WEEKLY STOCK COMMENT: AMAZON
Roy Davidson, 2 August 2018
AMZN is a multinational e-commerce company, and the world's largest retailer. Products offered on its customer-facing websites include merchandise and content purchased for resale from vendors and products offered by third party sellers. On the enterprise services front, Amazon Web Services provides cloud-based technological infrastructure to businesses. AMZN also provides other services, such as advertising services and co-branded credit card agreements, and manufactures and sells electronic devices, including kindle e-readers, fire tablets, fire mobile phones and fire TVs.
Amazon Web Services is the dominant player in cloud infrastructure services, and according to many, is the greatest disruptive force in the entire enterprise IT market today. It reported revenues of US$17.5bn in FY17, up an amazing 43% on the prior year. This accounted for 10% of AMZN’s total revenue and its operating earnings of US$4.3bn accounted for 105% of AMZN’s combined operating earnings. Based on revenues, Amazon Web Services is estimated to be six times larger than its biggest rival Microsoft Azure. While growth rates of over 40% are not sustainable long-term, strong adoption rates, existing customers migrating more of their IT workloads to the cloud, and the release of new cloud-based products and services provide significant growth opportunities.
AMZN started as an on-line book retailer in 1994 and over the last 20+ years has created a global e-commerce giant offering the broadest selection of retail goods. AMZN controls close to 25% of US ecommerce and slightly less internationally and continues to gain share at a solid pace. AMZN has used its fulfilment centres to lock merchants into using Amazon.com to list and sell products. Over the last decade AMZN has invested significantly in fulfilment centres which are warehouses for the company’s own inventory as well as for third-party merchants. Fulfilment by Amazon is a service created to allow businesses to store inventory and fulfil orders from AMZN’s fulfilment centres. Instead of competing with AMZN in ecommerce, many businesses continue to operate their physical stores and make online sales through AMZN. This has allowed the company to stay ahead of its peers on customer service and expand into more product categories, positioning it for further growth.
In our view, AMZN’s willingness to invest very aggressively in order to strengthen its market position gives it a competitive edge over its competitors who are less willing to commit to the same level of investment spending. We believe AMZN will make significant returns on these investments over the long-term. However, we believe investors’ expectations are now overly complacent and the appreciation in the company's share price year-to-date has left very little room for execution risk. AMZN’s success over the long-term has not come without a number of large product failures and we think investors need to be mindful that AMZN’s heavy investment strategy carries risks.
Risks to AMZN include: 1) economic downturn, 2) offshore expansion risk 3) increased competition.