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Is Amazon’s Retail Business Trading for Free?

The recent 8% bear market rally in the Nasdaq doesn’t hide what Amazon investors have faced over the past six months: a 35% decline. That decline compares to the Nasdaq down 23% over the same period.

Underlying this gap is the reality that Amazon’s retail business is now facing gale-force headwinds related to slowing demand and rising costs. There’s a case that those headwinds have pushed the valuation of Amazon’s retail business to zero. *Loup is an investor in Amazon.

Things change fast

It’s worth noting that Amazon was a key beneficiary of the past two years. During that time, the company could not keep up with demand and made the right decision to ramp investment in infrastructure. Since then, comps have gotten tough and the retail growth has slowed dramatically from 44% unit growth in March 2021 to flat growth in March 2022. At the same time, the company has been faced with rising logistics costs (related to fuel) and labor costs (for its nearly 1.5m warehouse and logistic workers). It’s been the perfect storm; a dramatic slow down in growth while, at the same time, experiencing a dramatic increase in costs. And, that’s just the start. It’s likely going to get worse for Amazon before it gets better.

Before framing in the case that Amazon’s retail business is trading for free today, investors should be bracing for things to deteriorate in 2022. I believe we’re entering a recession and consumer spending will soften. The theory is that higher interest rates won’t slow US—let alone global—inflation fast enough to encourage continued spending. I believe that the most difficult period for retailers will be the June and September quarters.

AWS & Advertising account for most of Amazon’s valuation

Amazon’s market cap is about $1.2 trillion. I believe that $700B is related to AWS and $500B is related to advertising, which leaves retail valuation at zero.

AWS. AWS is still early in its growth curve. The segment is about 10% of overall revenue and did $62B in sales in 2021, growing 37% for the full year. In 2022, that growth remained steady with 37% growth in March. This year, the Street is expecting AWS will grow 33% and reach $82B in revenue. AWS is also highly profitable, with its consistent operating margins of ~30%. Although, in March 2022, it took a meaningful step up to 35%. Combining the revenue growth outlook along with a projected 30% in operating margins yields a $25B operating income in the next year. I believe a 25-30X operating income multiple is appropriate given the long-term growth profile. Applying that multiple yields a $620-750B AWS market cap, which implies that the rest of Amazon is currently valued at between $425-550B.

Advertising. Advertising is also still early in the growth curve. The segment accounts for about 6% of overall revenue, with sales of $31B in 2021. The concern is that a slowing retail business will dampen growth for advertising. In theory, this makes sense. In practice, we have not seen this. In the most recent March 2022 quarter, advertising grew at 25% while the growth of units sold remained flat. Ad growth can outpace retail growth because the number of ads on Amazon is growing and the number of search queries that Amazon can monetize is second only to Google. This year, investors expect the ad business to grow at 25% and end the year with about $40B in revenue. The business has operating margins of close to 50% which creates a powerful combination with a healthy 20%+ revenue growth outlook over the next several years. Modeling a 50% operating margin, the ad business will generate $19.5B in operating income this year. Applying a 25X multiple to the ad business suggests that the segment is being valued at $500B.

Where does that leave retail?

Retail accounts for 85% of revenue and should grow around 5% long-term. In the near-term, investors should brace for the retail business to get ugly with revenue likely down 5-10% in 2022, below investor expectations of flattish growth. The other orbiting retail negative is that operating margins are low and between 3-5% in a good year. When 85% of your business is declining and losing money, it’s understandable that investors would not give value to Amazon’s retail business.

I believe the negative headwind in Amazon’s retail business will turn positive in 2023 and beyond. The reason for my optimism is that online sales are still less than 25% of global commerce, but should grow to be 50% over the next 20 years. Amazon is best positioned to capture this secular shift to online given their dominance of top of the funnel and logistics. Revenue growth should return albeit at a lower 5% rate.

As for profitability, I believe a sustainable 3-5% margin is achievable. The slope of the ramp in spending on logistics will slow to a pace inline with retail growth, which should lift profitability in the segment along with investors’ willingness to assign a fair value to the business.


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