Amazon set for lowest growth in 20 years Amazon set for lowest growth in 20 years Amazon set for lowest growth in 20 years

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

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research 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. To the extent that any content is construed as investment research, you must note and accept that the 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 under relevant laws.

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

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zurich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.