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Amazon Is Getting Back to Its E-Commerce Roots. The Stock Should Benefit.Amazon Is Getting Back to Its E-Commerce Roots. The Stock Should Benefit.Barron's (Online); New York Back in July, I wrote a Barron's cover story that made a bullish case for Amazon.com, tied to the enormous long-term value of the company's cloud-computing arm, Amazon Web Services. Mea culpa. Amazon shares have since fallen 25% , amid concerns about the near-term growth prospects for both the company's core e-commerce business and for AWS. While those worries are valid, I'm more convinced than ever that it makes sense to buy Amazon.com (ticker: AMZN) shares for the long haul. So, while shopping for Squishmallows and Barbie Dreamtopia Mermaid dolls over the holiday season, you might want to commit a few bucks to Amazon shares, as well. AWS has clearly been a soft spot since my bullish story. Revenue growth has been slowing faster than expected, and analysts now expect 25% growth in the December quarter , down from 40% a year earlier. But as Piper Sandler analyst Thomas Champion wrote this past week, AWS controls more than 50% of the cloud market and remains on track to hit the $100 billion revenue mark in 2023. That's more than triple the level at Salesforce (CRM), which is growing at half the rate of AWS. Give Amazon's cloud unit a comparable valuation, and it would represent more than half of Amazon's current market cap of around $940 billion. And, as I argued in July, I think the business is easily worth more than that. But I want to focus on Amazon's core business—online retailing. E-tailers continue to take market share, but consumers have pared back spending amid a macroeconomic mess that includes rising inflation, high interest rates, and a potential recession. Amazon's revenue from online stores fell 3% in the March quarter and then 4% in the June quarter, before bouncing back to 7% growth in the September quarter. For the holiday period, Wall Street analysts project a flat quarter compared with a year ago. That seems alarming—most estimates for the holiday shopping season still project at least modest growth in overall online sales. But online stores are just part of the e-commerce story for Amazon. The company has an enormous infrastructure of warehouses and delivery workers, which power its third-party seller services business, as well as a growing advertising arm that helps Amazon sellers draw attention to their wares. The third-party business should reach $125 billion in 2023, while the ad segment should top $44 billion, more than a third the size of Meta Platform's (META) ad business. During the pandemic, Amazon aggressively built out its platform—head count has doubled since the end of 2019 to more than 1.5 million. Amazon has conceded it overshot and has lately reversed course, cutting staff and shuttering some warehouses. That's where things get interesting. MoffettNathanson analyst Michael Norton recently picked up coverage of the e-commerce sector , noting that since 2001, online shopping has expanded its share of the U.S. retail market from 1% to 14%. Norton thinks the trend will continue: "It's more convenient and often cheaper for a consumer to shop online," he writes. But in launching coverage, he recommended just one stock—Amazon. And unlike the case I laid out in my cover story, Norton's approach largely ignores AWS and focuses on Amazon's e-commerce arm, which he thinks is undervalued. Norton's argument is that Amazon has been slowly turning around, paying new attention to its cost structure. He estimates the company spent $81 billion on fulfillment and transportation infrastructure from 2020 through 2022 and that Amazon is now positioned to reap the rewards. The analyst thinks Amazon will show improving unit economics on fulfillment as it reins in costs. Norton expects the company's spending on fulfillment and transportation to drop from an estimated $25 billion this year to $10 billion in 2025. Norton's view is that Wall Street estimates are too high for capital expenditures and too low on free cash flow. He thinks improved operating leverage and additional expense controls should drive pretax earnings 18% above Wall Street estimates in 2023, and 9% above the consensus in 2024. The analyst sees Amazon profits of $1.93 next year—way above the Street, at $1.68. He sees pretax margins reaching 4.8% next year and 6.7% in 2024, up from an estimated 2.5% this year. One useful way to evaluate Amazon's e-commerce business, Norton writes, is by dividing its gross merchandise value—the total value of goods sold—by square footage of warehouse capacity. He notes that Amazon's business by that measure peaked in 2020—thanks to the Covid-related shutdowns—at $1,255, falling to an estimated $918 this year, as capacity expanded and growth slowed. But he predicts the measure will rebound to $1,058 a square foot by 2025. "Profit beats and declining capital intensity are the formula for multiple expansion," Norton adds. "For three years, Amazon has experienced multiple compression as [pretax earnings] estimates declined and capital intensity was greater than expected. We believe we are at the end of the tunnel." Amazon shares have dropped by about 50% since their November 2021 peak, losing nearly $1 trillion in market value in the process. But as Piper's Champion notes, a 56% decline in 2008 set the stage for a 270% rally over the following 12 months. Past performance, as they say, is no guarantee of future results. But given Amazon's dominant position in cloud computing and e-commerce, I like the odds. This holiday season, Amazon shares could be the gift that keeps on giving. |
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