Sage Investment Club

HISTORY:The story of AMZN is one of trials and tribulation, it was not always smooth sailing where valuation steadily rose over the years. Rather, it was one that required a visionary CEO, one who had sufficient foresight to take gambles that paid off, one who could stomach the choppy seas of business cycles, one who had the determination and patience to see through their largest gambles. Having a humble beginning, AMZN’s IPO MC was valued at $430 Million before losing 95% of their valuation in the tech bubble crash. AMZN managed to survive the tech bubble crash but their valuation held rather steady at around 17 billion in the early 2000s. Meaning investors believed that AMZN could no longer grow past this threshold and have matured. Reaching 17 billion in valuation by itself would’ve been an impressive feat but it wouldn’t be enough for a story worthy for the history books as companies like WMT had a valuation of about 200 billion at the same point in time. AMZN released prime in 2005, their X factor to differentiate themselves from their competitor. Net income was 588 million that year but due to large investments into prime net income in 2006 fell to 190 million nearly 67%. Consequently, from 2005 to 2006 AMZN’s MC fell nearly 20% as investors did not fully believe in prime. But Jeff Bezos, believing in his dream for fast shipping, was unfazed by the whole ordeal and carried on investing heavily into the retail business. And this investment paid off as today we know AMZN as the 5th largest company by market cap in the world.Tl;dr: Jeff Bezos I love you please sponsor my University fees.INTRODUCTION:AMZN business model involves a few revenue sources, in no particular order.Online Retail + Physical Store (AMZN Store): Their online retail website that generates the bulk of revenue, as physical stores have mostly stagnated and occupy a meager amount of revenue I’ll combine both Online Retail and Physical Store into AMZN store in my DCF.Amazon Web Services(AWS): Their cloud computing services which helps take businesses big and small into the cloud. Providing servers as well for firms. Brian Olsavsky described AWS as a business that helps firms change their fixed cost into variable cost, meaning firms pay more as they use more.Third Party Services(3P): AMZN has extended their retail transport capabilities to their competitors allowing third party to set up their store on the webpage, leaving the problem of transporting the goods to AMZN.Advertising: The latest significant addition to AMZN’s top line, AMZN sold the capability for advertisers to have their products more visible to customers on their retail store and providing tools for advertisers to analyze the data collected.Subscription: Lastly, Amazon Prime. Consisting of Prime video, Prime Gaming and Prime shipping.Others: representing the other businesses that AMZN has tried breaking into like Twitch but for simplicity sake and because Others represented about 0.5% of revenue in 2021 I’ll not forecast this in my DCF.REVENUE:AMZN store:2022, Retail has been hit pretty hard due to inflationary pressures and Ukraine War bumping up costs. Retail has definitely taken a hard beating for 2022. As per 2022 Q3 earnings transcript, “reduction in fulfilment and transportation capital investment…to better align with demand.” We can expect revenue to have taken a hit and definitely lower than 2021’s 22% Y/Y.Past 2022 however, I expect AMZN store to pick up as there is a large demand for the convenience provided by AMZN. “more than 90 percent of consumers expect two- to three-day delivery as the norm, while 30 percent expect same-day delivery.” – (JPMorgan,1). Only AMZN is well situated in terms of fulfillment center, transportation and capacity for expansion to meet this goal. In fact, AMZN is expected to be the largest e-commerce platform world wide by 2027 (Statista,2) earning about 1.2 Trillion.AMZN store is likely to have very high growth going into 2023 until at least 2025. It took AMZN about 2 years to double their fulfilment network from 2019 – 2020 hence the negative cash flows back then. So I’m assuming AMZN is going to be an aggressive grower with high revenues and low margins as AMZN will be expanding into new markets it’ll probably minimally need to spend another 2 years doubling its current size. Hence I project high growth period from 2023 – 2025.AWS:2022, firms are likely to be more conservative in these uncertain times preferring to have more cash reserves in hand. AWS offers a pay-as-you-go approach, not requiring firms to tie up large capital into AWS and AWS helps business to reduce cost. As per 2022 Q3 earnings transcript, “we’ve seen an uptick in AWS customers focused on controlling cost” All that being said, I don’t really expect any crazy amount of growth in AWS as companies are more likely to have their capital tied up in footing the bill for higher labor cost. Even management forecast growth “more in the mid 20% growth rate”. Compared to 2021’s Y/Y at 37.1% so 2022’s Y/Y is about 13% lower than 2021’s Y/Y growth rate.AWS is likely to have high growth as well going into 2023 as management announces plans to introduce AWS to more regions “launch of the AWS middle east region in August and the recent announcement to launch AWS Asia Pacific.” The cloud computing is a whole new realm of endless opportunities for Amazon to capitalize on, with the market expected to grow from 548 billion in 2022 to 1240 billion in 2027, (marketsandmarkets,3) AWS being in a good spot at about 38% market share as of Q1 2022, (statista, 4) to capitalize on this large market. Similarly I expect high growth period from 2023 – 2025.3P:I was thinking about how exactly should I go about forecasting third party but due to a lack of available data I actually forecast 3P with respect to AMZN store.Of course this was not just a random guess, 3P has always observed a direct relationship with AMZN store. Taking 3P revenue as a percentage of AMZN store from 2016 – 2021 that number has held steady at a range of 25% – 43%, it makes logical sense as well for 3P to have a direct relationship with AMZN store as 3P are retailers facing the same economical environment faced by AMZN store.So throughout my DCF, I took 3P’s revenue as 33% of AMZN store, 33% is the average of 25% and 43%.3P undergoes same growth period Y/Y as AMZN store.Subscription:Subscription was treated the same as 3P. My rationale for this was that you have to use AMZN store in order for a subscription to Amazon Prime to be useful for you. At least anecdotally, barring lord of the rings I have not really heard of any memorable titles on Prime Video. In fact, “Seventy-nine percent of Amazon Prime users cite free shipping as the primary reason they subscribe to the service”, (chainstoreage,5).Subscription from 2016 – 2021 when taken as a percentage of AMZN store held steady at a range of 7% – 13%.So throughout my DCF, I took Subscription’s revenue as 10% of AMZN store, 10% being the average of 7% and 13%. Subscription undergoes same growth period Y/Y as AMZN store.Advertising:2022, I’d expect advertising to fall as the advertising industry has proven to be a cyclical one. Using GOOG as a proxy for example, advertising revenue for GOOG actually decreased Y/Y in Q3 so similar results can be expected for AMZN.I won’t expect very high growth for Advertising however as it is quite limited in terms of what can be advertised as compared to GOOG. For example, GOOG is able to advertise service companies but AMZN may not be able to advertise services on the retail webpage.Regardless, AMZN is still a strong player in the advertising industry. By 2023, AMZN is expected to earn 7.1% of revenue in the digital advertising market worldwide, (statistia,6).I wouldn’t expect much high growth for advertising as not much exciting news or technology was introduced for advertising that would significantly increase revenue.EBIT:As per Q3 2022 earnings transcript, “drop in operating margin…we’re working hard to make sure that current profitability is not the new normal.” Margins have taken a hit in 2022 due to higher labor costs from the tighter labor market and the Ukraine War affecting gas prices which affects energy prices affecting AWS’ margins. I’d expect 2022’s margins to be smaller than historical margins. The latest 3Y average margin was at 5.47%. Due to AMZN starting to lay off workers on 4th Jan 2023, I’d assume the margins were hit pretty hard, for them to have to further reduce expenses. Margins assumed at 4.5%.AMZN’s margins are not likely to significantly increase from 2023 – 2025 as AMZN is going to continue heavily reinvest back into the company so margins are most likely to go back to the norm of 5.47% by 2025 at the end of the high growth period.But, as AMZN goes off their high growth period from 2026 onwards, margins are going to increase as they stop focusing on growing their business but start to become mature. I’d assume margins are about 9% by the end of my forecast period in 2031.ASSUMPTIONS:Taxes are taken to be 20%, 2021’s tax rate was 19.26% so I’d assume in this similar conditions as closely as possible taxes are about 20%.D&A taken to be 7% with respect to revenue, historically from 2016 – 2021 D&A with respect to revenue on average was 7%.Other Ops Exp/Inc and Deferred income tax was omitted from being forecasted despite appearing on the cash flow statement as they were too meager so I opted for less granularity and omitted them.Change in NWC taken to be -0.5% with respect to revenue, historically from 2016 – 2021 the average was -0.5%CapEX assumed to be 11% for the high growth period from 2022 – 2025. Before decreasing to reflect a maturing company. A picture of CapEX and D&A side by side: net asset balance was taken throughout forecast period.TGR taken to be 2%.WACC is taken at 9.2%, Calculations is as such.Reference taken from here: when calculating %equity and %debt I took long term debt, other long term liability and total shareholder’s equity.COD = taking AMZN’s historic bond yield(Market Insider,7) and AA corporate bond yield average (Ycharts,8) at 4.7%%debt = (58919 + 22259)/ (58919 +22 259 + 137489) = 34%%equity = 137489/(58919 +22 259 + 137489) = 66%Risk Free Rate(RFR) = 3.6%, US 10Y Treasury YieldMarket Beta = 1.34 taking the average from Aswath Damodaran (1.49) and Yahoo Finance(1.19)Risk Premium = 5.94% taken from Aswath Damodaran (It’s an EXCEL so I can’t link it)COE = 11.5%QUESTIONS & NOTES:WHY DID I GUESS AWS AND AMZN STORE ARE THE COMPONENTS GOING THROUGH HIGH GROWTH?As per 2021 Q4 earnings transcript, “40% of that capex is going into infrastructure, most of it feeding AWS…About just under 30% is fulfillment capacity, building warehouses — warehouse only, not transportation. And then just under 25% is transportation capacity and building on our NACL network, principally globally.” So we can see AMZN believes in the growth of AMZN store and AWS so I think it’s justified in my DCF to assume high growth for both.WHY DOES HIGH GROWTH STOP IN 2025?AMZN’s actual valuation is very heavily dependent on how long the high growth period lasts for. No guidance was given for how long this period is going to be, but a decent guess for this would probably be 2 years from 2023. 2022 was a period of contraction from AMZN navigating higher labor costs and the Ukraine War. 2023 would be a good starting point for AMZN to begin expansion. Given that the AMZN network took 2 years to double. If 2 years later it doubles again to quadruple it is most likely able to also support other regions outside of the US to a competent degree.INACCURACY IN FORECASTING ADVERTISINGData available for advertising is actually quite limited due to a lack of information from management and historically advertising has only been reported from 2019 onwards. As more financial reports become available for advertising the degree of accuracy of prediction increases, unfortunately only 3 years of data from 2019 – 2021 is available. The story for advertising business in AMZN is sadly just too murky and vague right now for me to paint you guys a decent scene.How much AMZN’s margins are actually going to be after the high growth period? historically AMZN always had low margins as they reinvested back heavily to the company. Once again a lack of suitable historical data, where we can observe how high margins could be with an average economical condition and with all investments paying off. 9% may be cutting it too little for AMZN, but better safe than sorry.LASTLY,All my forecasting are based on me weighing all the factors and adjusting their impact according to how much impact I think they have.CONCLUSION:Ultimately, I value AMZN at $115.61, it is undervalued compared to market’s $84. This difference can probably be attributable to how strong the market thinks AMZN’s high growth will be compared to mine. But, I do think that there are a lot of doomsayers especially in the news where literally every other day I’d open my preferred news app and see at least 3 different article about how inflation has not eased off to a great extent. Barring short term expectations, I really do see AMZN being a strong company with great free cash flow potential. 2022’s 10-K is definitely going to make or break how investors view AMZN moving forward, Questions like “Can AMZN finally break their negative CF?” will finally have an answer and give investor some kind of confidence. 4/5 of AMZN’s revenue sources are cyclical so they’d be overly affected by the current environment’s pessimism.I see this 37% of difference in price not as risk but rather as an opportunity because I believe AMZN will minimally bounce back 37% sometime in the future, the question is just when.For the last time, I appreciate any advice or comments on my DCF I really spent quite a lot of time on this DCF juggling between scouring for data and army left me literally devoting 70% of my weekends getting data. I’ve read the story AMZN has told and retold it in my own account and I hope this value adds to anyone even if no advice was given!Screenshot of my excel:

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