Amazon’s free cash flow has been steadily declining for the last three quarters. For the short-term investor, this is a problem.
Roughly speaking, there were two alternatives: to worsen either the quality of service or free cash flow. The company chose the second option, and long-term investors should welcome this.
Amazon is actively investing in its future and its key high-margin directions are demonstrating accelerating exponential growth.
Despite the mixed quarterly results, the company’s capitalization will grow.
AdrianHancu/iStock Editorial via Getty Images Thesis
Amazon (NASDAQ: AMZN ) missed revenue and EPS estimates, dropping the stock down on earnings day. In addition, the company’s free cash flow turned negative. But by and large, this should be of interest only to short-term investors. From the perspective of a long-term investor, the last quarterly report was just superb. A rough look at Amazon’s financial results
Quarterly financial results are difficult to assess correctly outside the context of their impact on the company’s market price. Therefore, personally, every time I first look at the following three graphs.
Considering the nature of the long-term relationship between Amazon’s capitalization and revenue, the last quarter’s result only confirmed the company’s undervalued state. Moreover, an interesting detail catches the eye. The company’s revenue TTM in absolute terms for the last six quarters grew by 42%. During the same period, the capitalization of the company showed practically no growth. Given that the current forecast suggests further revenue growth, the idea that Amazon is undervalued seems realistic. Source: visualizedanalytics.com
Based on the long-term relationship between the EPS TTM absolute size and the company’s capitalization, Amazon’s current price is balanced: Source: visualizedanalytics.com
But, if we take the analysts’ average expectations as a basis, within the bounds of this model the company’s balanced price per share in Q2 2022 will be around $2700. However, don’t take this number literally. At the very least, it should be noted that the quality of this model is worse than the previous one. But the very fact that EPS is expected to decline amid rising revenues indicates a decline in margins. We’ll come back to this later.
And finally, let’s consider the third model, in which FCF plays the role of an independent variable: Source: visualizedanalytics.com
As you can see, in this case the situation is quite negative. The company’s free cash flow has been steadily declining for the last three quarters, and this already requires a separate study. What’s wrong with FCF?
We should start with the fact that operating cash flow, in contrast to free cash flow, in the last quarter was generally at an acceptable level. The difference between the two is capital expenditure. This is the first reason for the decline in free cash flow. Data by YCharts Indeed, since 2020 (actually since the beginning of the pandemic) the company has shown an unprecedented increase in capital expenditures, which accounted for 14.2% of revenue in the last quarter: Data by YCharts Here’s how the CFO comments on this process: …We made strong progress in Q3 to build and open new facilities. And as a result, for the first time since the pandemic began, we’re no longer capacity constrained for fiscal space in the network . September alone, we brought online more than 100 new buildings in the United States, including fulfillment centers, source centers, and last-mile delivery stations. For the year, we expect our 2021 footprint additions to exceed last year’s buildout, which was also significant. Put this in perspective, we are on track to double our fulfillment network over the two-year period since the pandemic’s early days… Source: Amazon Q3 2021 Results – Earnings Call Transcript So, the rise in capital spending was the company’s natural response to the challenges posed by the pandemic. This is a compulsory measure designed to ensure the maintenance of a high level of customer service in the changed conditions. Roughly speaking, there were two alternatives: to worsen either the quality of service or free cash flow. The company chose the second option, and long-term investors should welcome this.
The next factor that put pressure on free cash flow is inventories. In the last quarter, this indicator in the structure of cash flow provided a decrease of $7.05 billion, which is also significantly beyond the average values. Data by YCharts The CFO commented on this result as well: …We are just now getting caught up on space for inventory and inventory is being brought in to support the holiday. And if you look year-over-year, well, […]