Tech names are struggling right now, but I think savvy investors should take advantage of this weakness. Recently, a rotational trade has gripped the market wherein money is flowing out of big-multiple, big-growth names like Amazon.com, Inc. (NASDAQ:AMZN) and into low-multiple, big-tax-rate names like Nordstrom, Inc. (NYSE:JWN). Over the past week, AMZN stock is down 4% while JWN stock is up more than 13%.
The latter (JWN’s rally) makes sense. JWN stock was far too beaten-up, trading at just 14 times 2017 earnings estimates. Corporate tax reform is coming, and JWN’s effective tax rate normally hovers between 35%-40%. The 2017 Black Friday shopping weekend was also really good for retailers, implying that the worst may be over for struggling mall stocks.
The former (AMZN’s sell-off) doesn’t make sense.
AMZN had run up to an all-time high with a mega-rich valuation, but not much has changed about the underlying growth drivers over the past week. Amazon’s North America retail business is experiencing super-charged growth thanks to a confluence of tailwinds, including the integration of Whole Foods Market, Inc. (NASDAQ:WFM) and huge demand for Amazon’s suite of smart home products.
The international retail growth story is just as promising (Amazon recently rolled out to Australia). Amazon Web Services continues to scale nicely (Amazon remains the leader in secular growth market). Amazon might soon make its long-awaited plunge into the pharmacy market. The company is also building out its own delivery network.
All in all, there isn’t much reason to be bearish about AMZN stock at these levels outside of valuation. But even as it relates to valuation, I think AMZN stock is now undervalued.
AMZN Stock Is Presently Undervalued
It’s a little tricky to value AMZN stock considering its robust growth potential. This is a company that almost everyone agrees will experience explosive revenue and earnings growth over the next several years. The question, then, is simply: how much growth?
I think quite a bit.
Amazon’s North America retail revenue growth has trended around 20% to 35% for the past several quarters. Last year, it came in at the high-end of that range due to Whole Foods. This underscores a fundamental aspect of Amazon’s growth story. Amazon can super-charge growth at any point by pulling one of its many growth levers (namely, through either acquiring or building out new business segments).
The next growth legs will come from the logistics and pharmacy markets.
CNBC reported recently that Amazon has talked to generic drug makers, including Mylan NV and Sandoz Inc., about a potential entry into the pharmacy space. This is a huge $400 billion market that Amazon has been interested in breaking into for sometime. Whether Amazon goes at it itself or acquires a company like Rite Aid Corporation (NYSE:RAD), it is almost a guarantee that Amazon’s revenues will get a boost from a pharmacy market entry in the near future.
On the logistics side, Amazon has stealthily been building out its own logistics network to complement its growing e-commerce business. This is another huge market that companies like United Parcel Service, Inc. (NYSE:UPS) and FedEx Corporation (NYSE:FDX) have built multi-billion dollar valuations on. But Amazon, given its huge and growing fulfillment center network as well as its leadership position in digital retail, is particularly levered to disrupt this industry.
Not only will Amazon build out its own logistics network and squeeze UPS and FDX out of its delivery process, but Amazon could then be a logistics provider for other retailers. This wouldn’t be an unusual move for AMZN, which built out AWS for internal usage and then sold it to other companies.
From this standpoint, logistics could provide a huge boost to Amazon’s operational results over the next several years.
All in all, then, it is unlikely that Amazon’s revenue growth tapers off that much. Right now, revenues are growing around 30%. Roughly 30% revenue growth is here to stay for the next 5 years. Margin expansion from AWS scale and retail business maturation will likely turn that 30% revenue growth into 50% earnings growth.
If earnings do grow at 50% per year over the next 5 years, that puts earnings 5 years out at roughly $32.75. At that point in time, growth will likely decelerate some, but not by much given the company’s long-running tailwinds. My best guess is that revenue growth will slow to 20%, while earnings growth will slow to 30%.
A 30% earnings growth story should trade at double growth, or 60 times earnings (the S&P 500 is currently trading 20x earnings for 10% growth, or double growth). A 60 multiple on $32.75 earnings implies a 5-year forward price target of $1,965.
Discount that by 10% per year and you get to a present value for AMZN stock of around $1,220.
Bottom Line on AMZN Stock
Take advantage of this recent weakness in AMZN stock. The underlying growth story is only getting stronger, as catalysts from the pharmacy and logistics market will soon couple with catalysts in the digital commerce and hyper-scale data center markets.
All else equal, I think AMZN stock is undervalued below $1,220. That makes me a buyer on this dip.
As of this writing, Luke Lango was long AMZN, JWN, and RAD.