Where could Amazon’s stock be in 5 years (NASDAQ: AMZN)

Investment thesis:

Amazon (NASDAQ: AMZN) is a company with many moving parts. The company experiences headwinds in some segments and tailwinds in others. COVID-19 supply chain and mitigation spending have limited e-commerce profitability in recent quarters, while Amazon Web Services (AWS) has thrived. The Federal Trade Commission (FTC) seems ready to take its pound of flesh. On the other hand, the market for cloud services is exploding in size and Amazon dominates the market. Historical activity, aside from short-term headwinds, also appears to have the potential to evolve into healthy earnings. 2021 has been a declining year for the stock relative to the S&P 500. However, 2022 and beyond is still brilliant.

Amazon’s short-term headwinds

Amazon’s e-commerce business has faced several short-term headwinds.

Labor

The labor market in 2021 was plagued by shortages of available workers. The increased demand for workers and competition among employers has resulted in increased wages and enrollment bonuses for many. This resulted in increased costs for Amazon and a negative short-term effect on the bottom line.

We have incurred billions of dollars in additional costs to keep our employees safe and to support testing and other costs related to COVID. And we’ve grown our global workforce by 628,000 over the past 18 months and are hiring more, including over 150,000 in the US to meet seasonal demand in the fourth quarter. This demand for labor recently coincided with the shortage of available labor, especially in the United States. It started in the second quarter, but it really started to impact our operations and our cost structure in the third quarter.

This has led to salary increases and signing incentives, as companies compete for workers, as well as inconsistent staffing levels in our operations. In addition, the disruption of global supply chains and the inflation of the cost of materials such as steel and services such as trucking have also increased our operating costs. We estimate that the cost of labor, labor-related productivity losses and cost inflation added about $ 2 billion to operating costs in the third quarter, particularly in August and September.

– Brian Olsavsky – Chief Financial Officer

As mentioned in the earnings call, this hit particularly hard in the third quarter as the North America and International segments swung to a combined net operating loss. AWS still made $ 4.88 billion in operating profits.

COVID-19 and the supply chain

Managing hundreds of thousands of employees during a pandemic adds significant costs to the bottom line. Well-known supply chain bottlenecks also drove prices up faster than the company passed them on to consumers.

In addition, we have seen inflationary pressures in commodities and services, as I mentioned, particularly in steel and third party trucking. We have also seen over $ 1 billion in costs related to lost productivity and the disruption of our operations. In the third quarter, labor became our primary capacity constraint, not storage space or fulfillment capacity. As a result, stock placement was frequently redirected to distribution centers in order to have the manpower needed to receive the products.

This resulted in less optimal placement, leading to longer and more expensive transport routes. In short, our operations are normally well staffed and optimized to be in stock and deliver to customers within one to two days. Labor shortages in supply chain disruptions have upset this balance and have resulted in additional costs to ensure that we continue to maintain our levels of service to customers.

– Brian Olsavsky – Chief Financial Officer

From these comments, it is clear to see where the operating profits of the North America and International segments have gone. In the first quarter of 2021, the segments accounted for $ 4.7 billion in operating profit and in the third quarter of 2021, the segments showed a combined loss due to the above. There is, however, a silver lining here. All of these problems are temporary. Even in the first quarter, when segments were profitable, COVID-19 mitigation efforts added costs. As these headwinds recede, the segments should quickly return to profitability.

Amazon operates in three segments; North America, International and AWS. For the first nine months of 2021, AWS generated 13% of revenue and over 60% of operating profit. This was even more pronounced in the third quarter and is expected given the narrow margin nature of retail.

Graph created by the author with data from SEC filings.

AMZN – Long term opportunity

According to the cited study, the global cloud computing market could be worth nearly $ 1 trillion by 2026. AWS is the world’s largest vendor with over 30% market share. This opportunity is huge and growing. In the first three quarters of 2021, AWS generated operating income of $ 13.2 billion on revenue of $ 44.4 billion. This operating margin, 30%, is very impressive. The segment is also growing – fast. Q3 2021 revenue is 39% higher than Q3 2020.

Extrapolating these figures over five years requires certain assumptions. As mentioned earlier, AWS revenue was 39% higher in Q3 2021 than Q3 2020. I assumed AWS revenue for fiscal 2021 would increase 37% from 2020 and reach over $ 62 billion. From there, I took a compound annual growth rate (CAGR) in revenue of 25% for three years, followed by two years at 20%. I assumed the operating margin would stay at 30%.

Graph created by the author with data from SEC filings and author’s calculations.

As noted above, AWS revenue could increase by $ 175 billion by 2026, based on these assumptions, and generate operating income of over $ 52 billion.

To extrapolate the North America and International segments, I assumed two more years at 20% CAGR, followed by three years at 10%. I’m assuming an operating margin of 3.0% as these segments have historically struggled with profitability. In 2019, the operating margin was only 2.2% for these segments combined, followed by 2.7% in 2020. The resulting operating profit in 2026 would reach $ 23.5 billion out of $ 782 billion. revenue dollars for these segments.

The combination of all segments generates nearly $ 76 billion in operating profits on $ 957 billion in revenue by 2026, as shown below.

Charts created by the author with data from SEC filings and author’s calculations.

Amazon typically doesn’t buy back shares or significantly dilute shareholders. Since 2018, on average, the average number of diluted shares outstanding has increased by approximately 1% each year. I assumed that the dilution of equities would continue at this rate. Based on this calculation, Amazon could earn $ 140 per diluted share in operating income, or $ 110.60 per diluted share after tax, assuming a 21% tax burden, in 2026.

From there, the stock price projections are straightforward:

According to YCharts, Amazon’s P / E ratios at the end of 2021, 2020, and 2019 were 65.23, 77.97, and 80.31, respectively.

The company is expected to earn $ 41.73 per share in this fiscal year and $ 53.25 in 2022. The projection I made would create estimated after-tax EPS of $ 53.98 in 2022, in line with analyst expectations.

These results would generate enormous cash flow. Amazon may be using some of it to buy back shares, pushing EPS even higher. Indeed, if the cash flow is maintained at the current rate, share buybacks are likely in the years to come. Amazon had nearly 5% of the market cap in cash and short-term investments at the last report, totaling $ 79 billion.

In many ways, extrapolating the revenue and earnings of a company like Amazon is a futile exercise. There are so many moving parts and unforeseen events on the horizon. Nonetheless, I think the exercise is worth it, fun, and hopefully provide an interesting conversation starter.

Other possibilities

The FTC

As mentioned earlier, the FTC is going after Amazon for its retail business, and now, possibly AWS as well. At the heart of every problem is whether Amazon uses anti-competitive practices to stifle competition. I have written about this in much more detail here. Three scenarios could arise. First, the FTC’s efforts may fail and business continues as usual. I consider it a tie bet. The second scenario is that Amazon agrees to voluntarily make some concessions and perhaps pay a hefty fine. Scenario two is the most likely outcome, in my opinion. In the third scenario, Amazon splits into three companies, either by force or voluntarily. Many investors would like to see this. However, the company never gave any indication that this was even a consideration.

New sources of income

On a more positive note, Amazon could also uncover another viable and lucrative source of income in the next few years. The company is looking to expand its physical presence in retail. This will also serve to provide logistics mini-hubs in strategic locations. Payment processing software that would support PayPal (NASDAQ: PYPL) and Shopify (NYSE: SHOP) would be under development. The technology would make use of inventory tracking and other benefits and fit right into Amazon’s ecosystem. The global Internet connectivity market is estimated to be worth up to $ 1 trillion per year. Amazon’s Kuiper project is currently competing with SpaceX (SPACE) to capture this market by installing a field of orbiting satellites. Adding any of these revenues could further fuel EPS growth.

Conclusion

Amazon’s stock took a hiatus in 2021 after a tremendous run. Headwinds that started in 2021 and persist in 2022 are expected to ease in the second half of this year. AWS continues to operate at full capacity, showing tremendous growth and profits. Investments in labor and logistics will pay off as headwinds in the supply chain subside. There are excellent opportunities for growth, profits and new businesses over the next several years, and shareholders will likely be rewarded with the above-market returns they expect.