By Alec Hogg
To say I’m a fully fledged member of the Jeff Bezos fan club is putting it mildly. As is anyone who bought the stock a few years ago – in my case for $328 in December 2014. That purchase, and the five-fold price rocket, is a major reason why the Biznews Global Share portfolio has achieved such stellar growth these past four years.
But as you can see from the graph below, after its quite sensational run of the past year when the share price doubled and Amazon peaked above $2,000 to become only the second publicly traded business to be worth $1-trillion, the trend recently went into reverse.
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In just over a month, Amazon’s share price has lost over a fifth, a good part of that in the past couple of trading days in the wake of publication of the group’s third quarter results.
So what does your favourite Amazon cheer leader have to say now?
I’m still smiling. For good reason.
Well, for starters, the recent sell-off is a reminder that even the greatest investment propositions don’t go up in a straight line.
Mr Market suffers from a condition akin to manic-depression – he’s been manic for a while now but follows as night does the day. So when his world turns from sunshine to darkness, expect the same kind of overreaction on the downside as you’ve seen on the up.
Secondly, when things get particularly noisy, it’s best to focus on the facts. Fortuitously, we have Amazon’s third quarter’s financials and Friday’s conference call hosted by CFO Brian Olsavsky to draw on.
My feeling from all this is that Wall Street got ahead of itself in pushing the Amazon price too high on unrealistic expectations.
In the panic selling that we’ve seen in the past three weeks, many have missed what was a powerful operational performance in the three months to end September. The key issue upon which long-term shareholders need to focus.
In its quarterly results, Amazon publishes specific guidance on what it anticipates delivering in the next three months.
The group’s performance against these projections is where we should be focusing our attention. And not getting sucked in by overblown estimates compiled by spreadsheet jockeys.
Amazon 3Q profits at top end of guidance
Amazon’s second quarter’s results carried “guidance” that in the three months to September, Amazon would deliver Net Sales of between $54bn and $57.5bn (up between 23% and 31% on the same three months of 2017). The actual figure published last week was $56.6bn, up 29% hence close to the upper end of the range. If the impact of a stronger dollar is eliminated, the growth is 30%.
Three months back shareholders were also told to expect Operating Income of between $1.4bn and $2.4bn for the September quarter. The actual number published last week blew those expectations away, coming in at $3.7bn. Cause for celebration by any rational co-owner of the company.
Having worked through the numbers, I invested another half hour listening to Olsavsky’s quarterly earnings webcast.
As a shareholder, the call gave me a lot to enthuse about.
Efficiencies are improving at a rapid clip. After years of massive rises, the growth in staff numbers is now only half the sales increase. That will help make the increase in the minimum wage to 400 000 blue collar workers more affordable (estimates put its annual cost at $3bn). Robotics has played a major role here.
There is also a sharp decline in the rate of growth in spending on infrastructure (fulfilment centres, etc) – also well below the rise in sales.
As any business owner knows, when sales grow faster than costs, the crocodile jaws of profitability open. Every business strives towards reaching this idea. But it takes time to build the scale to make it happen. And that’s what Amazon has just delivered, hence its far better than anticipated surge in profits.
Profit margins growing at a rapid clip
Margins in the all important Amazon Web Services, for instance, jumped to 31% despite a 67th successive price cut. And sales there are still growing at almost 50% year on year, so as volumes grow, AWS will remain super competitive by cutting customer costs – helping the market leader handle much publicised challenges from Microsoft and Google.
What all this means to me is that after literally decades of sowing, Amazon is now starting to reap.
In all the noise of Mr Market’s wailing, this critical fact seems to have been lost. Even though, for shareholders, this could turn out to be the most important development in years.
One last point that punters didn’t like: Amazon is offering “guidance” that in the all-important fourth quarter of the year net sales will be between $66.6bn and $72.5bn, which translates into growth of between 10% and 20%. It is also very cautious on profits, forecasting a drop from the third quarter with operating income projected at between $2.1bn and $3.6bn.
This forecast slowdown in the growth of sales has spooked Mr Market.
Amazon’s quarterly sales growth hasn’t been as low as 15% (the midpoint of the guidance) since the first three months of 2015. And it compares with 34%, 38%, 43% and 39% in the four quarters leading up to September. Shock horror, say the Street’s worthies, this forecast proves the Bezos bulldozer is stalling…
The impact on sales of Whole Foods
What seems to have been forgotten is that those most recent over-the top quarters were boosted by fresh sales added through the $13.7bn acquisition of retailer Whole Foods and the continuously surging cloud computing arm (sales growing at 46%; profits at 75%).
Go back to before the Whole Foods deal, and percentage sales growth was in the 20s. Which is a more sustainable level than the post-deal numbers.
The over-riding reason for becoming a co-owner of Amazon, however, has to be built on the belief that the group is transforming retailing. Until that runs out of steam, it’s a stock to hold indefinitely. Being based in the UK, where the influence of Amazon is everywhere, it’s impossible to miss this reality.
Add in its huge lead first-mover advantage in cloud computing and the exciting new wave building in voice-activated devices (where Alexa is the market leader) and it should quickly be apparent the group has considerable runway left.
Those who missed the break when Amazon’s share price shot out of the starting gates three and a half years ago, may consider using Mr Market’s sudden depression to their advantage. The Bezos Bulldozer has a full tank, an expert driver and, if anything, is gathering momentum.
Need more convincing? Check out the table below. Every business owner knows that the health of your business is directly related to free cash flow. Enough said.
