Amazon

INVESTMENT SUMMARY UPDATE AS AT 31 DECEMBER 2023

Amazon is an American multinational technology company focusing on ecommerce, cloud computing, online advertising, digital streaming, and artificial intelligence.

Its ecommerce business has suffered many headwinds over the past three years. It incurred many excess costs during Covid, massively overbuilt its fulfilment-centre capacity (which doubled in size over the three-year period), and generated very low gross margins in its first-party business (direct sales to customers via the Amazon platform) as many brick and mortar retailers found themselves overstocked post-pandemic and Amazon committed to match prices. These headwinds resulted in massive losses in this segment.

Our investment thesis is that the losses are temporary and have created an opportunity to buy a business with strong moats and many years of above-market revenue growth ahead. Some of the inflationary costs, such as high freight expenses, have begun to reverse. We expect that as Amazon grows into the larger fixed cost base and works to drive efficiencies in its operations, the ecommerce profits will rapidly improve. Indeed, in the second quarter of 2023, Amazon mentioned their new regionalisation strategy for inventory management resulted in a 19% reduction in miles travelled and a 20% reduction in the number of touches per item. In the third quarter of 2023, Amazon reported significantly improved gross margins.

In addition, Amazon is ramping up its high-margin advertising business, which operates similarly to that of Google’s search advertising business. Amazon is better able to attribute sales to its adverts than competitors, which helps merchants clearly see their return on advertising spend.

Amazon’s other large business, AWS, is a cloud platform where the company builds, maintains, and operates computing infrastructure for other businesses. The cloud industry is an oligopoly between Amazon, Microsoft, and Google, with economies of scale in R&D and power consumption making it difficult for potential entrants to be sustainable. This business generates healthy operating margins in the high 20s. Recently, AWS suffered as customers pulled back spending and began optimising their cloud usage by shifting to longer-term contracts. We believe this optimisation process is nearing its end.

Amazon is trading at a multiple of 21 times 2026 earnings - a valuation we find attractive, given the strength of the two businesses and the opportunity for mid-teens revenue growth and margin expansion many years beyond this.

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