In the previous month, we published an article emphasizing the advantageous position Amazon (NASDAQ:AMZN) holds to leverage artificial intelligence and other technologies, including cloud-based payment systems. Since the publication of that piece, Amazon has embarked on an intense series of activities surpassing even our own projections. The speed and fervor exhibited by the company is truly remarkable.
In this analysis, we’ll delve into Amazon’s recent key announcements in the field of artificial intelligence. Furthermore, we’ll provide an updated evaluation of the company’s potential risks and current valuation. After careful consideration, we maintain a Buy rating on the company.
Amazon AI: Going On The Offensive
As the battle for AI supremacy continues to heat up, Amazon has been making significant strides in leveraging artificial intelligence across its vast ecosystem. This aggressive push into AI is not merely an adoption of the latest tech trend; it’s a strategic move that could reshape the company’s competitive landscape, fuel its growth, and yield substantial returns for its investors. In this analysis, we’ll explore Amazon’s recent ventures in AI, from building a dedicated AI team to acquiring an innovative AI startup, and discuss how these developments could bolster Amazon’s position in the market.
Just days ago, on May 8th, Forbes reported Amazon’s ambitious plan to build a new team dedicated to developing artificial intelligence tools. These tools are designed to create photos and videos for merchants to utilize on the Amazon platform. This move underscores Amazon’s aim to bolster its advertising business and its determination to leverage AI in finding innovative ways to deliver ads across its diverse portfolio of businesses.
Amazon’s advertising strategies are not limited to traditional online advertisements. We believe they have their eyes set on a multitude of areas, such as broadcasting sports ads on their free video streaming service and during Prime Video’s Thursday night Football broadcasts. Additionally, they’re exploring the potential of audio ads on Amazon Music and even venturing into digital ads on screens within Amazon Fresh grocery stores. This wide-ranging advertising initiative demonstrates Amazon’s commitment to maximizing their revenue streams while enhancing the user experience across their platforms.
This push into AI-supported advertising is a strategic move on Amazon’s part to remain competitive in the ad market. Top rivals, including Meta (META) and Google (GOOG) (GOOGL), are also investing heavily in similar projects. Amazon plans to employ AI tools to not only enhance ad delivery but also streamline the process of writing product descriptions.
In a significant move that bolsters Amazon’s AI capabilities, the company quietly acquired audio intelligence startup Snackable AI last year. Snackable AI’s technology, which automatically generates highlights and chapters in audio and video clips, has the potential to significantly enrich Amazon’s content and provide a more engaging user experience.
Amazon Web Services (AWS), the key player in Amazon’s AI push in our view, recently launched Amazon Bedrock, a new cloud service designed to help companies and developers leverage AI. Bedrock provides an easy way for users to build generative AI-powered apps without needing extensive data annotation. This service effectively addresses one of the major concerns for organizations wishing to create their own generative AI products: data security. Bedrock ensures that customer data remains secure and doesn’t leak back into the broader data pool used for model training.
In another exciting development, AWS announced the general availability of Amazon CodeWhisperer, an AI coding companion that’s touted as the fastest, most accurate, and secure way to generate code for Amazon services. Available for free, CodeWhisperer could directly compete with Microsoft’s (MSFT) CoPilot, and it further cements Amazon’s place in the AI space.
Amazon’s aggressive push into AI is a calculated move that promises to bolster its competitive edge, promote growth, and provide substantial returns for investors. By actively integrating AI across its platforms, Amazon is not only enhancing its services and user experience but also positioning itself for unprecedented growth in the rapidly evolving AI landscape.
Risks
While Amazon’s foray into artificial intelligence presents promising growth opportunities, we believe it’s crucial to consider the inherent risks as part of a balanced investment analysis.
A significant risk lies in the customer base of Amazon Web Services (AWS), Amazon’s cloud computing division. Unlike its key competitor, Microsoft Azure, which is favored by larger, more robust enterprises, AWS tends to draw a clientele composed of smaller companies and startups. These businesses, while dynamic and innovative, are often more susceptible to macroeconomic fluctuations due to their size and limited resources.
This AWS client profile not only exposes Amazon to greater economic volatility, but also presents a possible disadvantage in the burgeoning AI field. Larger enterprises, like those that typically partner with Microsoft Azure, generally have deeper pockets to invest in AI technologies and access to larger datasets, which are crucial to successful AI development and deployment.
Further concern arises from the recent slowdown in venture capital funding for AI startups. Given that AWS could greatly benefit from a thriving AI startup environment, a more than 50% drop in funding in Q1 presents a worrying trend for the company. With less investment flowing into the sector, there’s a risk that growth in AWS’s client base and, consequently, its revenues might be hampered.
Shifting our focus to Amazon’s core e-commerce business, we see that it has historically relied on more traditional forms of AI to streamline operations and refine customer recommendations. While this approach has undoubtedly served Amazon well in the past, the company may be missing out on the current “generative AI” wave, a trend that has the potential to revolutionize various business operations.
Microsoft, for instance, has demonstrated the impressive potential of generative AI with its demo of CoPilot for Office 365, which could greatly enhance productivity. Amazon’s apparent lag in adopting and leveraging such innovative AI trends could mean it’s missing out on substantial growth opportunities.
Additionally, as the race for AI supremacy heats up, competition for top AI talent is intensifying. This could drive up labor costs for Amazon, and given that the company may not be harnessing the full potential of cutting-edge AI trends as effectively as some competitors, it could end up facing increased costs without reaping the maximum benefits.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
In our analysis, we see Amazon’s Q1 2023 revenue figures as a clear positive, with a growth rate of 9.4% year-over-year, matching consensus estimates, and reaching an impressive $127.4 billion. Moreover, it’s worth noting that Amazon’s revenue has been growing at a compound annual growth rate (CAGR) of 22.4% over the past three fiscal years. This is a robust growth rate, although it’s important to note that the sell-side consensus forecasts a deceleration to 8.8% this fiscal year.
In Q1 2023 earnings, there is also a glimmer of hope in the improvement of Amazon’s operating margin, which increased by 0.5 percentage points from 3.2% to 3.7% compared to a year ago. However, we remain wary given the contraction of EBIT margin by 2.8 percentage points over the past three fiscal years, sliding from 5.2% to 2.4%.
Amazon’s EPS of $0.31 for the quarter, up a notable 182% year-over-year and beating consensus by 45.4%, was a standout figure. However, it’s important to keep in mind that this comes after a disappointing decline in EPS over the past three fiscal years due to overspending to support unsustainable revenue growth rates during COVID lock-downs. Encouragingly, consensus is forecasting an impressive rebound, projecting a 678.8% increase in EPS to $1.56 this fiscal year and a further 64.3% increase to $2.57 the following fiscal year.
The company’s net debt stands at $76.9 billion, which might seem alarming, but it’s only 0.9 times its expected current-year EBITDA of $84.1 billion, indicating a manageable level of leverage.
The stock has underperformed the S&P 500 by 7% over the past year, returning -2.0% in absolute terms. Currently trading at $110.19 per share, it sits 3.6% above its 200-day moving average but still 25% below its 52-week high of $146.57. We believe this is a comfortable technical setup where the stock has some momentum but still offers a discount to recent highs.
In terms of valuation multiples, Amazon is trading at an EV/Sales multiple of 1.9, an EV/EBIT multiple of 35.3, a P/E multiple of 42.9, and an FCF multiple of 29.0. These multiples indicate a premium valuation except for EV/Sales, where it enjoys an 11.7% discount relative to the S&P 500.
Conclusion
In our view, Amazon’s aggressive push into the AI realm presents a compelling investment case. The company’s proactive strategies, from establishing a dedicated AI team to acquiring Snackable AI, signal its commitment to remaining at the forefront of technological innovation. However, while these ventures promise substantial returns, they are not without risks. AWS’s customer base, largely composed of smaller companies and startups, exposes Amazon to greater economic volatility. Furthermore, a slowdown in AI startup funding and Amazon’s slower adoption of generative AI trends could hamper its growth in the AI landscape.
From a financial perspective, Amazon’s Q1 2023 revenue figures and improving operating margins are promising. However, the contraction of EBIT margin over the past three fiscal years remains a concern. Additionally, Amazon’s high valuation multiples suggest a premium valuation, warranting cautious optimism. Therefore, while we maintain our ‘Buy’ rating, we urge investors to balance the company’s promising AI ventures with the potential risks and current valuation. We believe that Amazon’s AI strategy will ultimately enhance its services, promote growth, and yield substantial returns for investors. However, a balanced view, keeping in mind the potential challenges and risks, will be crucial in navigating this investment landscape.
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