Sifting Amazon’s Cash Flow: Story Behind The Q4 Earnings Numbers (NASDAQ: AMZN)

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Amazon headquarters located in Silicon Valley

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This is the first article about Amazon.com Inc (AMZN) I’ve written for Seeking Alpha. I’ve owned AMZN shares for nearly a year now and remain constructive on the stock.

My reason for writing about Amazon is to attempt to add perspective to the most recent earnings release; specifically, full year operating income and cash flow results. Headline numbers appeared weak: pedestrian operating income growth and negative free cash flow. Nonetheless, upon examination, I did not find the situation alarming. I hope to outline my analysis in an easy-to-understand and straightforward manner.

Amazon Investment Thesis

Amazon is one of the great business stories of the 21st Century. To date, the corporate business model is nearly unassailable. Top-line revenue continues to increase rapidly, in spite of the company’s enormous span and scope. The balance sheet is sound.

Management identifies two key business metrics to be operating income and free cash flow growth. Currently, headline free cash flow is contracting, but upon closer examination, there are good reasons for it.

Currently, Amazon Web Services is the primary growth driver. This business unit appears to have a long runway ahead of it. The retail business is in a growth and transition phase; seeking to expand and cement its place as one of the world’s largest and most successful consumer discretionary retail operators.

2021 Results Were Noisy

My objective here is to boil down a noisy earnings report. I will try to separate the “significant few from the insignificant many.”

Let’s start by listing some 2021 headline highlights / lowlights:

  • Operating cash flow decreased 30% to $ 46.3 billion for the trailing twelve months versus $ 66.1 billion for full-year 2020

  • Free cash flow less principal repayments of finance leases and financing obligations swung to a negative outflow of $ 20.4 billion for the trailing twelve months

Amazon YoY free cash flow

Amazon 4Q 2021 earnings presentation

Amazon 2021 net sales

Amazon 4Q 2021 earnings presentation

Amazon 2021 operating income

Amazon 4Q 2021 earnings presentation

The headlines were mixed. Despite management’s focus on cash flow and operating income, we find free cash flow went negative, while operating income increased just 8.7 percent. Net sales rose.

Operating leverage was negative: net sales increased 22 percent, while operating income only advanced 9 percent. More revenue did not translate into more op income.

2021 net income blew out Street estimates, but this was largely due to an $ 11.8 pre-tax, non-operating gain on Amazon’s ownership in Rivian (RIVN) common stock. However, since the beginning of this year, Rivian stock has tumbled. It’s now trading below the price when it went public.

AWS (Amazon Web Services) was a bright spot. Revenue improved 37 percent, and operating margins followed suit.

What Mattered

Management focuses upon operating income and free cash flow growth. That’s a good place to start.

Operating Income

As noted earlier, year-over-year 2021 operating income rose, but the percentage improvement was far below the top-line net sales increase. That indicated negative operating leverage.

For their part, management did call out ~ $ 6 billion in 2021 inflationary pressures and Covid-19 productivity losses: about $ 2 billion in 3Q 2021 and another $ 4 billion in the fourth quarter. Without these pressures, year-over-year operating income would have improved 35 percent, thereby lapping YoY sales increases and resulting in positive operating leverage.

Cost pressures are expected to continue into 1Q 2022. However, my expectation is these are transient. Over time, labor disruptions will work itself out. Amazon is a wide-moat business and has enough pricing power to eventually pass on inflation.

For example, effective February 2022, the annual Amazon Prime Membership fee will increase from $ 119 to $ 139. It’s the first increase since 2018. I do not believe the company will lose many Members over the increase. On the current 200-million-member base, that’s ~ $ 4 billion additional revenue. However, Prime continues to grow membership. In addition, the $ 20 increase is for those with annual subscriptions. Members paying monthly will see a $ 180 annualized fee.

Cash Flow

I contend the real story is free cash flow.

Amazon management points out they consider repayments of finance leases and financing obligations to be to be integral to the business and therefore integral to cash flow. When combined with the standard free cash flow definition (operating cash flow less capex), it makes the negative free cash flow situation look even worse:

Amazon FCF breakdown

Amazon 4Q 2021 earnings presentation

But there’s more to the story.

For certain industries / companies, it pays to take a deeper dive into cash flows. For Amazon, I attempted to do so through by examining modified “Delivered Free Cash Flow.”

Here’s a general definition:

Levered free cash flow is how much capital a business has after you’ve accounted for net short and long-term financial bonds. Levered free cash flow represents the money available to investors, company management, and investments back into the business.

Levered Free Cash Flow may be expressed several different ways. I elect to use the following formula:

Operating Cash Flow ex Working Capital, minus capex, and net debt / lease financing activities

The data to populate the formula may all be found on the Statement of Cash Flows.

Additional detail:

  • To determine not Working CapitalI utilize delta Inventories, Accounts Receivable, and Accounts Payable.

  • I do not attempt to break out / apportion growth capital versus maintenance capital

  • Only debt / lease financing activities include net proceeds / repayments of short and long-term debt, plus principal repayments of finance leases and financial bonds

Note to Readers: in the comment section, I welcome your views about utilizing / calculating LFCF.

Let’s Cut to The Chase – Levered Free Cash Flow

For the last three years, the following table records Amazon’s LFCF.

Amazon Levered Free Cash Flow – 2019 to 2021 ($ B)

2021

2020

2019

Operating Cash Flow

46.3

66.1

38.5

x Working Capital

24.1

-6.5

-2.8

OCF Ex WC

70.4

59.6

35.7

Capex

-61.1

-40.1

-16.9

Net Financial Activities

6.2

-0.95

-10.1

Levered FCF

15.5

18.6

8.7

Upon examination, we find 2021 headline operating cash flow tumbled. Subtracting capex from OCF likewise yields an even less appealing 2021 FCF result.

However, drilling a bit deeper, we find last years’ working capital movement had a material effect on cash flow. In 2021, Amazon consumed significant cash as a result of building $ 9.5 billion inventory. In addition, receivables increased by $ 18.1 billion.

After accounting for movement in working capital, 2021 cash flow actually increased versus a year earlier. Notably, both 2020 and 2021 indicate large cash flow increases versus pre-pandemic 2019 figures.

Amazon management also initiated a material ramp-up in 2021 capital spending. The company spent more than three times the capital than it did in 2019. Most of this capex is being directed towards corporate growth.

On the 4Q 2021 conference call, management explained how capex is being apportioned. CFO Brian Olsavsky remarked:

So, when you look at those numbers and how they’ve grown over the last few years, I’ll give you the proportions, which I’m not sure we’ve initially shown before, is [that] about 40% – just under 40% of that CapEx is going into infrastructure, most of its feeding AWS, but also certainly, Amazon is a large customer of that as well as we build and structure for ourselves directly or through AWS.

About just under 30% is fulfillment capacity building warehouses – warehouse only, not transportation. And then just under 25% is transportation capacity and building out our AMZL network, principally globally. The remaining 5% or so is small things like offices and stores and other capital areas. But those are the three main areas.

Mr. Olsavsky went on to explain that capital expenditures and finance leases were going to increase in 2022.

Amazon management has elected to grow the AWS business aggressively while concurrently cementing the retail operation’s dominance. The capex figures on the preceding chart bear this out. Furthermore (and importantly) the growth initiative is consuming significant working capital. However, once the business settles out, delta working capital may be expected to stabilize along with it.

A Brief Balance Sheet Check

Our cash flow review is best supplemented by checking the balance sheet. Given the foregoing discussion, let’s look at three specific items:

  • Are debt metrics a reason for concern?

  • Is management building shareholder equity (thereby creating shareholder value)?

  • Is the business consuming balance sheet cash unduly?

Net Debt to Equity

There are a variety of ways to monitor corporate debt. In this case, I elected to use net debt to equity. It’s straightforward and easy to calculate. Here’s the three-year results:

2021 ND2E – 15%

2020 ND2E – 0%

2019 ND2E – 13%

There is nothing alarming about these figures; neither the trajectory nor the absolute.

Shareholder Equity Build

Over the past three years, here’s Amazon’s year-end total shareholder equity:

2021 Total Equity – $ 138 billion

2020 Total Equity – $ 93 billion

2019 Total Equity – $ 62 billion

Since year-end 2019, management has more than doubled total stockholder equity. This has not come via acquisitions and the generation of goodwill or intangible assets. Goodwill is only about 10 percent of Amazon’s total equity. Meanwhile, total diluted shares outstanding only inched up.

Nothing to worry about here.

Balance Sheet Cash

Please find the lowdown on year-end balance sheet cash and marketable investments:

2021 Cash on Hand – $ 96 billion

2020 Cash on Hand – $ 84 billion

2019 Cash on Hand – $ 55 billion

Clearly, there’s no problem here; other than questioning management’s plan for all that excess cash. The 2021 $ 96 billion total reflects about 6 percent of the share price.

Conclusion

The Amazon investment thesis remains intact.

Revenues are growing smartly.

Operating income is growing, though the company is facing near-term inflationary pressure and labor disruptions. Management has qualified the figures, and over time these issues are likely to pass.

2021 headline cash flow numbers look bad; however, when parsed for aggressive organic investment, the edge comes off. Aggressive growth in the AWS segment requires significant capital. Meanwhile, management is hardening the retail business. Senior leadership is laying up for the future.

Historically large capex expenditures and working capital requirements are consuming cash flows.

Meanwhile, the balance sheet remains healthy. Indeed, the strong stockholder equity build evidence management is creating significant shareholder value. This is not being accomplished through acquisitive activity and goodwill, nor depleting balance sheet cash and marketable investments. The growth is organic.

Using 2023 estimates, at 3.5x sales or 20x operating cash flow, I believe the current Fair Value Estimate for AMZN shares is ~ $ 4300. That’s a one-third move higher from today ‘$ 3158 close.

Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2022 investments.



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