Amazon Q4 Preview: AI And AWS Remain The Company's Growth Engines

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Amazon Q4 Preview: AI And AWS Remain The Company's Growth Engines

Seeking Alpha01-22 14:40

SummaryAmazon's Q4 is poised to benefit from strong AWS growth in generative AI and robust holiday sales, but capacity constraints and proprietary tools create long-term risks.Forecasting $1.2T ...

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Its fair value is $240, reflecting a limited margin of safety.Proprietary ecosystem and open-source disputes may limit multi-cloud adoption and developer trust, creating risks against rivals Google and Microsoft.imaginima/E+ via Getty ImagesIn my last analysis of Amazon (NASDAQ:AMZN) I honed in on its latest AI developments with its new Trainium3 chip and Project Rainier supercomputer. Since that analysis, in which I issued a Hold rating on overvaluation concerns, the stock has dropped by -3.2% in price.Based on my research, Q4 has likely been very strong for Amazon, with results potentially maintaining sentiment into Fiscal 2025. However, I do consider the stock to be somewhat overvalued at this time, and hence I reiterate my Hold rating leading up to the results day.Q4 PreviewBased on comments from Amazon's Q3 earnings call, management expects Q4 net sales of between $181.5 billion and $188.5 billion, implying around 9% year-over-year growth. Management also mentioned robust AWS growth will continue due to high demand for generative AI services. Though, similar to other Big Tech companies, it stressed capacity constraints with its data centers, meaning growth will be more moderated than otherwise for the time being. It generally expects faster adoption of AI services for the foreseeable future. To support this robust demand for AI services, the company has projected $75 billion in capex for 2024, with expectations for even higher spending in 2025. Of course, this is primarily being directed toward AWS's investments in AI chips for its data center expansions.Amazon's advertising business has been a strong growth driver recently (it achieved a year-over-year revenue growth of 18.8% in Q3). This has given the company an essential profitability boost that likely remained in Q4.In addition, despite an inflationary macroeconomic environment and high-interest rates recently curbing consumer demand for highly priced goods, Amazon has actually been benefitting somewhat from this. The reason is that its customers have been shifting to lower-priced goods on Amazon, increasing repeat purchases and basket sizes. Q4 sales were also maximized for the holiday, with investments in same-day delivery facilities and new promotions introduced. This improved customer service has also been supported by improved inventory placement, robotics, and regionalized fulfillment systems, driving lower costs and delivery speed. As those, like myself, who continuously study the business wisdom of Jeff Bezos know, he is religious about cutting costs. Indeed, every cost that is cut within Amazon translates to a price cut that can be given to the company's customers.As AI is currently the hottest industry in the world and driving the largest growth segment of Amazon, AWS, it deserves more attention here leading up to Q4 results. AWS's generative AI business is growing at triple-digit rates, and to support its position in AI, it has made a strategic investment in Anthropic recently of around $8 billion. This leverages Anthropic's models to attract enterprise clients and deeply enhances AWS's AI portfolio. Moreover, Amazon Q is driving around $260 million in annual efficiency gains through its AI-driven coding efficiency. This shows how AWS is positioning itself as an internal efficiency driver and a revenue generator through sales to customers. This is an extremely strong position for Amazon to be in. It is, quite simply, a leading beneficiary of AI demand, and these effects will inevitably be present in its Q4 results.ValuationAs Amazon is certainly a valid long-term investment, I use a period of five years in my valuation model.I forecast that the company will have a trailing 12-month revenue of $1.2 trillion in January 2030, with a net income margin of 10%, with expansion heavily supported by automation benefits. The result of my forecasts is a net income estimate of $120 billion for Amazon in January 2030.The company's diluted weighted average shares outstanding have increased by about 1% per year as a compound annual growth rate. If this trend continues, the company will have a share count of about 11.23 billion in January 2030. Therefore, I forecast Amazon will have diluted earnings per share of $10.69 in January 2030.Amazon stock is trading at a moderate price-to-sales ratio expansion compared to its five-year average, largely driven by margin expansion despite slowing revenue growth. I expect this to somewhat stabilize moving forward, as while automation will likely drive long-term margin expansion, it will take quite a lot of time for significant results. I use a conservative price-to-earnings ratio of 40 for my terminal multiple, which is just below current. The result of my forecast is a January 2030 stock price target for Amazon of $430. The current stock price is $225, so the implied five-year compound annual growth rate is 14%. This is just below my 15% annual return threshold for a Buy rating.Amazon's weighted average cost of capital is 12.6%, with an equity weight of 94.56% and a debt weight of 5.44%. Equity costs 13.24% and debt costs 1.57% after tax. When discounting back my January 2030 price target of $430 for Amazon to the present day using the company's weighted average cost of capital as the discount rate, the intrinsic stock price is $240. Therefore, the margin of safety for investment is 6.25%. The investment is roughly fairly valued in this model.Oliver Rodzianko's ModelRisksAmazon's size and market penetration means that it is unlikely to deliver remarkable returns, especially when also priced for perfection. This is indicated in my valuation model, but investors also have to contend with the reality that if the company encounters any operational setbacks, including from competition with the rise of Chinese companies like Temu and Shein in the Western hemisphere, the stock's valuation could contract significantly and further reduce the compound annual growth rate indicated in my model.Regarding AWS, the company does not have the best reputation for how it deals with open-source projects. AWS is known for taking open-source frameworks and rebranding them to directly compete with the original providers. Examples of this include Elastic (ESTC) accusing AWS of exploiting its open-source product without contributing back, and AWS introducing managed services based on DocumentDB after the company who developed this, MongoDB (MDB), changed its licensing terms to prevent such actions. Over the long term, such approaches could stunt the company's growth if customers seek more reliably ethical infrastructure providers. It could also slow down adoption of technology and reduce overall market growth if open-source as a concept becomes less common in the developer community due to infringement concerns.In addition, the AWS ecosystem is highly proprietary. While this simplifies deployments for existing customers, it also creates lock-in risks for enterprises. Many companies are adopting multi-cloud strategies, but AWS's proprietary tools lack the support for standardized multi-cloud integrations. In some respects, this does put it at a disadvantage to Google (GOOGL) (GOOG) and Microsoft (MSFT), though AWS may argue that such an approach asserts loyalty to its ecosystem, similar to Apple's \"walled garden\" approach with operating systems and hardware. However, over the long term, I think this could work against Amazon's total growth, as highly efficient organizations may seek open infrastructure from other Big Tech providers that does not limit their diversification and cost strategies.Conclusion: HoldIn my opinion, Amazon is one of the most robust companies on the planet. Yet, inevitably, any company in this position is going to have stock that is priced for perfection. This is, understandably, the case with Amazon. Therefore, I am not a buyer of Amazon stock at its present valuation because it is too expensive for a reliable 15% annual return over the next five years. That said, Q4 will most likely sustain current sentiment into Fiscal 2025, and there is a lot of growth to come, particularly driven from Amazon's AI offerings within AWS.","kind":"news","is_publish_news":true,"is_publish_highlight":true,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"hasMoreComments":false,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false}}