Ticker:                      AMZNNature of Business:    Technology ServicesLocation :                                USA
Recent Price:         $3,372.01    52-Week High/Low: $3,552.25/2,256.38Estimated Fair Value:      $3,314.30-$4,707.60
Expected Return:      14.1%Consider Buy:                   Below $4,010.95Business Risk:                     High
Financial Risk:      MediumEconomic Moat:               WideCorporate Governance: Strong

Company Overview
What began as an online store dealing in books has become one of the biggest e-commerce companies in the world.  AMAZON.COM Inc. was incorporated by Jeffrey Bezos in 1994. AMAZON is a technology company that sells lots of products online and in physical stores. It also markets cloud-based products, devices, digital streaming services and online advertising. 6PM, AbeBooks, Audible, IMDb, Shopbop, East Dane and Fabric are some of the subsidiaries of AMAZON.

Jeffrey Bezos, the founder, is the chairman and chief executive officer and chairman of the board of directors of AMAZON. Brian Olsavsky, who joined the company in 2002, doubles as the senior vice president and chief financial officer of the company.

Investment Thesis
AMAZON has consistently grown its revenue. Revenue has increased at a Compound Annual Growth Rate (CAGR) of 27.6% over the past ten years.  However, the high cost of sales has been responsible for the low-profit margins of the company. The cost of sales to turnover ratio, though high, has started declining. The cost of sales ratio of 59% in 2019 is far less than the company’s 18-year average of 72.3%. Profit margins should improve as a result of the strong demand for cloud computing services offered by its business segment, Amazon Web Services (AWS), and retail sales. Earnings from AWS are increasing; revenue and operating income from AWS have grown by 42.1% and 43.6% respectively on a 3-Year CAGR basis. The operating income margin is encouraging; AWS produced an average operating income margin of 22.9% unlike an average of 3.4% for the whole company. The International Business Segment has been generating operating losses and negative operating profit margin for the past six years.

AMAZON is certainly a leader in cloud computing and it has been positioned to continue to benefit from the increasing demand as businesses move their operations online. Rather than build their own Information Technology (IT) infrastructure in-house, businesses continuously demand IT resources provided by external companies since it is less costly. AMAZON has the financial and technological capabilities to provide cloud computing services to companies in different industries.

Retail sales growth has been propelled by online sales. Retail sales gained $18.2 billion year-over-year; it has leapt by 20.1% over the past three years. Customers are offered a wide range of products through its online and physical stores. Besides, the breadth of its offerings has increased because the products of third-party sellers are sold in AMAZON stores.  We do not foresee a slack in revenue and profits from its retail sales business segment in the years to come.

The subscriber base of AMAZON is expanding; subscription enables users to access digital content and enjoy additional benefits such as free delivery and discounts. Subscription sales have quadrupled in the last five years, rising from $4.5 billion in 2015 to $19.2 billion in 2019. AMAZON also provides online advertising services. The sale of advertising services is increasing but it forms a small proportion of total revenue.

AMAZON’s fair value estimate is between $3,314.30 and $4,707.60. We believe that AMAZON stock would produce a return of 14.1%. Investment in the company, in our opinion, is profitable.

Financial Overview
Revenue expanded by 20.5% year-over-year to $280.5 billion on the back of rising retail sales, income from third-party sellers and cloud computing services. Retail sales swelled by $18.2 billion or 13% to $158.4 billion. Retail sales growth was largely driven by online sales; online sales of $141.2 billion was a 14.9% rise in 2019. Physical store sales, however, were more or less flat at $17.2 billion.  Revenue from AWS, which provides cloud computing services, leapt by 36.5% compared to 46.9% increment of the previous year. The revenue of $35 billion from AWS accounted for 12.5% of the total revenue of 2019 (2018: $25.7 billion or 11% of total revenue). AMAZON realised $53.8 billion from helping third-parties sell their products; this was a 25.8% improvement on the previous year’s figure. In addition, subscription sales which have been growing, climbed by 35.6% to $19.2 billion.

Despite escalating operating expenses, operating income increased by 17.1% compared to the prior financial year. AWS made an operating profit of $9.2 billion out of a total operating profit of $14.5 billion. The International Business Segment has been announcing operating losses since 2014; it posted an operating loss of $1.7 billion in 2019 compared to $2.1 billion in the previous year. North America generated $7 billion or 48.4% of total operating profit. Profit Before Tax (PBT) stood at $14 billion, having gained 24.1% year-over-year. Profit After Tax (PAT) was $11.6 billion, up from $10 billion declared in the previous year.

2019 operating profit margin of 5.2% was 0.2% less than the figure for 2018; however, it surpassed the 18-year average of 3.4%. However, the operating profit and margin of AWS have been impressive. AWS produced 63.3% of total operating profit and 26.3% operating profit margin. PBT margin was 5% while PAT margin was 4.1% at 2019 financial year-end. The high cost of sales has been responsible for the low-profit margins of the company. Cost of sales increased by 19% from $139.2 billion to $165.5 billion between 2018 and 2019 financial years; this amounted to 59% of turnover in 2019 and 59.8% of turnover in 2018. Returns have been getting better in the past five financial years. Returns on Average Equity (RoAE) has hovered around 16% while Returns on Average Assets (RoAA) has been close to 4%.

AMAZON has a long-term debt of $23.4 billion at the end of the 2019 financial year; the long-term debt formed only 10.4% of total assets and 37.7% of shareholders’ equity. Finance cost rose by 12.9%  from $1.4 billion in 2018 to $1.6 billion in 2019. Operating income covered interest payments 9.1 times, up from 8.8 times of the prior year. The company made an operating cash flow of $38.5 billion which translated into a Per Share cash flow of $78 and an interest cover of 24.1 times. AMAZON has manageable debt and does not have difficulty in meeting its debt obligations.

Business Risk
The business is rapidly changing and requires continuous investment in technology. This means that operating costs could rise; high costs coupled with competitive pressure could depress profit margins. The company’s operations outside the USA expose it to significant risks which include foreign exchange risk and government regulations on digital content, e-commerce, data protection and privacy.

Recommendation: Buy

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