Amazon (NASDAQ:AMZN) is set to report its second-quarter results this Thursday, amid an ongoing rotation out of big tech.
The Setup – Ongoing Rotation Out Of Big Tech
I’ve been covering Amazon on Seeking Alpha since August of last year. I initiated coverage with a ‘Buy’ rating, as Amazon was in the midst of its still ongoing margin expansion and growth acceleration story.
Since reaching a bottom at the beginning of 2023, shares of Amazon have been rising almost undisrupted, more than doubling over the last year and a half:
During this period, there were only three material downturns, two of which occurred in parallel to a broad market selloff. However, the last downturn, which is still ongoing, is quite different.
We can see that Amazon is down much more significantly than the QQQ (QQQ), and even more so than the S&P 500 (SPY). It seems that the rotation out of big tech, which some observers have been forecasting for a long time, is finally happening.
I am not in the business of thematic or macro investing, and all I care about is the fundamental story of the company I analyze. Therefore, the question I want to answer in this article is very narrow, is Amazon an attractive investment at these levels? Spoiler alert – my answer is yes.
Revisiting The Amazon Investment Thesis
If there’s one claim that’s hard to contradict about stocks is that the shares in a company whose growth is accelerating and margins are expanding will most likely go up. If shares of such a company are trading at a reasonable valuation, then market-beating performance becomes almost a certainty.
This is exactly the story of Amazon ever since Q1’23.
After several years of imbalance between growth investments and profits, Amazon has finally reached a ‘Harvest Stage’.
The story is quite simple. One, Amazon over-invested in logistic infrastructure for its retail business. As Amazon’s retail business (1P and 3P) continues to grow and gain market share, utilization improves, revenues grow, and margins increase.
Two, Amazon’s advertising offerings, which are a very high-margin business, are growing at a rapid pace.
Three, AWS, the company’s most profitable division, is experiencing acceleration as the industry is coming out of an optimization-focused period, and AI drives increased demand.
There it goes. I think there is little doubt about Amazon’s top-line growth opportunities. As I’ve been saying in my last articles, as long as Amazon continues to improve profitability, I expect shares to work.
Let’s dive into each of the segment’s prospects heading into Thursday’s print.
E-Commerce Market Share, Third-Party Sellers & Efficiency Focus
There’s a reason I’m starting with the least-discussed retail business. In my view, this segment is extremely underappreciated by the market. With all the talk about AWS, AI, and ads, I don’t blame investors for their lack of focus on retail.
However, this is the foundation for advertising, Prime, and 3P services, all of which are highly profitable, and provide a very long growth runway.
Created by the author based on Amazon financial reports and market estimates.
As we can see, Amazon 3P sales as a percentage of estimated GMV continue to rise. In addition, Amazon’s implied take rate is also increasing, accelerating 3P services growth.
Created by the author based on data from the companies’ financial reports.
Amazon is gaining market share in retail despite charging more from its sellers, as it’s by far the most popular eCommerce platform in the U.S. and worldwide. It has the most users, the best conversion rates, and the strongest fulfillment capabilities. I don’t see that changing anytime soon.
In the upcoming quarter, key aspects to monitor will be non-advertising margin (which is still below pre-pandemic levels), 3P sellers growth amid ongoing price increases, and progress with the company’s grocery efforts.
Advertising, Retail Media & Prime Video
The Advertising secret has not been a secret for quite some time now, as Amazon is running through competition to become the third-largest digital advertiser in the world.
Created and calculated by the author using data from the companies financial reports. Share is calculated as the respective company’s share of the combined reported advertising revenue.
In addition to the existing ad offering which continues to grow rapidly, Amazon introduced ads in Prime Video at the beginning of this year.
To understand how big of an announcement this is, let me take you through the following exercise. Prime Video has 3.1% of viewing time in the U.S., according to recent Nielsen data. That’s 31% of the time that’s spent on YouTube.
YouTube ads are at a ~$35 billion run rate, reflecting a high-margin $11 billion opportunity for Prime Video ads.
There’s a caveat though, which is that Nielsen data measures CTV viewing, and a lot of YouTube engagement is done on mobile. Even if we cut those $11 billion in half, this is still ~$5 billion in incremental operating profit as it is today.
Amazon Prime Video continues to expand its offerings, like the recent NBA deal that’s been announced, and I expect it to gain more viewing share over time.
In the upcoming quarter, I expect to see a slight deceleration, but it’ll be very interesting to hear about the ad landscape following the recent YouTube Ads miss.
AWS Acceleration, Cloud Migration Runway & AI
Last but not least, AWS. The market initially viewed Amazon as an AI laggard, primarily because its proprietary closed LLM model Titan isn’t on par with the likes of Microsoft’s OpenAI or Alphabet’s (GOOG) Gemini.
However, through Bedrock, Q, and SageMaker, Amazon is slowly regaining the market’s appreciation. Furthermore, the market is shaping out quite differently than what initially thought, as open-source models like Llama are gaining steam.
If LLMs end up being “commoditized”, AWS stands to be a beneficiary, unlike the two other hyper scalers who heavily invested in LLMs.
This isn’t to say there’s no advantage in having an industry-leading proprietary LLM, it just means that even though Amazon is far behind on that front, AWS will maintain its dominance.
Created and calculated by the author using data from the companies’ financial reports; Microsoft’s fiscal quarter is two periods ahead of the calendar year, meaning Q1-24 is Microsoft’s fiscal Q3-24.
In the upcoming quarter, AWS is expected to see growth accelerate to 18% Y/Y, up from 17% last quarter. The company guided for continued acceleration throughout the year.
Valuation Is Extremely Attractive
Amazon is firing on all cylinders, with a clear double-digit top-line growth trajectory, through diversified revenue streams. Its margin expansion story is only beginning, with a significant runway for operational leverage, as long as management remains committed to maintaining and improving efficiency.
Unsurprisingly, EPS is expected to grow at a 22% CAGR between 2024-2028:
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In my view, there’s a very slim chance Amazon doesn’t materially beat these expectations, which bake a material slowdown in margin expansion.
Amazon is trading at 32 times 2025 earnings, the lowest multiple in its history. Moreover, this is at a time when Amazon’s cash conversion is expected to be the highest it’s ever been.
In light of the above growth rates, I view this as an extremely attractive entry point. Some of the reasons shares have been pressured the past month are transitory, like Jeff Bezos’ selling and an unbiased rotation out of big tech, and long-term investors should capitalize on that short-term opportunity.
Putting a 38x ( a smidge under 1.5x PEG) multiple on ’25 earnings, we get to a price target of $220 a share by the end of this year, reflecting 20% upside.
Conclusion
Amazon is set to report its second-quarter earnings this Thursday, amid a rare selloff caused by transitory reasons, including Jeff Bezos selling, and a broad big tech downturn.
The company remains one of the cleanest double-digit growth stories in the market, as it continues to gain market share across the largest pools of revenue worldwide, including retail, advertising, and cloud computing.
Amazon’s management has been executing exceptionally with a balanced profitable growth approach, and I expect that to continue, leading to market-beating returns.
I encourage investors to capitalize on this attractive entry point and upgrade Amazon to a ‘Strong Buy’.
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