Episode 15 | Amazon’s Financial Future: Navigating Growth, Debt, and Maintaining the Day 1 Culture Under CEO Jassy

In Episode 15 of "Market News with Rodney Lake," Rodney Lake, Director of the GW Investment Institute, reviews Amazon's recent financial performance, focusing on the increased debt levels on the balance sheet since Andy Jassy took over as CEO. Lake examines the company's trajectory, highlighting a significant rise in free cash flow—now nearing $50 billion—after a dip in 2021 and 2022. While Amazon's balance sheet remains stable with an interest coverage ratio of 11 times, Lake raises concerns about the company's future debt trajectory and ongoing valuation, currently trading at 33 times forward earnings. With Amazon Web Services continuing to dominate, Lake scores the company a solid 7.5 to 8 but emphasizes the need to monitor management's ability to innovate and maintain the “Day 1” culture. Tune in to learn more!

Transcript

Thank you for joining Market News with Rodney Lake. This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the director of the GW Investment Institute. Let's get started. Welcome back to Market News with Rodney Lake. I'm your host, Rodney Lake. We're coming to you live. Not really live, but from the Innovation Studios here in Duquès Hall.

Thank you to the Duquès family. Much appreciated. All right. Today the topic is Amazon. So we're going to be talking about Amazon. And we're going to look at the company through the GW Investment Institute framework business management price valuation and balance sheet. So Amazon Amazon is the ticker reminder. This is not financial advice. This is not investment advice.

You know hire a professional to do that. This is for educational purposes. So let's talk about Amazon. I'm sure all of you have heard about Amazon. And you might have things in your basket right now. And maybe you just ordered something with the one click shopping. It's important. It's pervasive that you're maybe your front porch if you have one, there's a box there or downstairs in front of your building.

There's a box there. This is pervasive, you know, lots of Amazon Prime subscribers. So you're talking 200 million now in Amazon's business. Well let's so let's tackle the B first. The business is really everywhere. And people have talked about sort of how important it is for them in their day to day life. And really it's started from an online bookseller and it's really graduated into so many different things.

And we're going to touch on a little bit of that. So it's gotten into new business. It's been able to innovate and it's grown substantially over the years. So let's let's first talk about okay, well what's the market cap of this business. So this is on the higher end. This is one of the of our large holdings at the investment Institute.

One of the reasons that I'm talking about it, but it's a lot of people know Amazon. It's a $2 trillion company. We're in late September in 2024. It's a $2 trillion company. Obviously, this is an important company for lots of different people. It's an important company for the investment institute. But, you know, it's important for different reasons.

As an investor, it has done very well for us, and it's done well for a lot of people over time. And as a business, this delivers sometimes everyday products to people's houses. And, you know, with 200 million subscribers in Amazon Prime, which was, you know, something that they thought of, you know, it's ubiquitous, in a certain way.

But for the business, you know, what do they do? It's online retail, where it started selling books, but then it became the everything store selling everything, and one of the most significant parts of the business that they added. And the person who's now the CEO, Andy Jassy, really led the charge on Amazon Web Services. So they were had all this excess server space that they could sell, and figured out, well, maybe this is a business unto itself.

And they did just that. I'm oversimplifying the whole set up for, for anybody that I want to do a deeper dive on that. That's a separate topic. But the Amazon Web Services really became the backbone for lots of other companies so that they didn't have to do something called on prem or on premise servers. So they could say, well, I'm going to rent time from Amazon and they'll manage all this stuff in the cloud for me and this service I'll pay for.

And if you can have these great economies to scale, well, you can really offer that at a much lower price. And you could do that on your own. It's more convenient, more reliable. Someone else manages it for you, you pay the fee, and Amazon does the rest of the work. And they built that business and have grown that business into a very substantial business.

And for a long time, maybe even up to seven years. They had a lead in that business where you didn't really have other people get into that business. But certainly you had people like now Microsoft with Azure really get in their cloud with Google and and Oracle as well. Some other there's other competitors, but those are some of the really big competitors.

But it took like seven years for them to get there. So Amazon really had to have a big lead here and really build out a ton of infrastructure. If you go out to Northern Virginia, there's lots of data centers out there and some are Amazon's. And so the business when you think about, okay, how should we score this business.

Well, parts of the business, you know, online retailer you're not really talking about a super high margin business. Right. And so when you look at the gross margins there are 48% for Amazon, which is which is pretty good in the net margin. So are lower at seven and a half and so well maybe you think well they're definitely better business businesses out there.

If you look only at the gross in net margins. We talked about Nvidia before. We've talked about Microsoft before. They're better on both of those metrics. But Amazon has become very important part of people's lives. And so really, you know, they're willing to, you know, use Amazon for a whole bunch of different things in the in the profit margins are very different on the online retailer space, versus the third party, that they provide so other sellers can sell on their platform versus AWS.

AWS would be closer to like a Microsoft style business with Azure, and it's really providing a service that you can charge a premium for, you know, versus, competitors when you get specialized services, and you have, you know, you can have a much higher profit margin on that business than you can, let's say, selling towels and all the shipping costs that are related to that as an example.

But, you know, the blended, gross margin here is 40%, which still makes it a very good business. And so when we think about Amazon as a business, you think, well, there are different parts of that business. And now they're in the video business with, you know, the distribution there, they've gotten into the football business as an example with Thursday Night Football.

And so it's in a whole bunch of different things. Now, one concern you might have is that maybe they're into many businesses now. Maybe they need to narrow. Maybe they need to figure out what they want to be when they grow up. But it seems to be working for them right now. They continue to grow the business. So when you talk about the revenue, growth, you know, you're not talking about these enormous numbers anymore as it grow.

But you're talking about pretty steady. It now $600 billion. And June 30th, 2024, and growing about, you know, 10 to 11% per year. Well, when you're growing 10% per year, that's a big number next year projected to be or by the end of the year, rather 635 and by next year, at the end of 2025, you're talking 700 billion.

So those are big numbers, even when you have modest growth rates, when that when the basis is that big, you're talking about, very big numbers. Now, when you look at the free cash flow. Good. And certainly it has transformed over the years. And, you know, Amazon was burning cash for a long time, was being criticized. If you were watching it grow from IPO until now, which is quite a long time, a couple of decades.

But when you look at, where it is now, you know, it's generating your project or generated rather through the end of, June here. This year, 2024, it generated $48 billion in free cash flow, which is not the same as Apple as an example, but it's a big number. And it certainly has transformed again over the past several years.

Even in in 2021, you know, they were -14 billion in free cash flow. But, you know, they're plowing a lot of money back into the business, too. So they're always trying to grow, they're always doing things. And so you look at CapEx for this past year, it's $60 billion. And so when you put these things together, Amazon still has some real room to grow.

You would think, wow, it's so big. How does it get, any bigger? Well, it's plowing quite a lot of money against 60 billion back into that, you know, investments in the business, that CapEx. And so that that's a big number, that's pretty big percentage of sales right now of revenue, about 10%. And so that's meaningful.

And you want a company to grow and you're you're gonna need to do that. So when you talk about the business, maybe you think, well, it's not quite as good. If we score from 1 to 10, ten being the best as Microsoft or Nvidia right now. But it's an excellent business and people depend on it for a variety of different things.

So it has that moat around its business where it's sticky. You have loyal customers and people. Maybe you're not going to switch. They have Amazon Prime. Well, well, maybe I'm not going to switch to another provider, or maybe I'm just going to go ahead and order that on Amazon. And so maybe we give that business to 7 or 8.

So now let's move on to management. So Jeff Bezos is the founder and CEO. For a long time until recently, and really was the visionary behind the business. And, you know, given lots of credit, he left, you know, Wall Street, basically the shore, to go out and build this business. Clearly a bright person with lots of talent and skill.

And started very humbly, on that desk, you know, famously that's made out of a door, and, you know, packing books himself

And so really starting with the idea of how to delight the customer. And if you read the memos, they talk about day one at Amazon. I think that's important. And I think the culture that they've built and it's up to management to build the culture, is a fantastic one for a company that can continue to grow at scale because you have to really think about how do we continue to innovate on day one?

AWS is an example of that. The Prime is an example of that. And so what can they do it from here? That's the big question. And certainly that's the open question that lots of people are asking. Obviously, the visionary has moved on from CEO. And Andy Jassy now is the CEO. And he's the one who led the charge on AWS, as we mentioned.

And so certainly someone who's very familiar with the company, somebody who helped build an important enterprise within, Amazon is leading the company and has been now and seems to be doing an excellent job. Amazon continues to grow, continues to function well. The challenge now will be for an analyst to understand is can he replicate the same type of culture of innovation where they are going to they're going to get the next AWS, they're going to find the next, you know, Prime, you know, style, idea.

There's not necessarily going to be Amazon Prime, but it's going to be something else where it's innovative. It's new, but plays on a theme. You know, if you think about Amazon Prime, it's a little bit like Costco membership, right? You pay the fee for the opportunity to participate in these other categories. And so Costco membership is similar to that.

So it wasn't necessarily a new idea by itself. However, when you couple it with the things that Amazon was doing, it's an innovative idea expressed in their own unique way. And, you know, kudos to the people there. Now, can Jassy do the same thing as Bezos and create that culture where that can happen now? They have very specific ways they run meetings or Bezos did.

I'm guessing, that Jassy is running things similarly, but as unless we really have to pay attention to that. So you want to read those annual memos, you want to listen to the conference calls, you want to make sure that you feel like the culture is similar to what if you thought it was good that it's similar to the way it was with Bezos?

Are they do they have that room, room to innovate? Do they have the room to really think outside of the box and create these new things that, well, people think, well, why would people want to use our server time? Well, it turns out that they did and really a lot. And it creates a whole nother business segment.

And they had years to run with that. So that's a super important culture, to keep. And to keep moving forward is not easy. And so really it's up to Jassy and the current team to do that. Obviously, they can check in with Bezos any time that they need to, but it's really up to the current team. And Jassy is the CEO to lead that charge, to make sure that the culture, continues and that they have that innovation.

So management team, I'm giving a high grade. I would say that they're an 8 or 9 even at the moment, and they have done a fantastic job. Now when we look at the price versus valuation, this, you know, this is a great company right now. And it's a great business with a with a great management team. If you don't want to say great you can say, good.

This is a good business. The good management team are a great business with a good management team. I think right now you can say either one of those things and it can be accurate. And obviously that some what whatever perspective you have on it's a $2,000,000,000,000 trillion company. And what's the multiples. So if you look at the forward multiple it's at 33 times the S&P at 25 times.

So that's really not that expensive. If you think about well I'm paying 25 times for the S&P and 33 times for the forward. Looking at the end of the year and 24 for Amazon I wouldn't call that, you know, a super duper premium or anything by any measure. But but it's more expensive than the market. So what justifies that 10% growth rate?

Maybe not. I can't get too excited about that. But the big reinvestment in the business, along with a 10% growth rate now with a 45%, gross margin and hopefully improving over time, that maybe starts to justify that higher number. And if they can continue to grow that free cash flow, even better, which they have been able to do so over the years.

You know, that's kind of bounced up and down. But now you're talking about free cash flow, of nearly $50 billion at 48 and, and projected to go to 54 and 72 by the end of 2025. Those are much bigger numbers. And so if you think about, okay, well, are we willing to pay up for those earnings? It looks like, obviously people are.

And as investors that the investments do our students really have to think, okay, should we this company we own it, should we continue to hold this company right now? You know, it seems everyone thinks, yes, time will tell where our analysts come out on that. But as far as the valuation goes, is it justified at the moment at 33 times versus the 25 times for the S&P?

I would say it's definitely there. And maybe you know, this is not a 1010 being the best. But maybe this is something closer to like a 6 or 7. So it's not a fabulous valuation where it's a screaming buy and you would say like, oh my gosh, something happened and we should be backing up the truck and buying as much as possible at this valuation.

But it's a valuation that seems fair at 33 times. Again versus the S&P at 25 times. This is something you're not going to, you know, say, well, you know this is something ridiculous. So it's absolutely worth, spending time to think about this. And it's absolutely worth, thinking that, you know, are we justified for this premium. But at the end of the day, it looks fair.

I would say that it's fair. And and for our analysts, you know, they have to do that work as well. But again, if you comp it versus the S&P, it looks to be a fair valuation. So now let's move on to the balance sheet. So other tech giants have, you know sort of this bulletproof balance sheet that we've talked about before, this really rock solid foundation.

You know, Amazon is not in the same situation, let's say similar. So when you talk about cash and cash equivalents, at June 30th, you're talking almost 90 billion, but you have 150 billion in debt. So you have, you know, net debt, you know, 60 billion, let's say. So. It's not it's not, you know, it's not that net cash position that makes us sleep at night with Apple and Microsoft and some of these other companies.

But it's also they have, a big pile of cash. The debt seems manageable. And if you look at the interest coverage ratio, you're talking 11 times. And remember, interest coverage is Ebit earnings before interest. And taxes over interest. So we're not necessarily super worried about that. Amazon has has historically been a super, super cyclical business.

So it's not like you know where to concern. You know earnings have been you know variables sometimes up and down a little bit but not so cyclical. Like a commodity company as an example. But it's something that we have to be mindful of. And it's not something where, you know, again, you can sleep at night with an Apple or Microsoft balance sheet where you have net cash and you're really not worried.

They do have some net debt, but but not something where we should be overly concerned about interest coverage ratio at 11 times is something that I think we can live with. But it's something where we have to keep an eye on this. Is it something that should be alarming? No. Is it something that we should be watching?

Yes. Again, about 90 billion in cash, about 150 billion, in debt. So. So net debt in this case, not net cash, but net debt in this case of about 60 and so 60 billion. But, you know, interest coverage ratio again Ebit over interest at 11 times. And generating nearly 50 billion in cash, access to the debt markets.

Nobody's that concerned about Amazon. And with rates lowering that should be a good tailwind for them if they wanted to, if they want to or need to refinance any of this $150 billion of debt. Now, the one thing I will mention on the debt side is that debt has grown. So you're talking about a 50% increase, in the net debt with basically a similar amount of cash, over the same time period.

In 2020, you had 100 billion in that debt. Now you have as of June 30th, you have 150 billion. So this is for our analysts, something that we definitely need to watch. So you've seen the debt increase by 50%. And the cash though has not really increased by as much. So if you look at what was it back at the end of 2020, it was 84 billion.

And now it's 89 billion. So the net position has also changed pretty considerably. So in that in that time period in 2020, they were on a net cash position by $15 billion. Now it's net debt by by $60 billion. So it's not alarming. But as an analyst, it's definitely something that we need to watch. And it's something that has changed considerably over that four year period.

And so, as an analyst, we got to think, well, okay, well what's driving that? And you got to really dive into that. Now debt has increased by 50%. Cash has really not increased by that much. And we ended we went from a net cash to a net debt situation. Is that justified? It doesn't mean it's right or wrong right now.

And again, we're not concerned because we're not concerned about the interest coverage ratio. But when you have such a big move, for such a large company and you increase the debt by 50%, it's something to take note of. It's something to investigate. It's something to do additional due diligence on. And our students will need to do that this semester to make sure, okay, is Amazon.

You know, what are they doing with this this additional debt. You know, making sure that it's responsible when we talk about capital allocation, what can companies do with capital allocation. So, you know, they can grow the company. There are two parts of that that is acquisitions or growth by building new products in-house. That is dividends. But Amazon doesn't pay.

That's share buybacks. And that's paying down debt. In this case they have not been paying down that they're actually increasing the debt. So as capital allocators we got to think about okay well that component they're actually going the other way. They're actually increasing the amount of debt. And so what are they doing with that capital. It's increased by 50% over the last four years.

Again, something that we should be paying attention to, something that we should be watching, not be overly concerned about. But we absolutely need to keep track of that in our in those. We'll need to work on that. So what do you give the balance sheet? All that said. Well, between the one and 1010 being the best again is that's probably something closer to like a 6 or 7 right now.

Six might be a little low, but so you could go with the 7 or 7 and a half if you wanted to really make them feel better. But it's definitely something to watch. And that's why I would probably even say a six, because, you know, you want to put it in. There is a score to say, hey, let's really watch this and make sure that we're comfortable with what's happening, because the trajectory here is not going the way we would like.

As equity investors. Remember, the largest risk for any company is going out of business. I don't think we're anywhere near that. But again, we want to make sure, to keep an eye on this. So now let's just do a little bit from each of the categories. For Amazon. Again, it's an important holding for the investment institute, the business.

You know, we would say that that's a 8 or 9 or something in this category. And some of the things that we would say, what are the reasons for that? Well, look, everyone uses Amazon Prime, at least 200 million people are subscribers. And people have these boxes in front of their houses, in front of their buildings, down at the desk in their building.

If that's the set up every day. And these boxes are ubiquitous, they're trying to do now drone deliveries. And if people want something, they go on, they click it shipped. And Amazon has figured out a way to get it to them. And they have been relentless in the pursuit of delighting the customer. And the day one attitude which is connected to the management is fantastic, and they're really figuring out ways to entrench themselves into the life of people.

And so when people think about, well, I'm going to order something, a lot of times it's straight to Amazon. Is it there if it's there and even sometimes now okay, I hope I'm getting a better price. But you know, how many times is everyone really checking. And I think Amazon has, you know, does a reasonably good job of trying to give people, a good price.

But that said, you're integrating this into people's lifestyles. So, you know, think of another company like Apple, which we talked about, that's also ubiquitous in people's lifestyle, from owning a phone as the example. Amazon is there in another way, right? It's not through a phone necessarily, but it is through. Hey, if I'm going to order something, it's likely going to be on Amazon.

So if I want a product, delivered to my house, whatever it happens to be, maybe the first check is Amazon and maybe I buy before I even check anything else, and it's already on the way to my house. So kudos to Amazon on the business side for entrenching themselves for thinking up, this type of how do we delight the customer?

How do we get products, out to the customers the fastest, you know, building their own delivery networks, building their own warehouses? These things are all super important. On the execution of delighting the customer. So then the other segments, you know, like AWS thinking, you know, outside of the box and building that into a tied to business and really that, you know, long ago, ten years plus, let's say, was not necessarily as important as it was now as the world has grown into and including in artificial intelligence, this business of, you know, running things off prem or off premises has become more and more important.

Everything is in the cloud, including a lot of the AI functional I.T and Amazon was early to that game with Amazon Web Services led by Andy Jassy, which we'll move on to in the second for management. But that is a, you know, segment crusher, right. They really killed that for let's say, more than they had a seven year lead, let's say on a lot of people.

But now you have other dominant players that are doing great in that business, Microsoft, Google and Oracle as well. But they really built their enterprise. They certainly built the brand name for that business. A lot of people trust Amazon Web Services, and so it's a super important part of their business. The one of the people who led that or person who led that, Andy Jassy is now CEO of Amazon.

So when we talk about management, you had Jeff Bezos setting that culture day one innovation. Let's think of these new things, like Prime, like AWS. And let's delight the customer. Let's provide video and all these other things. So the culture that has been set from Jeff Bezos and now Andy Jassy, I would rate high on management now.

And their responsibility with the different metrics in the business have also been good. And so, you know, business you would say maybe that's an 8 or 9. When you talk about the management, you're probably talking about that seven or 8 or 9, depending on let's give Jassy some time to prove himself, even further and make sure that you can make that transition between Bezos and and Jassy.

And really that day one culture is what you're looking at unless to think, can they keep that? Can they keep that culture? Can they have that day one outlook where, you know, let's think of new things. Let's make sure, you know, let's not say that, you know, it's all been done. And this is the way that we do it.

Let's reconsider, let's think from first principles and make sure that we're, you know, delighting the customer, with whatever the service or product that we're providing. And I think, again, the time will tell. But so far, so good for the transition. And it's been some time. However, you know, it's important when you talk about, you know, when you transition from a founder, think Steve Jobs, to Tim Cook, you know, what is the, you know, that going to look like?

Obviously it worked out super well. For Apple. And if you're an investor, which we were, for investors in Apple and for customers. And so ideally, in this case, Jassy does a good job as a reminder, you know, Macy's is still involved. He's still the chair, and co-founder of Amazon. So it's not that he's not involved, at all.

But when you look at, you know, Jassy, he's been a few years in the seat. And so time will continue to tell. But things have been going well so far. And and again, it's not it's not three days. It's it's more like three years. But you know, it's still not the same as the founder. So we'll have to watch that closely.

But you're still going to give a seven or an eight I think on management now balance sheet we mentioned you know they've moved up 50%. Over the past few years. So that's a little bit of a concern. From a net cash position to a net debt position. So when you're talking about the balance sheet in 2020, you're you're, 84, 85 billion in cash and, you know, 100 billion in debt.

So your net cash, let's say $15 billion. And now, you know, fast forward you're at 89 billion in cash. And and and 

150 in debt. So in that position of debt of 60 billion. So that's not as comfortable. Interest coverage ratio is 11 times again Ebit over interest. So not alarming again. But that trajectory is really something to check out.

Why has over this period. And by the way this corresponds with when Jassy has taken over. Approximately why now go from a net cash to a net debt position. Now the the another part of that to consider is, but free cash flow has, has gone up considerably when you talk about 2020 was 25 billion and even dip negative in 21 and 22.

And now it's positive 48 close to 50. And June 30th. So that's the other side of that coin. So it's something to watch. But still give the balance sheet probably a six. Right now. Something to watch. Watch that trajectory. Where is that going? And then when we do price evaluation again, we talk about this is probably, a 6 or 7.

So we do because, you know, you're trading at 33 times forward in the market. Is that, 25 times the S&P 500. So again, business, I would say 8 or 9 management. You're talking seven eight. You know, price valuation, you're look at, you know maybe a six in the balance sheet probably a 6 or 7. So you know pick your aggregate score here.

So you're probably talking in the seven and a half eight category right now depending on how you weight each of those categories. But there is some things to watch for Amazon. You know. Can Jassy continue. The culture is something to continue to watch. He's been in charge for a few years. Let's check out what's happening with the balance sheet.

This is for our analysts, as we're owners of Amazon. And you know what it where do you think the business is going? You know, Amazon Web Services has been a juggernaut, for a long time. You know, can they continue to innovate. And really that's up to the management team. But overall a fantastic company. It's been a great portfolio company for us.

Well I'm sure many people will continue to use Amazon. But that's a wrap for this episode. We'll see you back on market news with Rodney Lake. Tune in then. Thank you.

Disclaimer the content shared. The GW Investment Institute podcast is for informational and educational purposes only, and should not be considered investment advice. The opinions expressed in this podcast are those of the host and guests, and do not necessarily reflect the views of the GW Investment Institute or the George Washington University. Listeners should not act upon the information provided without seeking professional advice from a qualified financial advisor.

Investing involves risks including the loss of principal. The GW Investment Institute. The George Washington University. And the podcast hosts. Do not assume any responsibility for any investment decisions made based on the content of this podcast. Always conduct your own research and consult with a financial advisor before making any investment decisions.