Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Bear with me while I throw a few numbers at you:
- Negative $241 million.
- $596 million.
- $2.4 billion.
- $3 billion.
- $10 billion.
These numbers aren't random. They describe the y-axis on Amazon.com's (AMZN +0.34%) profits as they've gone from negative to nearly vertical over the last five years. The tech titan's profits are surging -- and that has one analyst feeling very optimistic indeed about Amazon.com stock today.
Image source: Getty Images.
Upgrading Amazon
StreetInsider.com has the details. This morning, investment banker KeyBanc announced it is upgrading Amazon stock to overweight and assigning a $2,100 price target -- nearly $400 more, or 23% higher, than where the shares trade today.
KeyBanc has two major reasons for upgrading Amazon, which can broadly be described as: retail, and not retail.
On retail, the analyst argues that Amazon is making multiple moves toward improving the profitability of its core business of selling stuff to people over the web. Five years ago, this business kept the lights on for the company, but wasn't much of a profit driver, as Amazon earned less than a 1% operating profit on its more than $50 billion in annual sales. Last year, however, Amazon North America earned operating profits of $7.3 billion on sales of $141.4 billion -- an operating profit margin of 5.2%, or seven times higher than what it was earning just five years earlier.
Granted, Amazon's smaller international business is still losing money. But the improvements in North American retail are still pretty impressive -- and in KeyBanc's view, they're only the start.
Once again: Negative $241 million, $596 million, $2.4 billion, $3 billion, $10 billion. Amazon is "pivoting to a company with accelerating profitability," points out KeyBanc. As this trend continues, the analyst sees the company exceeding analyst expectations and growing the profitability of its retail segment by $5 billion, even as it builds out a new chain of grocery stores priced below Whole Foods levels to further expand its retail reach.
Check out the latest earnings call transcript for Amazon.
Turbocharging growth
But that's not all KeyBanc likes about Amazon. By now it's well-known that the real source of the company's biggest profit margins is its Amazon Web Services (AWS) cloud computing division.
Last year, AWS produced roughly the same amount of profit as Amazon's North American retail division ($7.3 billion). But AWS did this one a sales base five times smaller -- just $25.7 billion. With operating profit margin north of 28%, AWS could arguably be the real driver of profits for the company...if it can keep those AWS profits growing.
But here's the thing: Although AWS is growing great guns, with sales roughly doubling over the last couple of years, profits at AWS have only more or less paced the rate of sales growth -- up 135% in two years. Assuming AWS is close to maxed out on profit margin already, the only way Amazon can keep profits growing at a rate sufficient to justify its 84.5 P/E ratio is to grow AWS sales a lot faster.
Luckily for investors, this is what Amazon intends to do, says KeyBanc. Grouping AWS and Amazon's growing advertising businesses together, KeyBanc projects that the company could do $100 billion in business ("by 2022," says TheFly.com), while maintaining "very strong" growth rates and profit margin.
What it means to investors
So what's the upshot of all this for Amazon.com shareholders? I come away from KeyBanc's upgrade with two main points:
First, the growth in profit margins at Amazon's retail business is no fluke, but rather part of an intentional, sustained drive toward growing profits. Although we may not see another sevenfold improvement in retail profit margin anytime soon, just the $5 billion addition to operating profit from retail that KeyBanc is promising would equate to 68% profits growth from the North American retail business.
At the same time, the growth in AWS and advertising may be an even bigger story. If KeyBanc is right about revenue there growing to $100 billion by 2022, that would be a fourfold increase in the size of Amazon's most profitable business in just three years. Assuming a flat profit margin of 28% on that new revenue, this could tack on $21 billion more profit to the $5 billion in profits that KeyBanc already sees retail adding.
If the analyst is right about all this, Amazon's operating profit could surpass $38 billion (an increase of more than three times) in three years -- and Amazon could give Apple a serious run for its money for the title of most profitable company in the world.
