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