Amazon's (AMZN -2.56%) business-to-consumer e-commerce segment and Amazon Prime Video have huge brand recognition and quite the following. And many consumers are familiar with Amazon's various holdings like Twitch, Whole Foods Market, IMDb, and even Ring. But one of its business segments still operates mostly out of the public eye, and its incredible value to the company is still not well known, except to stock traders who follow the company.
Amazon Web Services (AWS) is Amazon's global cloud infrastructure business unit, and it continues to grow at a breakneck pace. In fact, some investor analysis suggests AWS alone is worth over $1 trillion to the company. When you consider that Amazon as a whole has a market cap of $1.17 trillion, that is saying something about AWS's importance.
Let's take a closer look at what makes AWS a great business, and why it makes Amazon a "value stock" worth considering in May.
Image source: Getty Images.
AWS looks unstoppable
Amazon had a rough first quarter. Its e-commerce business is facing slower growth, tough comparisons to pandemic-heightened performance, and rising costs related to inflation employment costs and continuing supply chain issues. On top of all that, its stake in Rivian Automotive has lost billions in value over the last few months.
The one bright spot for the quarter was AWS, which continues to be Amazon's ace in the hole. AWS is lean, growing quickly, and is very profitable. AWS booked $18.4 billion in first-quarter 2022 revenue and $6.5 billion in operating income. Trailing-12-month sales are $67.1 billion and trailing-12-month operating income is $20.9 billion, giving AWS an operating margin of 31.1%, a revenue growth rate of 38%, and an operating income growth rate of 43%. A 30%-plus operating margin isn't uncommon in the tech space. But you would be hard-pressed to find a large IT company that is growing revenue and operating income as fast as AWS.
Playing with valuation
Determining a fair price for a stock is one of the most challenging tasks in investing. And it's even more critical during a bear market when valuations compress and fundamentals are put to the test. Just for the sake of this argument, let's take a look at the value of AWS compared to tech giant Nvidia (NVDA -10.01%). Despite being in different industries, Nvidia and AWS actually have a lot in common in terms of their financial metrics. Nvidia has a trailing-12-month operating margin of 39% -- quite a bit better than AWS. But its revenue and operating income are growing slower than AWS's despite Nvidia ramping up its profitability considerably over the last few years.
| Metric | AWS | Nvidia |
|---|---|---|
|
Revenue |
$67.1 billion |
$26.9 billion |
|
Operating income |
$20.9 billion |
$10 billion |
|
Operating margin |
31% |
39% |
|
Revenue growth rate (YOY) |
38% |
23% |
|
Operating income growth rate (YOY) |
43% |
37% |
Data sources: Amazon and Nvidia. YOY = year over year.
Given AWS's faster growth rate but Nvidia's higher operating margin, let's just call it a wash and value the companies at the same price-to-sales ratio (admittedly a big assumption). If that were true, then AWS, which earned 250% more revenue than Nvidia in the last 12 months, would have a market cap that is 2.5 times the market cap of Nvidia. That would give AWS a market cap of $1.163 trillion today -- which is coincidentally a little higher than the value of all of Amazon at the moment. Accepting the math of this scenario, an investor buying Amazon stock now and giving AWS the same multiple as Nvidia is basically getting the rest of Amazon's business for free.
A balance sheet that is built to last
Amazon has more cash and cash equivalents on its balance sheet than long-term debt -- giving it a net cash position of over $11 billion. Amazon also doesn't pay a dividend, which gives it more room to navigate challenges, reinvest in the business, or repurchase its own stock now that it is a lower price.
Despite the strength of Amazon's balance sheet, one big red flag is the company's excessive spending. This chart sums up the pattern perfectly.
AMZN Cash from Operations (TTM) data by YCharts
Amazon's cash from operations had been steadily rising but has been on a downtrend the past year while its capital expenditures continue to accelerate. That means Amazon sports negative free cash flow (a sign of overspending). Amazon has long been notorious for injecting its profits back into the business in the name of growth. But given the heightened competition in the e-commerce industry and the streaming segment, it may be a good idea for Amazon to reel in the spending so it can generate consistent positive free cash flow.
A compelling buy now
No company is perfect. Amazon's slowing overall growth and high spending are currently being underwritten by the strength of AWS. Although AWS may be one of the few segments that is working right now for Amazon, Amazon is one of the most influential and powerful companies in the world and it has the tools to address any issues it's facing.
Amazon isn't a value stock in the traditional sense. But once you factor in the value of AWS, Amazon's strong balance sheet, and its diverse and industry-leading e-commerce business, the company starts to look way too cheap. For investors who thought they missed out on Amazon over the past couple of years, buying the stock now that it's down over 40% from its all-time high could end up being a great deal.
