- Amazon.com stock is showing strong momentum even after crossing the $800/share mark for the first time a fortnight ago.
- Many analysts have given the stock a significant PT raise.
- Does Amazon still have enough gas in the tank to rise above $1,000 per share?
Amazon.com, Inc. (NASDAQ:AMZN) stock price crossed the $800/share mark for the first time about two weeks ago, more than doubling the stock price in just 17 months. But AMZN shows no signs of slowing down, tucking on a 5% gain since then to trade at the current $841.66.Wall Street has been weighing in with a flurry of upgrades coming from Evercore, Argus, Mizuho Securities, Morgan Stanley, and JPMorgan with price targets ranging from $855 to $1,000+.
"We believe Amazon continues to show strong ability to take share of overall eCommerce, and its flexibility in pushing first-party versus third party inventory is a major advantage compared with other retailers." Further: "Our price target is based on a sum-of-the-parts analysis as we believe this methodology appropriately attributes value to the company’s large, fast-growing and surprisingly profitable …Amazon Web Services segment, which Amazon continues to invest in."
AMZN stock now sports a year-to-date return of 22.1%, and a market cap over $400B, making it the fourth most valuable company in the U.S. after Apple (NASDAQ:AAPL), Alphabet Inc-C (NASDAQ:GOOG), and Microsoft (NASDAQ:MSFT). Large-cap stocks generally struggle when they get that big--AAPL stock sports a YTD return of 76.1%, Alphabet stock is up 1.6%, and Microsoft stock price has gained 2.5% in the same time frame. Apple stock was famously headed for $1,000 but did a U-turn in the 700s and fell all the way to the 300s before a stock split saved it more blushes.
JPMorgan, Evercore ISI, and RBC Capital Markets have predicted AMZN will hit $1,000 in two-years time.
The big question now is: does Amazon still have enough gas in the tank to get to $1,000? What is a likely time-frame? What risks might jeopardize the fairy tale run?
Riding the cloud wave
The biggest reason why most analysts and the investing world are optimistic about Amazon's growth prospects can be summed up in one phrase: AWS. Amazon's public cloud has been growing so fast and posting operating margins that previously most analysts did not believe were achievable in the cloud business.
During the last quarter, Amazon recorded revenue of $30.40B, $850M above the consensus on Wall Street and good for 31.1% Y/Y growth. Meanwhile, EPS of $1.78 beat the Street average by $0.67, a huge improvement from the $0.19 the company recorded a year ago. The huge jump in profitability can be chalked up to AWS, which finished with revenue of $2.89B, a robust 58% Y/Y growth. The segment finished with operating income of $863M, equal to 56% of Amazon.com's total operating income.
With excellent revenue and profit visibility in the AWS segment, it's easy to project Amazon's growth trajectory fairly accurately. Analysts expect Amazon to record 80% earnings growth this year and generate full-year EPS of $5.82. The company is expected to finish calendar 2017 with EPS of $10.50. A share price of $1,000 would mean that Amazon's PE ratio falls to just 95, less than half the current reading of 209. In short, if Amazon maintains its current growth trajectory, it can easily hit $1,000 by the end of 2017, possibly much earlier, ceteris paribus. That's a return of 18.8% from the last closing price of Amazon stock (october 6 close).
Medium-term risks for AMZN
AWS is still growing like a weed. But looking at the long-term trend, it's clear that growth is beginning to slow. After hitting a peak about a year ago, AWS growth has slowed by about 20-percentage points in the space of one year.
This is not to say that the public cloud market is close to saturation--far from it. Morgan Stanley predicts that the public cloud market will grow from $70B in 2015 to $141B in 2019. The big problem is that AWS, the largest industry player with more than 10% slice of the market, is growing so much faster than everybody else. It's only natural that AWS cools off a bit due to increasing competition from the likes of Azure and Google Cloud. Azure has consistently been growing in triple-digits, and Google Cloud has also been seeing explosive growth lately.
A far bigger risk for AWS, however, is price competition by cloud rivals. About two years ago, Amazon, Microsoft, Google, and even International Business Machines Corporation (NYSE:IBM) were engaged in the infamous cloud pricing wars leading to dramatic price cuts. This is what led to a dramatic slowdown in AWS growth in early 2014 (see graph above).
Also see: The latest top technology stock picks from Amigobulls.
And now we could be seeing another cloud pricing war developing. Microsoft has just announced a series of wide-ranging price cuts for Azure, in some cases by as much as 50%. This move could trigger another cloud pricing war, and AWS might be forced to jump in to remain competitive. AWS sports an operating margin of 30% when you exclude employee stock-based compensation and some other minor costs. A sizable price cut such as Microsoft's could mean significant margin erosion and thinner profits for Amazon. Microsoft has several other profitable businesses and can, therefore, afford to freely cut cloud prices. But Amazon's e-commerce profits are almost non-existent. If Amazon.com was to start engaging Microsoft in a race to the bottom, this would almost inevitably lead to serious downside pressure for Amazon.com stock. This remains a short-and medium-term risk for AMZN stock.
As things currently stand, there's little to stop Amazon.com stock from hitting $1,000 in a year or maybe less. Investors should, however, keep a close eye on whether Amazon will slash AWS prices to match Microsoft Azure's price cuts.