Got a treat for you.
I’ve got you listed as a reader on the “A” list email club which means, I’m sending you extra value emails that I won’t be posting anywhere else or sending to the rest of the group.
Because you’ve shown that you appreciate my emails, I want to return the favor by giving you special goodies.
And here’s one.
An investment letter from Coho Capital. Jake Rosser is the managing partner but one heck of an investor.
His analysis is what helped me invest in Amerco (UHAL) and has been one of my big wins over the past couple of years.
This time, his latest letter is all about Amazon (AMZN).
And I must say, I’m ashamed.
Because I blindly convinced myself that Amazon is a great company but a BAD stock.
But I read The Everything Store a month back and it was one heck of a read. You learn about the company and Jeff Bezos in a way you never will from the media.
My wife also sells her products through Amazon so I am very well versed in the Amazon system and what they do. With Old School Value, I use Amazon Web Services so I also have first hand experience of the vast array of products.
Before you read the thesis, Jake uses a Munger quote very effectively.
“Over the long-term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold for that 40 years, you’re not going to make much different than a 6% return, even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.” – Charlie Munger
And after reading this letter, it’s made me want to buy Amazon at the right price.
Summary of the Letter
- Amazon holds a 41% share of online commerce. The next largest competitor is Best Buy with a 2.7% share. And yet despite its dominant position, Amazon continues to grow faster than the competition – capturing 60% of total US online sales growth in 2015.
This next image is a bit old, but it’s safe to say the margin has widened in 2016.
- With Amazon’s domestic infrastructure largely in place, we expect margins within the company’s e-commerce segment to inflect materially higher as operating leverage continues to ramp.
- Amazon Prime is a cornerstone of Amazon’s growth strategy as Prime customers tend to spend more and embed themselves more deeply within the Amazon eco-system. According to Consumer Intelligence Research Partners, Prime members spend $1,100 a year compared to $600 for non-prime customers. For long-term Prime members, the numbers are even more compelling with those using the service for 7-10 years spending 8-10x more than non-Prime members.
- Close to 50% of the units sold on Amazon are from third parties (3P). Third party sales comprise Amazon’s Marketplace business where Amazon serves as the storefront but participating merchants are responsible for shipping, logistics and inventory management. Margins on 3P are higher than Amazon’s regular e-commerce business with merchants paying Amazon a royalty of up to 15% on sales. Apart from higher margins, Amazon Marketplace serves as a natural on-ramp to Fulfillment by Amazon (detailed later).
- Last year, Amazon broke out financial metrics for its Amazon Web Services (AWS) business for the first time and the numbers were a revelation. AWS grew revenue 70% to $7.9B in 2015 and the division accounted for 83% of Amazon’s operating profit. This year AWS is on pace to surpass $10 billion in annual sales. If it were a stand-alone company, AWS would be the fastest to ever achieve $10 billion in revenue.
- Demand for FBA was so robust last year that Amazon incurred extra costs during last year’s holiday shopping season to rush-ship packages. In order to suppress demand, Amazon raised pricing on inventory storage fees by 213%. And this is what one comes to realize when studying Amazon: there is untapped pricing power everywhere.
- We believe Amazon is poised for a multi-decade period of excess economic returns. One can quibble with Amazon’s valuation on a 12-month basis but if one focuses on the long-term economic potential of its multiple platform businesses, future returns will send many toward happy retirements.
- At its core, Amazon is four operating segments with some of the most dominant moats in all of business. All four of these businesses are leveraged to multi-decade growth trends in cloud computing and e-commerce with reinvestment prospects as far as the eye can see. Each of these businesses possesses untapped pricing power, have sticky customer bases, and are poised for material margin expansion. To top it all off, the businesses are presided over by an owner-operator CEO focused on long-term free cash flow generation.
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