Amazon (AMZN) shot up 10% after its first quarter report on April 28th, as the company marked its fourth profitable quarter in a row. The e-commerce giant, which has historically only posted sporadic profitable quarters since its founding in 1995, hasn't reported four quarters of profitability in a row since 2012. With bearish calls that Amazon had been sacrificing profitability for growth in the rearview mirror, Sanford Bernstein’s Carlos Kirjner slapped a street-high $1,000 price target on the stock Tuesday, saying this is only the beginning for the stock, which-- at $700 per share--is trading at all-time highs and up 17% in the last month.
The key driver, according to Kirjner, is gross margin growth.
“Amazon’s businesses are now so large, fast-growing, and profitable that it is harder and harder for the company to find new areas of investment to keep up with the growth in gross profits,” he wrote.
Five key reasons why margins will expand significantly from here:
1. The shift to revenues from the higher-margin Amazon Web Services (AWS) division. AWS, the company’s fast-growing cloud computing segment posted revenue of $2.6 billion in the first quarter, marking a 64% year-over-year increase. There are no cost of goods sold for this division. Kirjner estimates AWS revenue of $17.6 billion in 2017, and the margin impact will be pronounced, as “AWS adds $5-$6 billion in revenues with well over 50% variable (operating income) margin yet again,” he wrote.
2. The shift toward more third-party Marketplace revenues, whose only costs of goods sold are shipping costs associated with the portion of Marketplace units fulfilled by Amazon. Kirjner estimates third party business to have gross margins of 75%.
3. Kirjner sees a positive mix shift in first-party business. as higher margin categories such as apparel and consumables are growing faster than lower-margin categories, according to recent commentary from Jeff Bezos and the management team. Management said apparel and consumables were the fastest growing category.
4. Content expenses are expected to slow to slow. As Amazon's content library grows, its growth will decelerate significantly, according to Kirjner. “We believe that along 2017 we will see streaming-content-related COGS decelerate and ultimately grow slower than retail gross profit, further contributing to gross margin expansion,” he wrote.
5. Amazon’s new robot-filled fulfillment centers--known as 8th generation--are becoming a more significant portion of the installed base and will boost margins, according to Kirjner. “In 2017, 8th generation fulfillment centers will likely exceed 40% of Amazon's fulfillment capacity. We believe the variable cost per unit fulfilled in these newer fulfillment centers is significantly lower and, as they become a larger portion of the installed base, we may see fulfillment expenses improve even faster than they did in 2015,” he wrote.
“Time is on the side of margin expansion,” Kirjner wrote, which will only be aided by continued revenue growth, driven especially by the Prime membership program. Last quarter, Amazon’s core e-commerce business grew 32% in North America, aided by the Prime program, which offers unlimited express delivery on millions of products. Prime has at least 46 million members worldwide, according to estimates based on numbers that Amazon has disclosed.
Meanwhile, some of the company’s new company initiatives--including Tuesday's announcement of a YouTube-like video service--provide additional avenues of growth with minimal investment.
Bernstein’s estimates for the next 3 to 12 months are considerably ahead of consensus, especially as the firm’s 12-month price target reflects a 24-month view. Bernstein’s 2017 EBITDA forecast of $22.5 billion is 14% ahead of consensus.
“Amazon does not trade anywhere near what we think it is worth on a fundamental basis...There are changes in trajectory of fulfillment and content spend that are not reflected in consensus. As a result we are bullish in the short, medium and long-term and think we may see margins expand much faster than they have in the next two years than they have in the last two,” Kirjner wrote.
Importantly, Kirjner reiterated target is not based on higher valuation but, rather, underestimated profits. He outlines that Amazon currently trades at 20x EV/EBITDA for the next twelve months; the $1,0000 target corresponds to 18x mid-2017 to mid-2018 EBITDA. Kirjner’s gross margin target is 39% for 2017 compared with consensus expectations for 36%.
