How is it
that a business can increase sales from $609 million in 1998, to $89 billion in
2014 without making any money? How can a business go from having 3 distribution
centers in 1998 to 131 all around the world today without making any money?
Well, it turns out Amazon actually does make money. A lot of it! You just need
to count the cash.
If you are
like me, for years you have heard that Amazon does not make any money. And
indeed they do not make much on a net income basis. On the other side of
that coin, there is quite a history of companies making a lot of money on a net
income basis when there were really no earnings at all (Enron, Worldcom, etc.).
Isn't it
interesting that the first consolidated financial statement that Amazon lists
in their 10-K(Annual Report) is their cash flow statement? There are almost NO other
companies out there that do this. Normally, the income statement or balance sheet
comes first. What is Amazon’s management focused on? Maybe on generating more
cash? We strongly believe that they are.
At Delphi
Value Investments we analyze companies profitability based on their Owner
Earnings (OE). Put very simply, that is the cash the business generates (cash
from operations) minus the capital expenditures it takes to maintain the
business’ competitive position (Maintenance Capex.). So for Amazon, that
Maintenance Capex accounts mostly for keeping its computer systems up to date
and repairing the fulfillment centers it currently has. Any new fulfillment
centers would be considered Growth Capex because those new warehouses will be
used to grow new sales and profits.
In 1998, Amazon had sales of $609 million and showed a net loss of $124.5 million. But,
things were not as bad as they seemed. The business generated $31 million in
cash from operating activities and spent $28.3 million on capital expenditures.
As I noted above, all of this capex was probably not for maintenance. Much of
it was being used to grow. We estimate about 50% was used for maintenance or
about $14 million. This is also relatively close to the depreciation charge of
$9.6 million. On this basis, in 1998 Amazon had around $17 million in owner earnings.
Not bad for a new company!
Now let’s
fast forward to 2005. By this time Amazon had about 18 fulfillment centers
around the world. Amazon’s sales were $8.4 billion and net income was $359 million.
The business had cash from operations of $733 million, but capital expenditures
of just $204 million. Again, it is hard to estimate how much of that is
maintenance and growth but let’s just assume 50% again. That means that Amazon
had profits (OE) of $631 million!
Since 2005,
Amazon has continued to grow like crazy! They have entered new businesses like
Amazon Web Services and Kindle, and they have added thousands of new items to
their fulfillment centers. In addition, they have built around 110 new
fulfillment centers. The company now has 131 fulfillment centers and a large
number of data centers for Amazon Web Services (the number proved elusive).
With all of these new business ventures one would expect capital expenditures
to increase significantly, and they did.
In 2014, Amazon had $89 billion in sales with a net loss of $241 Million. However, as
before, the cash tells a different story. Cash from operations came in at $6.8
billion with capex being $4.8 billion. Because Amazon does not break out how
they spend their capital expenditures it is VERY difficult to get a precise measurement
of maintenance capex, but, it is still plainly obvious that a lot of their
capex is for growing the business.
Jeff Bezos could very easily decide today that
he didn't want to add any more fulfillment or data centers and just make do
with the assets Amazon already has in place. We would then see a significant decrease
in capital expenditures (we would guess around $1 billion). Without the new
capital expenditure spending we would see the depreciation charge stay roughly
the same. I strongly suspect sales would increase, but at a slightly lower rate
than the last few years. There are two main reasons we believe this to be true.
First, Amazon is becoming more popular with its customers and we believe this
will naturally increase sales. Secondly, some of the new fulfillment and data
centers were not operational during all of 2014. There will be some benefit to
having these new assets fully operational in 2015. Since sales would
grow and depreciation would stay steady we would begin to see higher net income.
We would also see higher income taxes
and the financial news networks announcing that Amazon is now massively
profitable (this last part is pure speculation on the authors’ part)!
Obviously,
Jeff is too smart to do this because he believes, and we agree, that new
investments offer a very high rate of return for Amazon (and very little income
taxes). In 2011, Amazon had 80 fulfillment centers and now they have 131. I
suspect that around 30% of capex in 2014 went to building the new fulfillment
centers (Growth Capex). I do not have a good estimate for the capital expenditures
for Amazon Web Services. For 2014, my estimate for maintenance capex is around
$3.5 Billion. This brings us to an owner earnings figure of $3.3 billion for
2014. That means that since 2005, Amazon has grown our estimate of OE by an
average 46.9% per year!
Unfortunately,
we will not be buying Amazon’s stock for two reasons. The first and the largest
reason is that the stock price is WAY too high for our tastes. The market
currently values the business at $171 billion (Market Cap). We do not like the
prospect of paying $171 for a business to receive $3.30 in profits. If we think
about that in terms of a bond, that bond will pay us 1.9% initially, and will
grow significantly in the future as the business grows. 1.9% is just not cheap
or interesting enough for us, even for a business as great as Amazon. Now, if I
had to choose only between a 30 year Treasury, paying 2.73% or Amazon at 1.9%, I
would take Amazon stock any day. Fortunately, we have thousands of other
companies to look at.
We hope that
at some point in the future the stock price comes down to a more rational
level. This may never happen, and that is just fine.The second
reason is that we had to make a lot of “rough” assumptions to get to our owner
earnings figure. We like to have better estimates of maintenance capex when we purchase
shares in company. If we took the time, I feel that we could likely get a
better figure for that. But, since the stock price is nowhere close to
interesting for us we will just move on.
Full Disclosure: No
position in AMZN
