Since last month’s article in May, there has been a major sell-off in the market. This has particularly affected stocks that benefited from the post covid run such as tech stocks. Rising inflation and falling consumer demand also caused major sell-offs in consumer staples and retailers such as Target and Walmart. These large corrections were a long time coming for many stocks but the question on everybody’s lips is whether a recession is coming, which will ultimately result in these continuing to fall. There has been a conservative bounce back in the market with the Nasdaq finishing the week up 5.1% and Amazon, which I will be taking a deeper look into today, finishing up 6.3%. Amazon is in my opinion best placed to deal with the potentially turbulent economic conditions that lie ahead. I will investigate the different aspects that make up the colossal, multi-faceted business that is Amazon and why I believe there is still room for more growth as it begins to enter new markets.

Amazon Web Service

Amazon Web Services may not be what springs to mind when you hear of Amazon, but their juggernaut online web services contribute around 13% of total revenues and are the fastest growing area of the business with revenue growth consistently growing around 30% YOY over the last 7 years. Amazon's web services provide a vast array of on-demand cloud computing platforms and APIs that can be used by individuals, companies, and governments. The services operate on a pay

-as-you-go basis which is very attractive to companies who aren’t looking to pay large subscriptions for their cloud services. It’s for this reason that major companies such as Airbnb and Netflix can avail of AWS services along with thousands of smaller companies who want to minimise costs.

Cloud computing is a structure that allows on-demand network success to shared computing resources within three main areas, SAAS, PAAS and IAAS (Software, Products and Infrastructure as a Service.) It’s easiest to imagine the cloud structure as a pyramid with SAAS at the top and IAAS at the base. You would be familiar with many examples of SAAS such as Microsoft Office and Google Mail. The SAAS market is a saturated one and companies like Microsoft have a large advantage with end-users (the everyday person). AWS however, is more concerned with the latter of the two services, PAAS and IAAS. PAAS offers a programming language environment, web server and databases targeted to developers. Many programmers and developers prefer to use these cloud services as they are cost-effective for rapid development and allow faster markets. IAAS then allows for an entire computing infrastructure where all computing resources can run in a virtual

environment where multiple users can access them.

The IAAS and PAAS market combined makes up $118 billion of the over $1 trillion industry that is cloud services. Amazon currently holds the largest market share of the IAAS and PAAS market with 34% of the market and as the market continues to grow it is expected that these areas, in particular, will see the fastest growth. IAAS and PAAS only make up a fraction of the entire industry as a whole despite their huge scale capabilities. AWS revenue has had continued growth over the last seven years and a further 37% growth in 2021. It is expected that AWS revenue should reach $100 billion in the next couple of years as the demand for cloud services is rising amongst new tech start-ups and existing companies. AWS is an incredible moat and the profit margins within the IAAS and PAAS space are expected to increase in the coming years. Current profit margins are running at around 40-50% for IASS products which make up the majority of AWS services and PAAS services are running higher margins at nearly 80% depending on the service. Amazon’s real growth over the coming years in the space will be when companies see the need to upgrade their infrastructures and cloud software systems. They will have to turn to PAAS and IAAS services, where AWS is continuing to expand and innovate as well as improving profit margins year on year. Oracle one of Amazon's main competitors has held a large proportion of the market share in the PAAS sector with their databases but Amazon is fast approaching. With the improvements in their databases, I believe there is still room for growth in the ever-expanding market that is cloud computing services.

The World's Leading Retailer

Amazon generates more than 30% of e-commerce sales in eight of the nine major US retail categories whilst their share of US E-commerce sales as a whole hit an all-time high of 41.4% in 2021. These statistics are quite staggering when you begin to think of the rise in popularity of online retail and e-commerce in the last decade. When you buy products from Amazon.com you are buying directly from Amazon's wide product range and range of individual sellers. Although this is the largest single retailer service in the world, Walmart being the second largest at less than half its size, it is the Amazon Marketplace that asserts Amazon's dominance in the e-commerce space. The Amazon Marketplace is so well integrated into Amazon.com that you probably don't even realise you're purchasing from third-party sellers. The marketplace accounts for at least 60% of Amazon's Gross Merchandise Volume (GMV) and nets a whopping 25% share of total US e-commerce sales. There has been a particular rise in the Amazon marketplace as self-employed entrepreneurs are looking to sell their products to an audience of millions. The marketplace has over 300 million users and an estimated 65% of the entire US population visited the Amazon shop in 2021 at least once a month to shop for products. Therefore, it is a no-brainer for those trying to reach a wider audience for their products. 25 cents of every dollar spent shopping online goes through the Amazon Marketplace and this is only expected to grow over the coming years with estimates suggesting Amazon may top $1 trillion in GMV by 2025.

The Amazon Marketplace currently has over 353 million products listed for sale and of these 353 million only 12 million are sold by Amazon themselves. This means that as the third-party side of the e-commerce business keeps growing, Amazon's own inventory-based online revenue could begin to dwindle. In response to this, I expect Amazon to begin increasing their fees/commission for using the Marketplace as an intermediatory for third-party sellers. This will help to combat the potential loss of market share in the company's own online business.

It is estimated that 4 in every 5 customers will simply go to Amazon just to look at products they wish to buy regardless of where they end up buying them from. Amazon.com sees over 2 billion website visitors each month through 17 different international marketplaces around the world. This allowed Amazon to generate more than $26 billion in advertising revenue by the end of 2021. Amazon is also able to leverage its huge online marketplace to advertise the other aspects of its business such as AWS, Prime Video, Twitch and many others. The main reason Amazon has been able to maintain such a significant market share is that ultimately customers trust them. According to a FeeAdvisor study in 2019, 89% of customers stated they are more likely to buy products from Amazon than any other e-commerce site. The reliability of delivery and the smoothness of the app/ website just makes the whole Amazon experience stress free and as simplistic as possible for the consumer. Evidence of this is that Amazon's most popular product category is its electronics category. Not only do they have the widest range of products on the internet for electronics but often they have the best prices and customers can be assured that, with these more significant purchases, they will receive their products intact and on time.

In my opinion, I don't see Amazon losing much ground on its current market share in the e-commerce space any time soon. I can see continued growth in the coming years due to its trustworthy relationship with its current customer base along with the expansion of its customer base over the COVID years. Revenue from online stores has rocketed from $141 billion in 2019 to $222 billion in 2021 meaning Amazon is attracting more customers and also customers are spending more. As customers get accustomed to lower prices and the simplistic process of ordering from Amazon, I believe Amazon will be able to retain this influx of new customers and continue growing its e-commerce revenue to upwards of $250 billion in the coming years.

Prime

There are over 200 million Amazon Prime members across 22 different countries. Amazon's Prime membership currently costs $12.99 and accounted for $12 billion in revenue in 2021, a 7.7% increase from that of 2020. The everyday user of Amazon can avail of free next-day delivery shipping, prime video, Amazon music prime, prime gaming, prime reading, free grocery delivery from amazon fresh and much, much more. This is obviously of huge benefit to the customer and has allowed Amazon to

build up such a wide customer base that now trusts and is happy to avail of all the different services Amazon prime has to offer.

Due to the strong customer base and dependability of its prime services across the world, I believe Amazon is in a good position to continually increase its monthly revenue services whilst still expanding the number of prime members year on year. If Amazon was to raise its prime monthly subscription by a single dollar it would increase its revenue by $200 million, so the opportunity for growth in the space is huge.

Amazon Prime Video has around 24,000 movies and over 2,100 shows to choose from, more than any other streaming site. Netflix, a key rival for prime video, has seen its number of users drop for the first time in recent years, announcing a net loss of 200,000 subscribers this year. This has largely been due to the lack of content being added, which can be put down to COVID, as well as the rising prices of subscriptions. When you compare the standard subscription price of Netflix which comes in at $15.49 a month to Amazon's Prime subscription price of $12.99 with everything it offers, the decision for consumers is easy. For this reason alone, I see Amazon's much more attractive subscription price to customers being the reason many Netflix subscribers will begin to move over to Prime Video. An interesting point to also add is if Netflix begins to improve their tech infrastructures and improve their apps, they will be aiding Amazon as their software and systems are built upon the AWS cloud system.

I feel that live sport is going to be one of, if not the biggest stimulus for Amazon's growth over the next 5-10 years. Current live sports subscriptions are absurdly high. In the UK and Ireland Sky Sports' full package comes in at approximately €40 a month and full sports packages in the US cost around the $70-80 mark. Live sport is an enormous market with billions of consumers and one that Amazon is only beginning to dip its toes into.

Amazon is set to pay $1.2 billion in annual fees to bring Thursday Night Football away from Fox Sports and onto their streaming channel. This is 80% higher than what Fox was originally paying, proving that Amazon knows the potential scope and opportunity that comes with asserting its place within the market. Prime video has also begun live streaming the UK Premier League, the most-watched sports league in the world. Premier League viewership on NBC was up 21% this season showing demand for worldwide interaction of sports is on the rise. Prime’s inaugural set of live Premier League games at Christmas time has been a major hit. This year’s match between Manchester United and Arsenal was the most-watched Premier League match ever on the service, bringing in viewership of more than 4 million. Prime Video announced its strongest quarter for live sports in the first quarter of 2022 and I believe that this is only going to grow over the coming years. When Amazon eventually establishes a live sports package that can rival the industry leaders of today, like Sky Sports in the UK and FOX in the US, they can uncut competitors to retain customers. This will lure consumers away from the big subscription prices they are already paying and if Prime Video gained another 100 million subscribers to their live sports package, they could raise an additional $2.5-5 billion in revenue.

Amazon Fire TV and live sports will be key players in the company's ability to push more linear TV ads into its services. Fire TV has more than 50 million viewers worldwide and reaching such a wide audience will allow Amazon to tap into the $19 billion US-connected TV market. Amazon will also be able to deliver targeted ads to those who are watching specific shows as they provide such a wide array of services, from movies to documentaries to live sports which will increase demand from advertisers who are currently being impacted by the diminishing culture of third-party cookies.

Allowing these ads to become more mainstream will also raise demand from advertisers, thus, allowing Amazon to inflate the premium for these Connected-TV Ads.

A growing sector, in which Amazon-owned Twitch TV is pioneering, is Esports. Esports is a fast-growing market that has had successive growth over the last 10 years. Viewership numbers rocketed during lockdown when everybody was stuck inside playing video games. In 2020 there were 18.6 billion hours watched on Twitch. Twitch holds 90% of the market share when it comes to live video game streaming with its main rivals coming in the form of Facebook Gaming and Youtube Gaming. Twitch made an estimated $2.3 billion in revenue in 2020 alone and the space has been continually expanding since then with ESPORTS viewership expected to pass 500 million by the end of 2022. Times are changing and many kids nowadays dream of becoming the next FIFA gaming world champion as opposed to being a real-life world cup winner. Crazy I know, but a growth opportunity for Amazon nonetheless. Cloud gaming is another area that is on the rise where gamers can play and choose games without the need for physical disks. AWS is pioneering in the cloud gaming space with revenue estimates expecting cloud gaming to have a market cap of $6 billion by 2024, up nearly 4 times from 2021 levels.

Grocery, Delivery, and Developing Areas

Amazon has 29 fresh supermarkets across six states and is looking to expand its fresh grocery business. Amazon's revenue from brick-and-mortar store sales, which include Whole Foods Market, grew around 16% to $4.7 billion in Q4 of 2021 from $4 billion a year prior. Amazon wants to keep expanding its physical store business with the key characteristic of its shopping experience being convenience. Amazon has cut back on labour costs with their ‘Just Walk Out' form of payment, where you scan your amazon account on the way in and out and it charges you for your shopping. Ultimately, this will not be the deciding factor in whether customers decide to do their shopping at Amazon Fresh, and Amazon knows this, subsequently, they have homed in on an area of the market they feel there is an opportunity. The area they are targeting is somewhere in between up market (Waitrose in the UK) and lower cost supermarkets (Tesco in the UK). They believe many consumers find themselves wanting quality fresh products and are willing to pay more for them. With the sheer size of Amazon's business, they can avail of economies of scale and thus provide consumers with these higher quality products at slightly better prices than upmarket rivals. Albeit, these prices are still more expensive than the large retailers, with Amazon grocery prices coming in at 27% higher than Walmart's on average. Only time will tell whether this strategy will pay off but having the click and collect grocery available with Amazon's click and collect services from their regular online retailing website will attract a lot of customers.

Amazon currently only holds about 1% of the total food and beverage retail market but it is expected this could rise to around 2.5% by 2025 with only 14 stores open at the minute and another 42 in the pipeline. Amazon however would still need to gain a significant share of the grocery market to sustain its growth and make it worthwhile. Amazon's Prime service offers customers the opportunity to avail of free delivery which is a big pull for many customers and along with the easy use of the Amazon Grocery app it could attract a large pool of consumers. Many people turned to online delivery and ordering of groceries over the covid period, but reports show that online grocery sales rose 6% from November 2020 to December 2021, with nearly 69 million US households buying groceries online in December 2021 alone.

There have been some points made about the lack of customer service experience in Amazon's physical stores as it is so automated. Some customers look for this in their shopping experience which could ultimately result in Amazon losing out in a certain segment of the market. I do think that Amazon's higher prices could potentially be detrimental to them, especially coming into a fragile economic climate where everyday consumers may start turning to cheaper alternatives. I do believe, however, that Amazon will eventually begin to start bringing their prices down more and more as they begin to increase the volume of sales in their physical stores.

Amazon has the third-largest overall fleet of trucks in the world. Amazon’s cutting-edge technology allows it to optimise its shipping and delivery service making it one of the world's most trusted delivery services. Amazon's Delivery Service Providers (DSP) network is a network made up of over 2,000 independent shipping contractors. The DSP services allow Amazon to keep up with their vast range of orders from around the world as well as reduce costs. Growing the DSP service in the coming years will allow Amazon to sustain its planned growth and will be a key factor in maintaining its market share in the e-commerce space. Amazon has also purchased 11 aircraft with plans of beginning air cargo hauls across the country allowing for more efficient delivery speeds. Ultimately, Amazon is playing the balancing game between maintaining their high standards of customer service and their operating/delivery costs, which in times of rising inflation is eating into their profit margins.

The Bad and the Ugly

We are living through times of high inflation and a potential recession looming which will ultimately hurt Amazon as the world's biggest retailer. Amazon already has tight profit margins with total net profit margins for the company coming in at 4.48% in the most recent quarter. This is well below the desired 10% threshold and if the mammoth sales numbers begin to decline, we could see an even further slip in these net profit levels. That being said, a lot of the reason for profit levels being so low has been the sheer level of reinvestment into the different areas discussed above. I believe establishing a dominant presence in cloud software and the entertainment subscription business through prime is what will allow Amazon to start widening its profit margins in the coming years. Through these services, Amazon will be able to gradually increase subscription prices and fees for cloud services that customers will be happy to pay because of the quality of the services. This will help to fight the razor-thin operating margins of the global e-commerce business.

There have been talks recently of an increasingly de-globalised world. Many economists and investors fear that globalisation may have peaked after 30 years of growth. With the war in Russia impacting global trade and tensions in Taiwan threatening another potential setback to globalisation, the question is whether we will see a reversal in the ever-growing interconnected world we live in today. This would inevitably have huge effects on Amazon as they currently deliver to over 100 countries outside of the US and have prime membership subscriptions in 22 different countries. An awful lot of Amazon's growth potential will depend on it being able to access markets outside of just North America. Personally, I am more optimistic than some on the state of global world trade, I believe that we have come too far, and the world is simply too small of a place now to revert back to the old ways of consumers being restricted to domestic goods. Emerging markets in South America and Africa will begin to start entering the globalised market which will help to ease any loss of trade with countries such as Russia and China. Amazon still also has over 40% of e-commerce sales in the US meaning that even in a de-globalised world, Amazon still has a very firm grip on its domestic and biggest market.

Amazon employs over 1 million people worldwide and although this has helped to improve the labour market globally and in the US it has also come with its fair share of controversies. There have been reports of gruelling work conditions within the Amazon warehouses where employees are forced to work long hours under surveillance and timed bathroom breaks. This has taken a mental and physical toll on workers who have been said to say they feel more like robots than humans. There are also issues with workers' rights within Amazon's corporate offices. Reports of stories such as employees being put on a performance improvement plan whilst struggling with physical and mental health issues along with overly stressful and demanding expectations. The average Amazon warehouse worker leaves within 8 months, with statistics like this it is no wonder Amazon has been under the spotlight. Amazon workers have created their first union in New York, at a warehouse in Staten Island. The introduction of the Amazon Labour Union could be the stimulant for change across Amazon warehouses all over the world. The average warehouse employee salary is currently $16 which is still about 12% above the national average but pressures to increase wages and implement more privileges for workers will inevitably hurt Amazon's bottom line. These issues around workers’ rights are unacceptable and Amazon will have to improve on this front going forward.

Crunching the Numbers

YouSo, enough about Amazon's company model and time to talk about the real reason I'm writing this article, Amazon's current stock price. After a 26% drop in the NASDAQ since the turn of the year and general killing on tech stocks from their all-time highs of COVID, I feel there are some potential bargains to pick up, not least the one of the biggest stocks of them all, Amazon. The company’s shares have dropped nearly 25% since the turn of the year despite posting positive earnings showing growth in revenue and good development in their growing areas such as live sports and grocery. The reason for Amazon's move has been purely based on negative macro outlooks with rising interest rates and supply chain issues heightened by Russia's war with Ukraine. I believe however that despite the warning signs for a potential recession, consumer strength seems to still be fairly strong.

Touching quickly on the potential overemphasis on this recession, Brian Moynihan, CEO of Bank of America, has stated that US consumers are in good financial shape and are managing well in a high inflationary environment. He also stated that within BOFA accounts he can see that customer account balances are higher now than they were pre-pandemic. In contrast, Jamie Dimon, CEO of JPMorgan, came out just yesterday stating that people should be embraced for the ‘economic hurricane’ that is about to hit the US. This is quite contrary to beliefs he had just several weeks ago where he emphasised consumer and business balance sheets as well as consumer spending being at healthy levels. It is hard to tell what the future holds but the Fed’s hawkish outlook as of late, although more reactionary than methodically timed, is still somewhat promising and could help to brace the fall for the US economy. If I had to rub my crystal ball so to speak and predict what the future holds, I can see a recession coming but with consumers having more cash available and business' having more controlled balance sheets, along with a well-saturated labour market, I hope that we will not see as impactful of a crash as we did in the likes of 2008. I also hope that a lot of this bearish outlook has been priced into the market already, but if it is to be as bad as many are predicting we could still see another sharp drop from here.

Amazon has poured an awful lot of its gross profits into capital expenditure meaning they are in a better place than most companies to consolidate and avail of the different sectors they are dominant players in. Between the financial years ending 2020 and 2021, Amazon spent over $100 billion on capital expenditure, which to me is very smart because this was the time to do it. Amazon was availing of huge revenue sales during the covid years allowing them to grow all of the different areas discussed above. I believe Amazon's capital expenditure will become much more controlled over the next few years with an average of 3.33% CapEx growth until 2024 when we will hopefully return to a more controlled and growth-friendly economic climate.

Having lower Capital Expenditure allows Amazon to improve its net profit margins over the next couple of years when sales revenue growth may halt as consumer confidence decreases. This is important as when times are tough people will turn to the cheapest options along with companies they trust. I believe, therefore Amazon will be able to maintain solid revenue with its loyal customer base over the coming years. Many people rely on Amazon for their own companies, be it through AWS or the Amazon Marketplace which I think will only help Amazon's business model as they're not solely relying on individual consumers for their core revenue streams. For me, after the growth Amazon has had over the last number of years, to be trading at the levels it is, something would have had to have gone seriously wrong. I don't believe this is the case and if we look at the market cap of Amazon in September 2018 of $994 billion and compare it with today's market cap of around $1.2 trillion, we can see around 16.13% growth. Compare that with the subsequent revenue growth between 2018 and 2021 of 101% and gross profit growth of 110%.

Now, I do believe tech stocks over recent years have been potentially trading at an inflated level but Amazon is so much more than a tech stock, as its track record of not having a negative EBITDA over the last 12 years shows. As discussed in the paragraphs above, Amazon has maneuvered itself into a vast array of markets and now has several different revenue streams that it can reply on in the coming years. Amazon still has another 26% to climb just to get back to its March 22 levels, never mind the potential long-term growth it could see heading out as far as 2026. I am running a slightly lower market average return in my model of 7% to account for potential lower growth in the front years along with high risk-free rates of 8% to account for inflation. This will hopefully allow us to pick up a nice fair value for Amazon that I think is potentially even on the more conservative side as we begin to look out 5/6 years in the future. Amazon has plenty of potential areas for growth along with strong core revenue streams from its e-commerce business.

Final Comments

Sometimes you're looking so hard for the answer and it's sat in front of you the entire time. This is what I found to be the case to be with Amazon. After the recent market drop, I began looking at different companies who, despite an inflated price over the COVID years, actually increased their customer base and developed a sustainable business model. If we take Zoom, for example, its Market Cap is currently at the same level it was in March of 2020 before any of the covid business took off. Comparatively, in this same time, Zoom's revenues have grown by 227%. This is why it is another company I have been looking into but ultimately, I decided on Amazon as the no-brainer due to their established business model along with the much-expanded customer base they gained during the covid period. I loved Amazon's entry point of around $2100 where it was just two weeks ago. Subsequently, it has risen again to around the $2,400 level but I believe this is still an attractive entry point given my target price of around $3,300. Obviously, we are going through unstable economic conditions, and anything can happen, but I believe Amazon is a stock that I can trust, given everything discussed. I maintain that it will inevitably come back to the fore over the medium to long term, meaning there will be nice gains from its current share price for me.

Until next time,

Euan McNicholl

Disclaimer

This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.

Amazon - A Prime Opportunity