Amazon remains a show-me stock but we're encouraged by some positive Wall Street commentary

Published Tue, Nov 15 20222:55 PM EST

Amazon (AMZN) received several mentions Tuesday from Wall Street analysts covering a range of topics. The cautiously optimistic commentary about the initiatives management is taking to cut costs and bring investments to a level more in line with revenue dynamics and the slowing global economy increases our conviction that margin pressure should begin to abate. Still down about 40% year to date, Amazon shares have gained about 15% since last Thursday's surge higher along with the broader market. The stock had been on the skids since reporting just an OK quarter and weak guidance after the closing bell on Oct. 27. However, with signs that Amazon is about to address its bloated cost structure, which was something sorely missing from last month's release, we hope the stock can continue on the road to recovery. Morgan Stanley's take Morgan Stanley reiterated Amazon as a top pick, noting that the online retail and cloud giant, along with Alphabet (GOOGL), are their preferred ways to play the mega-cap space with overweight (buy) ratings. However, analysts there remain cautious on Meta Platforms (META), with an equal-weight (hold), due to "higher structural question marks about META's moats" and current capital expenditure spending. While including commentary on Alphabet and Meta from the note as a point of reference, we're mostly focusing on Amazon. Despite their relatively bullish outlook on Amazon, they remain cautious due to elevated inflation, high costs, weakening consumer balance sheets and economic headwinds. These concerns caused them to "modestly reduce" estimates on Amazon, as well as Alphabet and Meta. Morgan Stanley left Amazon's price target at $140 per share, which represents about 40% upside from Monday's close. The analysts are now modeling 5% growth in U.S. ecommerce in 2023, down from 10% previously. The analysts cut Alphabet and Meta's price targets. GOOGL's went to $120 per share from $125, room for a roughly 25% gain. Meta's went to $100 from $105, about 12% below Monday's close. From a top-down view, Morgan Stanley maintained that Amazon remains "strategically positioned" to take market share in e-commerce and enterprise spend "through/post downturn." From a bottom-up view, the analysts acknowledged that Amazon, along with other large-cap tech names, is finally taking its medicine. In Amazon's case, this refers to a broad cost-cutting review , and according to The New York Times, plans to lay off roughly 10,000 employees as soon as this week. Based on midpoint estimated salary ranges, the job cuts could reduce costs by about $2.75 billion. A lot of money to be sure, but remember that relatively speaking, that's only about a 1% reduction of Amazon's global workforce of 1.54 million people. Earlier this month, Amazon expanded its hiring freeze to its entire corporate workforce. MoffettNathanson's take MoffettNathanson updated investors on their view of the broader e-commerce landscape, saying they prefer market-share gainers like Amazon "as the algorithm of the internet creates a self-fulfilling prophecy for continued share loss once it starts." Of course, that implies that share gainers will continue to gain. Before digging in, the analysts there said they "do not subscribe to the bear case of peak e-commerce penetration" because online shopping is more convenient and often cheaper than shopping in-store, not to mention is more transparent given that comparing prices across websites is inherently easier than traveling from one physical store to the next. Speaking on share losers, the analysts called out Covid as a "double-edged sword" as the pure-play names such as Wayfair and Chewy came out of it in a competitively worse position because the pandemic forced the legacy brick-and-mortar players they were taking business from to accelerate investments in e-commerce infrastructure. Amazon, of course, is far from a pure-play, offering what may be the broadest inventory selection of any retailer in the world, be they online or physical. On its note, MoffettNathanson said that if an online retailer is going to sell commodity products, they need fulfillment scale and speed, two areas where Amazon has overinvested in recent years — and, as a result, is now in a position to grow into that capacity. In reviewing what makes a great marketplace, the analysts highlighted Etsy , taking a favorable view of the online platform for handmade items' success in aggregating a highly fragmented global market of 7.5 million artisans and creators under one umbrella. However, they called out Amazon's business model as the gold standard due to Prime memberships driving customer loyalty and recurring purchases while keeping retention costs low. Moreover, because Amazon's direct traffic rates are best in class, they have some of the lowest ad spend of all their peers. That direct traffic has also allowed the company to build out an advertising business that generates nearly $40 billion annually — $9.5 billion alone in the third quarter. Looking forward, MoffettNathanson said, "profit beats and declining capital intensity are the formula for multiple expansion. For three years, Amazon has experienced multiple compression as EBIT [earnings before interest and taxes] estimates declined and capital intensity was greater than expected. We believe we are at the end of the tunnel." Barclays' take Barclays believes Amazon provides a favorable risk/reward at current levels as retail operating margins improve in 2023 and Amazon Web Services stabilizes. Regarding AWS, recall that customers have been pulling back on the cloud in an effort to better align costs with their own customer demand. After all, the most attractive thing about moving to the cloud is that it converts fixed costs to variable ones. However, the focus of the Barclays note was on Amazon's India business, with analysts calling out that both Amazon and Walmart -owned Flipkart were both growing their toplines in the low-30% range as of March 2022 and around 20% to 25% heading into 2023. A solid rate of growth to be sure, however, even better, they believe the pace of operating losses is improving. Amazon India is 4.4% of international retail revenue and 23% of international operating income losses, according to Barclays. Even more encouraging than what's going on in retail, they also noted that "AWS growth in India has been accelerating nicely" off a low base. Keep in mind that the profit margin profile of AWS is leaps and bounds ahead of retail. As of March, AWS India was generating $1.2 billion in sales growing at 65% annually on a foreign exchange-neutral basis, the fastest rate since 2019. Remember, India is the second-most populated country in the world — just behind China and well ahead of the United States. The Club's take Taking all of these updates as a whole, Amazon remains something of a "show me" story following its most recent quarterly results. While we wished we sold shares at a higher level, hindsight is 20/20 — and at this point, we think fundamentals are set to improve going forward. As noted in our earnings analysis last month, we believe that management is prepared to make the tough choices needed to lean out the operation — and as profit margins are cleaned up on the back of cost-cutting initiatives, free cash flow should significantly improve. That, in turn, should lead to a higher stock price. While we think current levels offer an attractive risk/reward for longer-term investors due to improving fundamentals, more patience will be required. At the moment, we prefer names where the spending is already more aligned with the operating environment and where the macroeconomic backdrop is more supportive. Moreover, we tend not to like chasing large moves such as what we've recently, a view consistent with our decision to trim shares of Microsoft (MSFT) earlier this week. 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An Amazon Prime truck is pictured as it crosses the George Washington Bridge on Interstate Route 95 during Amazon's two-day Prime Early Access Sale shopping event for Amazon members in New York, October 11, 2022.

Mike Segar | Reuters