disappoint against expectations in the coming years. Amazon’s operating income fell to $3.5bn in Q4, which higher than the $2.4bn expected, but the lowest figure since Q3 2019 and its worst Q4 result since Q4 2017, as accelerating costs and investments are impacting profitability.

Amazon delivered Q4 revenue of $137.4bn vs est. $137.8bn, and AWS revenue was in line with estimates, but more importantly the Q1 revenue guidance was $112-117bn vs est. $120.5 telling yet again the story that analysts are too optimistic on the pandemic winners which are facing tough headwinds. The Q1 operating income guidance is $3-6bn vs est. $6.1bn which suggests lower profitability trajectory than expected but the wide range shows that Amazon has little visibility on its costs and revenue. What makes the price action weird at Amazon is that most companies get punished for guidance revenue lower than estimates. If Amazon hits the mid-point of its Q1 revenue guidance it will translate into 5.5% revenue growth (a long way from 16% y/y expected for all of 2022) which will be the lowest growth rate since Q3 2001; even the Q4 revenue growth rate at 9.4% y/y is one of the lowest growth rates in the company’s history, and still investors are rewarding Amazon. Why?

There are several potential explanations. One is the cloud business AWS which is still a market leader and growing fast. This business it the main driver of the equity value, but with antitrust regulation changing and with the focus on Amazon, the company might be forced to separate the two businesses. This could be forced on the notion of the precautionary principle of prohibiting Amazon from cross-subsidizing its retail business with cash flows from the cloud business.

The second potential explanation for the market’s enthusiasm is the capital expenditures which sits 96% (the difference between the two lines in the chart below converted back from logarithmic values) above the level if Amazon had following its trend growth in investments from before the pandemic. Given Amazon’s previous success and ability to generate high return on capital, some investors might think that these investments will lead to massive future growth. But the pandemic has been unusual and the bottlenecks in logistics could have forced Amazon to insource more of its operations which means that a larger part of capital expenditures are just maintenance investments swapping from third parties to its own balance sheet, and thus the actual amount available for real future growth is lower than perceived. In any case, the 262% increase in capital expenditures during the pandemic will begin to weigh on operating income through depreciation and given Amazon’s size it is questionable whether it can get the same ROIC out of those investments as before.

Finally, Amazon’s business model has never been stress-tested during high inflation and fast changing supply chains, and bottlenecks in global logistics. These forces on top of tightening financial conditions increases the downside risks on Amazon’s operations.

The market is still paying around 27 times 12-month trailing EBITDA which more than double the MSCI World Index and 34% premium to Nasdaq 100 companies. Alone the sheer size of Amazon means that the mean reversion effects on growth are intensifying and we believe the valuation metrics will continue to come down and act as headwinds for investors. While we are in favour of the wisdom of the crowd, we believe the price reaction to Amazon’s earnings is potentially wrong and investors are overestimating growth.

Source: Saxo Group
Source: Saxo Group
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.