Latest / Market News with Rodney Lake / Episode 108 | Amazon's AI Spending Boom: Growth, Risks, and Valuation

Transcript

Episode 108 | Amazon's AI Spending Boom: Growth, Risks, and Valuation · Market News with Rodney Lake

• 0:01
  Thank you for joining Market News with Rodney Lake.
• 0:04
  This is a regular program for the GW Investment Institute where we talk about timely market topics.
• 0:10
  I'm Rodney Lake, the director of the GW Investment Institute.
• 0:14
  Let's get started.
• 0:16
  Welcome back to Market News with Rodney Lake.
• 0:18
  I'm your host, Rodney Lake.
• 0:20
  Today's episode it's going to be on Amazon.
• 0:22
  Remember, educational purposes only.
• 0:25
  This is a GW Investment Institute podcast.
• 0:28
  This is the GW School of Business, the George Washington University.
• 0:32
  And we're right here in Duquès Hall in the Duquès family studio.
• 0:36
  Welcome back to everybody that's been listening on the podcast.
• 0:39
  If you're just listening to the audio on Spotify or on Amazon, even that's an episode today.
• 0:45
  But Apple as well.
• 0:46
  And of course, if you're following us and watching us on YouTube, thanks and welcome back and welcome to the show.
• 0:50
  If your first time here, send us, send us some comments.
• 0:53
  Excuse me.
• 0:53
  And we'd love to hear from you. So.
• 0:56
  All right.
• 0:57
  Today remember educational purposes only.
• 0:59
  We're going to go over Amazon.
• 1:00
  And as we typically do when we go over a company, we're going to go over the Beam framework.
• 1:06
  So business management price valuation and balance sheet.
• 1:09
  That's what we're going to tackle today.
• 1:11
  And look at that with respect to Amazon.
• 1:14
  And so we're going to go through each category.
• 1:15
  We're going to talk about each category.
• 1:18
  And we're going to start with the business here.
• 1:20
  So the be the first B of the two B's is the business.
• 1:24
  So I think most people are familiar with Amazon.
• 1:26
  If you're a consumer you probably have Amazon Prime or or at least know somebody that does, you know don't ask them to order your stuff.
• 1:34
  Just get Amazon Prime where shareholders.
• 1:36
  So and again educational purposes only here.
• 1:39
  But if you want to order a toothbrush or if you want tokens from AWS, it is Amazon and everything in between.
• 1:45
  And so certainly a convenient place to shop if people want things next day.
• 1:49
  A lot of times that can happen.
• 1:50
  And really surprising sometimes how quickly things come to your door.
• 1:54
  I think that's a huge convenience.
• 1:54
  That's a huge value add.
• 1:56
  And obviously that's why a lot of people appreciate Amazon's service.
• 2:01
  Now, on the other side of the game here is the tech stack that they've been building out a AWS for years.
• 2:06
  And we'll talk about Andy Jassy who led that and now is the CEO.
• 2:09
  And obviously Jeff Bezos still involved, very much as a founder, co-founder of the business, back in the 90s.
• 2:17
  And but here we are today, the business is is a very sizable business, one of the one of the mega cap companies.
• 2:23
  So let's get right into some of the stats on the business.
• 2:25
  So how big is this company?
• 2:26
  What's the market cap currently here?
• 2:28
  We're in about mid-October.
• 2:31
  The market cap 2.8 trillion.
• 2:33
  So this is with a tea.
• 2:34
  So it's one of the large cap companies, one of the Mag seven companies that we love to follow.
• 2:39
  One of our larger holdings for the investment institute.
• 2:41
  So our students have to think about should we be sizing this position up, should we be scaling back?
• 2:46
  What should we be doing with this position?
• 2:48
  Our stock pitch will be coming up here soon at the end of the semester.
• 2:52
  So our students really have to think about, you know, what do we do with Amazon?
• 2:56
  Obviously a bigger position of the portfolio but also a big position in the market.
• 3:00
  So if you're in the S&P obviously you're holding Amazon as well.
• 3:04
  All right.
• 3:05
  So we talked a little bit about their businesses.
• 3:08
  So obviously that is a huge part is retail huge part is AWS.
• 3:12
  And so Amazon Web Services being one of the hyperscalers here.
• 3:16
  And I think that's where we'll probably spend most of our time talking about here.
• 3:18
  And we're not going to do a deep dive into each one of these things today.
• 3:21
  Obviously this episode just going over each category here.
• 3:25
  But it is important to understand, you know, each business now on the retail side, obviously that's a lower margin business, like most retailers are in high volume and they have the third parties on there as well.
• 3:35
  That has been a good business, that has been scaling and they have been building out the fleet.
• 3:38
  It requires the warehouses, it requires all that transportation.
• 3:41
  But they have been steadily building out this infrastructure and doing a fabulous job at doing that.
• 3:47
  And it's serving their customers well.
• 3:50
  That's a lot of value add that goes to the customers, and the customers appreciate and benefit from that.
• 3:54
  And that keeps people coming back to Amazon on the retail side.
• 3:57
  Now on the AWS side, and there's other parts of the business that we're not necessarily going to cover today.
• 4:03
  Advertising has been growing as well.
• 4:05
  But on the AWS side, that's really where this, you know, the artificial intelligence or the superintelligence.
• 4:11
  Now C instead of just AI has been seen so much growth.
• 4:15
  And this is where they're spending a lot of CapEx.
• 4:16
  So they're going to be plowing a lot of money back into the business.
• 4:19
  That's super important for the company continued to grow and take advantage of what's coming here.
• 4:23
  And of course, they have their own training chips that we've talked about before.
• 4:27
  And if you're following Amazon, I think it's important to follow what they're doing on those chips.
• 4:31
  And it's super important to think about how they're positioning themselves in this AI s superintelligence infrastructure build out and what that's going to look like in one year, three years, in five years, super hard to tell.
• 4:44
  60 months from now, what's the world going to look like with superintelligence?
• 4:48
  And certainly beyond that, even tougher.
• 4:50
  But I think as analysts, business people, investors, we can absolutely think about, okay, well, what's going to happen in the next year, what's going to be happening next three years.
• 4:58
  And let's really focus in on, okay, over the next 12 months.
• 5:01
  As Thomas Carlyle said, it's not what's, you know, dimly in the distance, but what's straight in front of us to focus on here.
• 5:05
  So that's where we're going to focus on next 12 months, next 36 months.
• 5:09
  How does Amazon position itself well and how is it it's already done a lot of that.
• 5:14
  But how is it continue to grow that advantage that it has?
• 5:17
  How does it continue to build out this infrastructure, both on the retail side, on the AWS side and continue to monetize on the advertising side?
• 5:24
  And I think, again, Andy Jassy, taking over from Bezos, has done a fabulous job and continues to do a fabulous job here.
• 5:33
  And Amazon continues to to build out.
• 5:34
  Now what's let's get into some of the stats for the story as well.
• 5:38
  So a couple of things to note here.
• 5:41
  So let let's go over a couple of things.
• 5:42
  So you know Q2 revenue here 20 billion.
• 5:47
  So the the numbers here obviously going to be big for for Amazon.
• 5:51
  So when we go over the financials here as we mentioned market cap 2.8 again we're about mid-October when we're recording.
• 5:56
  This would come out a little bit after we record it.
• 5:59
  So when you look at that obviously one of the the mega cap companies, one of the Mag seven.
• 6:03
  But let's look at let's look at the revenue.
• 6:05
  So if you break down the revenue the last 12 months through the June 30th.
• 6:10
  You know, Q3 is coming out soon.
• 6:11
  We don't have it yet when we're recording this, but it's going to be coming out soon.
• 6:14
  And maybe we do a refresher to update our companies, to make sure that we're up to date on everybody that we cover and possibly or we, you know, we'll add that in a little bit later.
• 6:24
  So stay tuned for that as well.
• 6:26
  But let's go with what we have today to talk about Amazon.
• 6:29
  So if you're looking at calendar Q2 here that's June 30th is the last reported number as recording this $775 billion of revenue.
• 6:40
  Obviously these are gigantic numbers for for Amazon, for any company for that matter.
• 6:47
  And if you look at okay, what's the growth of that.
• 6:49
  Well they grew 15% year over year.
• 6:51
  They're expected to grow another 15% for next year.
• 6:53
  Again, we care about what's today and tomorrow.
• 6:55
  And so if we go out one year for 2026 through the end of this year, first, sorry, six months out and then we'll go year out for next year, year and a half.
• 7:05
  So 1231 projected 828 billion.
• 7:09
  So big numbers 15% year over year there and then expected to grow approximately another 15%, 14.6 the consensus here for 1231 2027.
• 7:19
  So that's, you know, closing in on $1 trillion of revenue, 949 billion for the estimated.
• 7:26
  That's again, the consensus here.
• 7:28
  Wall Street 2027 estimate.
• 7:30
  So really closing in on $1 trillion of revenue, which seems really crazy.
• 7:36
  15% growth year over year, obviously driven by, you know, what's happening in AI, driven by the retail.
• 7:42
  And if you look at here, let's go look at some of the gross profit here.
• 7:46
  So if you look at the June 30th numbers, 393 billion, that is a 50% gross margin.
• 7:52
  So quite good.
• 7:53
  Now this is where, you know, they diverged from some of their mega cap peers.
• 7:57
  If you're looking if you're talking about it in vedere these are the premier margins in the business.
• 8:02
  But when you get down to the net income 78 billion to the June 30th, the 10% margins, right.
• 8:07
  As I mentioned, retail as going to pull that down and the AWS is going to pull that up.
• 8:12
  AWS is going to have much higher margins than it's going to have on the retail side, but they're certainly not going to have the same type of margins even on the on the AWS side, that in in video would because of the structure of their business. Right.
• 8:25
  This is much more cap x heavy.
• 8:27
  For example Nvidia designs the chips, doesn't manufacture the chips, Taiwan Semiconductor does.
• 8:33
  So that is a different business model.
• 8:36
  But both are making a lot of money right now.
• 8:39
  And certainly on the revenue side, Amazon generates lots of revenue.
• 8:42
  And then when you get down to the bottom line here, you're talking about net income of $78 billion.
• 8:47
  Still a big number, but the margins are 10% by the time you get there.
• 8:51
  Now let's look at what we're going to stick with June 30th.
• 8:53
  We're going to bring back some of the prior numbers that we talk about.
• 8:57
  Let's go back sometimes to talk about how the business has performed over time.
• 9:00
  But let's dive into okay.
• 9:02
  Well what's the what's the free cash flow now.
• 9:05
  Well, if you look at you go from that income of 78 billion again June 30th, we'll do some refreshing here when the Q3 comes out.
• 9:12
  But free cash flow is now negative because they're plowing a ton of money back into CapEx, building out this AI infrastructure.
• 9:19
  They have their own training chips, building out data centers.
• 9:22
  So so far trailing 12 months, $173 billion on track to spend 221 billion through 2026 is the projected number from this point and certainly aligned with what they have been saying.
• 9:38
  And if you look at again to 2027, year end counter year end, their fiscal year is is a counter year.
• 9:44
  1231 2027 you're talking about $281 billion in CapEx.
• 9:50
  So free cash flow, negative write, generating tons of revenue, generating accounting profits, spending a lot of money on building this out, investing in that infrastructure, investing for the future and playing to win.
• 10:03
  We've talked about this before in this game.
• 10:05
  It seems to me I could be wrong.
• 10:07
  Again, educational purposes only been wrong before Dale Carnegie.
• 10:10
  So what is the setup here?
• 10:13
  They are playing to win.
• 10:15
  These numbers are significant.
• 10:17
  These numbers are material.
• 10:19
  These numbers are a company that's positioning itself to win a game that they think is consequential.
• 10:25
  That is the AI superintelligence build out.
• 10:28
  And they're spending two on track to spend$221 billion this counter year 2026.
• 10:34
  And then another that's not you know added to to get to 81.
• 10:39
  That's another 281 billion next year 2027.
• 10:44
  So these are gigantic numbers to build out this AI infrastructure.
• 10:47
  Now some of the you know ideas could be, well how are they going to spend all that money next year if you can't get permitting if you can't get power?
• 10:56
  And we talked about some AI bottlenecks, for example.
• 10:58
  And so it will be interesting.
• 11:00
  And we're going to have to keep checking in on this.
• 11:01
  And I think that's it's, you know, worthwhile for some of these scholars like Amazon to talk about what's happening in real time.
• 11:09
  And maybe we'll spend a little bit more time talking about Amazon and some of the others that are holding for us than we would have in the past, because things are changing so rapidly, and the numbers are so significant that I think it's worthwhile to make sure we're checking in.
• 11:22
  Now, let's go back a little bit just to show how much things have grown.
• 11:25
  So if you go back, you know, 2022, for example, on the revenue side, 500 billion.
• 11:32
  So we were like, oh, that's a big number.
• 11:34
  And now and now again, you're approaching $1 trillion.
• 11:36
  And so and it's steadily grown, you know, 10%, 11%, 11%, 12% over those years, 223, four, five and through, you know, June 30th here and expected for 20, 26, 15%.
• 11:50
  So these are generally good numbers.
• 11:51
  And and if you look at the profit margins, they have not changed dramatically.
• 11:55
  And so they've been aligned with the business.
• 11:57
  And but they've been doing better in general.
• 11:59
  So if you think about okay, well what's happening.
• 12:02
  They actually have been lifting their profit margin over time.
• 12:04
  And so if you look at the revenue growth we mentioned that pretty consistent here.
• 12:08
  And if you look at the gross margins, you know they've lifted those gross margins from the 40s in 2022 to 50 expected 51 by the end of 26 here and 53 for next year.
• 12:20
  And they're lifting their net income margin.
• 12:22
  So if you look at 2022, you're talking about 1.5%.
• 12:26
  And now you're at 10% expected to go to 20% for the full year.
• 12:30
  Now again, that's the AWS.
• 12:32
  That's the mix of the business.
• 12:32
  That's the advertising.
• 12:34
  That's the higher margin businesses making a bigger difference and expect it to be about 14% for the full year next year, down for county or 2027 consensus again, and then free cash flow negative for both the end of this year-2829 billion round up 28.9 for the fiscal year for the full year, which is fiscal year, 26 counter year and then 2726 billion, minus approximately 27, -27 and 27.
• 13:07
  Easier to remember for that for the free cash flow.
• 13:08
  So putting a lot of money at work very consequential, very important to keep track of what's happening here.
• 13:14
  So on the business side, obviously we have to keep thinking, you know, about what's happening with the business.
• 13:20
  Is this a business that that we, we as investors, analysts, business people we want to be part of and doesn't make sense for us now, given the fact that they're positioning themselves really well, obviously, that that's a higher score.
• 13:35
  And given the fact that there's spending a lot of cash, you know, maybe that there's a place for us to be a little bit more conservative on the rating for the business.
• 13:43
  And so overall, Amazon, fantastic business putting all this CapEx to work.
• 13:48
  Obviously, we've been supportive of that in the past and talking about your plane to win.
• 13:52
  But if we if we knock a little bit off for that, so maybe it's a nine and we take a half a point off right now just to say, well, we're concentrating the risk on the capital allocation right now, which is also on management, which we'll talk about that next.
• 14:03
  But let's give the business today an 8.5 right.
• 14:08
  Accelerated earnings but negative free cash flow.
• 14:10
  So we'll we'll let's talk about that from here.
• 14:13
  All right.
• 14:14
  So up next is management Andy Jassy.
• 14:17
  And the capital allocation here is the is the main story that that we really want to talk about.
• 14:22
  So when we talk about where he came from and obviously we don't spend too much time on the past.
• 14:27
  But Jassy built up AWS.
• 14:29
  And so very good set up there.
• 14:31
  Obviously Jeff Bezos remains around here.
• 14:34
  So we want to give a lot of credit to the team here.
• 14:36
  And we've talked about all the CapEx when we're talking about the business.
• 14:39
  That's obviously driven by management decisions here.
• 14:42
  And so we want to give them credit for playing to win and certainly positioning themselves in these fantastic businesses, you know, starting before Jassy but including Jassy with AWS and now on the advertising piece here as well.
• 14:54
  And so these things are going well.
• 14:56
  And it looks like they're preparing for the future.
• 14:58
  So when we talk about capital, very good.
• 15:00
  When we talk about okay, where's the preparedness.
• 15:03
  You know that that's the P.
• 15:04
  And this, you know, you know, set up for capital allocation.
• 15:07
  And you know, it looks like they're preparing for a future that they think will involve a ton of AI, a ton of superintelligence.
• 15:16
  And they're going to be right there with all the infrastructure to help and make sure that their clients can do what they want to do, and they're there to provide value, just like on the retail side, on the AWS side, and on the advertising side.
• 15:27
  So they certainly had a good track record for this.
• 15:30
  And again, it's us have been aligned.
• 15:31
  When we talk about that, certainly it looks like the compensation for Jassy is tied to long term metrics.
• 15:37
  Metrics. We could spend a whole episode going through that.
• 15:39
  But it is important as an analyst, business person, investor, really understand, okay, you know, get into the proxy statement.
• 15:45
  Make sure you understand. Okay.
• 15:47
  What's the mix of the compensation isn't long term oriented.
• 15:50
  Is it tied to metrics that will reflect performance for the underlying business over time so that you as a shareholder can participate in that?
• 15:59
  And for us and the student investment funds, obviously we're looking for that on the track record.
• 16:05
  Obviously, Amazon has had a tremendously good track record.
• 16:07
  And before Jassy and Jassy now as the management team here, and alignment certainly looks like, you know, we're aligned with with this.
• 16:16
  And and then on the long term side, long term in nature has been absolutely the set of planning for the long term.
• 16:22
  You can agree or disagree with what they're doing, but there's certainly team themselves up for the long term.
• 16:27
  So on the management side you know fantastic.
• 16:31
  Overall the capital allocation again is the piece where we want to give them credit for saying, okay, we're we're planning for the future.
• 16:38
  But also, you know, obviously they're accelerating into the future of AI and they're accelerating into the future of all that infrastructure.
• 16:46
  So maybe, you know, obviously an eight and it will shave off a half a point there just for the concentration risk momentarily and see how some of it plays out.
• 16:55
  So that's a 7.5.
• 16:57
  Now let's let's get into the price versus valuation.
• 17:03
  So we b MPB.
• 17:05
  Let's let's get into the price versus valuation.
• 17:08
  And if we think about okay well where are they now.
• 17:10
  Well right now you're you're paying up now on the forward side.
• 17:14
  This is where the risk is. Right.
• 17:15
  So certainly are those earnings going to materialize in the way that we think and the going to continue to grow.
• 17:22
  And at such a large company, obviously the market can get nervous about that.
• 17:26
  So right now the forward is approximately 18 times.
• 17:29
  And so that doesn't sound very expensive.
• 17:31
  But when you think about all the things that need to go right, well, that can be, you know, a concern.
• 17:36
  And certainly all that has to has to happen.
• 17:39
  So if we think about okay, well what can we give it on the price.
• 17:42
  Well obviously you might want to get you start maybe around an eight.
• 17:45
  You knock that down to a seven and then maybe take another half point off.
• 17:49
  Ended up at a six five here.
• 17:51
  Because well they need to really grow into that.
• 17:53
  And maybe it doesn't happen in the way that we think.
• 17:56
  Again, maybe some of the bottlenecks slow it down.
• 17:58
  Not nothing to do with things that are in its control, but the the probability that they can get all the permitting, they can get all the power.
• 18:06
  Everything's sorted for the data centers.
• 18:08
  That helps drive their revenue growth.
• 18:09
  Maybe it's not as quick as we all had planned for, and certainly not not as quickly as they had planned for.
• 18:15
  So we'll take some of it out on the price here.
• 18:18
  And so again, maybe we start at an eight, knock it off a point and then go to the other half point to be conservative here.
• 18:25
  Obviously we're given a we're really, we're, you know, holding the, the feet to the fire here for the scoring today for Amazon.
• 18:31
  It's one of our holdings to be super clear, not investment advice, educational purposes only here.
• 18:37
  But we're going to take it down to a six and a half for for now.
• 18:40
  All right. So that that's where we are.
• 18:43
  So we've gone through the business the management the price valuation.
• 18:46
  Let's get into the balance sheet now.
• 18:47
  And then we'll wrap it up with the whole composite score here for Amazon.
• 18:52
  So on the balance sheet side there's not a lot to worry about here.
• 18:56
  Amazon has been fairly responsible with what it's doing.
• 18:59
  Obviously it's levered up a bit.
• 19:00
  So that's a little bit of a concern.
• 19:02
  But and it has negative free cash flow now.
• 19:05
  So that's also a little bit of a concern.
• 19:08
  And so we're not sleeping totally like babies at night here for for the Amazon balance sheet.
• 19:12
  So it is something that we have to watch out.
• 19:14
  We it is something that we need to keep track of.
• 19:16
  And again a reason I said well maybe we need to check in with some of these names a bit more often than we have in the past.
• 19:22
  In the podcast, when we talk about some of our larger holdings for the Investment Institute student funds.
• 19:28
  And so possibly we will do that.
• 19:30
  So if you look at June 30th last data, we have 2026 cash, 122 billion on the balance sheet and then total debt of 241.
• 19:39
  So obviously that's not something that we're thrilled about.
• 19:43
  It's not something that, you know, again, those numbers don't really help us sleep at night.
• 19:47
  But if you look at the interest coverage ratio, this is something you get a bit more comfort over.
• 19:51
  And remember, interest coverage is Ebit earnings before interest and tax over interest expense 35 times right now.
• 19:57
  So again, we'd like the balance sheet to be a little bit cleaner.
• 20:01
  And you know obviously generating negative free cash flow right now generates some concern on that.
• 20:07
  So again that combination puts the balance sheet let's say at an eight.
• 20:11
  Right. It's not something ten or even a nine.
• 20:14
  We're sleeping a baby.
• 20:15
  But at 35 interest coverage ratio you know earnings before interest in tax over interest 35 times right now pretty good.
• 20:23
  We're at an eight.
• 20:24
  And they've been responsible in the past.
• 20:26
  And certainly we don't think that they lack access to the capital markets should they need it.
• 20:30
  However not the fortress balance sheet that some of our other companies have been not a ten or a nine and a half, but we'll push it down to an eight.
• 20:39
  So let's pull it all together.
• 20:41
  So we talked about the business.
• 20:43
  So Amazon obviously putting itself in a position to win and really allocating capital in that way.
• 20:50
  Obviously AWS the big growth engine for the company advertising coming on strong and retail being their direct connection with customers, Amazon Prime doing firing on all cylinders there and doing a great job business.
• 21:03
  We said an eight and a half management.
• 21:05
  Andy Jassy company continuing to excel on the revenue side and again back to the capital occasion.
• 21:12
  Playing to win for that.
• 21:14
  So fantastic job there. Seven and a half.
• 21:16
  We gave them on that. On the price versus valuation.
• 21:19
  Obviously they got to grow into this and make sure that 18 times forward does work out.
• 21:24
  So we pulled that down to a six and a half being a little bit tough today.
• 21:27
  And then on the balance sheet side you know responsible but not fortress.
• 21:33
  That's an 835 times interest coverage ratio.
• 21:35
  Remember Ebit over interest expense.
• 21:37
  That puts you at a composite score of a 7.625.
• 21:42
  So really I think excellent score especially we were tough on on Amazon.
• 21:47
  But remember where before the third quarter announcement of earnings here.
• 21:51
  So we're probably going to check back in when we record this so that this might be out when the third quarter comes out.
• 21:56
  So I do think it's a name that we're going to constantly check on.
• 22:00
  The market is moving quickly.
• 22:01
  I think, you know, when you have a 12 month window, it seems like, you know, forever from here when you talk about AI and superintelligence.
• 22:09
  So it is a name we'll probably continue to check back in on.
• 22:12
  But those are the scores for today.
• 22:14
  And that's a wrap for this episode of Market News with Rodney Lake.
• 22:16
  We'll see you back on the next one. Thank you.
• 22:23
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• 22:30
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• 22:39
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• 22:45
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• 22:50
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• 22:57
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