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Should you invest in Amazon?

Amazon’s pricing power and favorable revenue mix are some of the benefits. This leads to increased profitability and lower capital expenditures in the future.
There are some cons and negatives to buying AMZN shares. These include the stiff competition in the ecommerce segment and the difficulty in achieving success in new market segments.
My Amazon Hold rating remains unchanged. There are pros and cons to Amazon, and its valuations don’t support a Buy rating.

Elevator Pitches

I will continue to give a Hold to, Inc. (NASDAQ:AMZN). shares. In a previous article, published December 17, 2021, I discussed AMZN’s outlook for 2022.

My most recent article is focused on the pros and con’s of investing in Amazon shares. My Hold rating is based on the fact that Amazon’s risk-reward ratio is more or less equally balanced. AMZN’s pricing power in its own home market relative to Prime is one thing. The shift in revenue mix and the reduction in capital expenditures should also be a positive sign for Amazon’s future profitability. Amazon may not be able to compete in new growth areas and geographic markets while its core ecommerce business is competitive.
Key Metrics for AMZN Stock

Before I discuss the pros and cons of investing in Amazon, I will review the most recent financial metrics for the company as per the Q4 2021 financial results.

AMZN’s revenue grew by 9.4% YoY, from $125.6 billion in 2020 to $137.4 million in the latest quarter. Amazon’s Q4 2021 topline was in line with market expectations. The company’s quarterly sales were just -0.13% below the consensus revenue forecast.

Amazon’s operating income fell by 49.7% YoY, from $6,873 millions in Q4 2020, to $3,460million in Q4 2021. However, this was +44.2% more than the consensus estimate of Wall Street analysts at $2.4 billion. AMZN’s Q4 2021 operational profit was also higher than the previous guidance of $0 to $3.0 billion.

AMZN’s future-looking guidance for AMZN is mixed.

Positively, Amazon’s Q1 2022 Revenue Guidance of “between $112.0 and $117.0 Billion” and its operating income guidance of between $3.0 billion to $6.0 billion as per its fourth quarter earnings release suggest that the company will generate operating income margins of 2.7%-5.1% in the current quarter.

This means that AMZN’s operating profit should be significantly higher in Q1 2022 than its Q4 2021 operating profit of 2.5%. My earlier update on December 17, 2021 for AMZN expressed concern that Amazon’s 2022 earnings might fall short of expectations because of a higher-than-expected rise in labor costs. The fear of a shortage of workers is now less real than it was previously. Amazon stated that the labor shortage is less severe in Q1 (2022 than in Q3 (2021) during its Q4 2021 earnings conference on February 3, 2022.

The negative side of the coin is that Amazon’s mid-point Q1 2022 revenue guidance of $114.5 billion was 5.4% lower than the consensus top-line forecast of approximately $121 billion by the sell-side analysts.

In my December 2021 article, I stated that “it’s very likely that ecommerce sales growth will slowly normalize closer to prepandemic levels”, which “will translate into slower retail revenue growth going ahead.” AMZN’s revenue guidance in the first quarter this year was lower than I expected, which supports my views.

After I have discussed the key financial metrics of AMZN, I will discuss the pros and cons for Amazon investors in the next two sections.
Pros Of Buying Amazon Stock

My view is that AMZN’s key investment merits are its pricing power relative to the US Prime membership, a more favorable mix of revenue with higher-margin companies growing faster and a gradual reduction in capital expenditures going forward.
Pricing Power

Amazon announced in its Q4 2021 earnings media releases that it will increase the price for Prime memberships in the U.S. with the monthly fee increasing from $12.99 to $14.99 (+15%) and the annual membership rising from $119 to $139 (+17 %).”).

This is not the first time AMZN raised the price for Amazon Prime in the US. Amazon Prime membership cost increased by +25% to $79 from $99 in 2014. Amazon introduced a monthly Prime subscription in 2016 at $10.99. Amazon Prime’s monthly and annual subscription plans were increased by +20% and +18% to $12.99 and $119 respectively in 2018.

Amazon stated in its Q4 2021 results briefing, that it had “welcomed millions” of new Prime members and experienced “consistently high renewal rates” during the most recent quarter.

Amazon’s Prime membership base, which is essentially “sticky”, as demonstrated by the high percentage of members that have been retained, as highlighted above. This gives the company considerable pricing power.
More Favorable Revenue Mix

According to the company’s FY 2020 10-K filing, Amazon’s AWS revenue (Amazon Web Services), grew by 39.5%, from $12.7 billion in Q42020 to $17.8 million in Q4 2021. While its other revenue (advertising revenue) grew by +32.2%, from $7.4 billion up to $9.7 trillion over the same period. AMZN’s retail revenues increased by just 4.1% YoY during the most recent quarter.

Gartner (IT), in its February 2022 research, predicted that more than half of enterprise IT spending in “the application, infrastructure, and system infrastructure markets” would shift to “public cloud computing by 2025. This indicates that AWS’s strong growth momentum should continue for the next few years. Amazon’s advertising revenue is expected to rise rapidly in the future. Apple’s (AAPL), iOS privacy changes are a tailwind to AMZN but a headwind to other internet advertising firms that rely on third-party information. CNBC’s May 6, 2021 article stated that Amazon holds a vast amount of consumer data, which will “likely become a rarer and more valuable commodity for marketers.”

In my December 2021 AMZN article, I stated that Amazon will reap the benefits of a favorable revenue mix. This is a positive factor for profitability. As the revenue contribution from the higher-margin AWS businesses and advertising businesses grows (as opposed to lower margin retail businesses), it will be more profitable. These are my same views.
Expectations Of Lower Capital Expenditures

According to S&P Capital IQ data Amazon’s capital spendings will fall from $61.1 billion in fiscal 2020 to $55.8 billion (FY 2021), $54.6 billion, and $49.7 trillion for FY 2022 to FY 2023, FY 2023, and FY 2024 respectively. This aligns with comments made by company management at the Q4 2021 results briefing.

Amazon stated that capital expenditures related to the fulfillment center side are “moderating” when it was asked when AMZN will “emerge from this investment cycle”.

Summary: I believe Amazon has the potential to increase Prime members’ prices. In the medium term, a more favorable revenue mix could lead to higher profitability for AMZN. These are key investment merits for stock.

The following section will discuss the risks and negatives of investing in Amazon.

Click here for Amazon Stock Forecast 2030.

The Cons of Buying Amazon Stock

In my opinion, the key risk factors or negatives associated with an investment in AMZN’s shares include stiffer-than-expected competition in e-commerce, and the challenges linked to expansion in new geographies and new product categories.
E-Commerce Space: Competition

Amazon’s Q4 2021 retail and e-commerce revenue growth was modest, and its Q1-2022 overall revenue guidance was lower than expected. This article discussed earlier. AMZN’s increased competition in the ecommerce space is a major factor.

AMZN faces stiffer competition from niche e-commerce platforms and social media companies.

It is becoming increasingly difficult to distinguish between social media companies and e-commerce platform providers. Meta Platforms (FB), which introduced Facebook Shops in 2020, described it as a new initiative that allows companies to “easily set up an online store on Facebook or Instagram for free”. It is focused on a mobile-first shopping experience. Snap (SNAP), is also betting on augmented reality, or AR ecommerce. Bloomberg reported that SNAP was working with businesses to bring products to its Snapchat app via camera overlays. This allows users to digitally try on a new shade of lipstick or a different shoe style.

Amazon must also compete with niche players in ecommerce. Before Amazon became the online retail giant it is today, AMZN was once a niche seller of books. It later expanded into other retail sectors. Even though Amazon is the dominant company, niche players like Etsy (ETSY), and Wayfair (W), have been able to create a niche for themselves in their areas. These niche players will not be able to take away significant retail market share from Amazon but they could limit AMZN’s future expansion in certain product segments. Amazon, for example, has not been able to challenge ETSY in hand-made product categories.
It is difficult to expand foreign markets

According to the company’s fiscal 2021 10-K filing, the Amazon domestic (North America and foreign) revenue split is still approximately 2:1 after years of expansion overseas.

Answering a question about the possibility of Amazon Prime pricing increasing in international markets speaks volumes to AMZN’s relative competivity in these markets. Amazon stated that it considers the relative cost of supplying Amazon Prime to the customer and the use and value we create for customers when deciding whether to increase the Prime membership price in certain markets. This means that Amazon has a lower price power in international markets, where it is less established and faces fierce local competition.

It might be unrealistic to expect faster growth in global markets to outweigh the slowing growth in Amazon’s home market in the long-term.
Expanding into new growth areas might not be a successful strategy

Amazon’s potential expansion into areas such as healthcare and lending is a great opportunity for investors. It may also achieve the same success it achieved with AWS and its core ecommerce business. The truth is, Amazon might not have the success investors are hoping for with its new growth initiatives.

The grocery segment is one example. Amazon has a small market share in the US grocery sector, despite AMZN having acquired Whole Foods Markets in 2017, and spending a lot of money to grow this business over the years. This could be due to the fact that Amazon doesn’t have an edge or competitive advantage within these new markets where there is intense competition.

Amazon’s core ecommerce business is facing significant competition. The company may not be able to live up its potential growth in new markets and areas.
Are Amazon Stocks Worth Investing in?

If there are more benefits than cons and the valuations are attractive, it is worth investing in a stock. Amazon does not seem to have this problem.

According to S&P CapitalIQ data, Amazon is currently valued at 19.2x its forward EV/EBITDA multiple. This is lower than AMZN’s 10 year mean forward EV/EBITDA value of 22.9.

AMZN should trade below its historical average EV/EBITDA multiple as there is a possibility of slower revenue growth in the medium-term. Based on consensus forecasts from S&P CapitalIQ, Amazon achieved a revenue growth rate of +27.2% in the FY 2016-2019 period. However, it is expected to see a slower revenue growth rate of +14.9% in the FY 2022-2025 periods. The flip side is that AMZN’s top-line expansion slows down over the next few years, which is offset by an increase in profitability. According to market consensus, Amazon’s EBITDA margin will increase from 15.3% in FY 2020 to 18.2% by FY 2025.
Bottom line

Amazon is a Hold because I see both headwinds and tailwinds for the company over the next few years. AMZN’s current valuations don’t seem too expensive but they also aren’t cheap, so a Hold rating is fair.