The Long and Short
Amazon debt looks attractive to retail, tech peers
Meredith Contente | February 4, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
With Amazon.com Inc. (AMZN – A1/AA/AA-) straddling both the retail and technology sectors, it’s appropriate to compare AMZN bonds to both ‘A’ and ‘AA’ retail and technology peers.
The company’s cash position provides significant financial flexibility should it want to invest further in the business, pursue mergers and acquisitions, or even pay down debt. Amazon’s net cash position currently stands at $47 billion, and is likely to grow further given its strong cash flow and the fact that the company does not pay a dividend or repurchase shares. That flexibility results in less concern for AMZN than peer Home Depot (HD – A2/A/A) in a rising rate environment; and their long-end bonds look relatively cheap.
In the long-end, AMZN 4.25% 2057 and AMZN 3.25% 2061 bonds actually trade wide to HD 3.5% 2056 bonds (Exhibit 1). While there is roughly a 14-point dollar price differential between the AMZN 4.25% 2057 bonds and the HD bonds, that differential should not be a factor given AMZN’s sizeable cash position relative to HD’s. Furthermore, in the 10-year part of the curve, the trading relationship is reversed, with AMZN trading roughly 8 bp through HD. We view both aforementioned AMZN bonds as attractive for investors looking for yield in higher quality credits.
Exhibit 1. AA/A Technology and Retail 30yr+ Bonds
Cash is King
While AMZN posted strong full year results with solid growth in operating income, it was the balance sheet improvement that was really impressive. AMZN ended the year with cash and equivalents of $96 billion, which we note was up from $84 billion in the year ago period. AMZN is on track to exceed $100 billion of cash and equivalents in 2022, joining the ranks of technology giants including MSFT, AAPL and GOOGL. For comparison purposes, we note that HD’s cash position stood at just over $5 billion at the end of 3Q. To further drive our point on how large AMZN’s cash position is, if both AMZN and HD were to cease generating free cash flow, AMZN could repay all of its debt and still have over $40 billion of cash left, while HD’s cash position would only be enough to repay debt maturities through 2024. That said, refinancing risk due to higher rates is less of a concern for AMZN than HD.
Margins Have Come a Long Way
As recently as four years ago, AMZN’s EBITDA margin was in the single-digit category as the company was focused on making long-term investments in the business, including the Prime service and the grocery business. We note that AMZN ended fiscal 2017 with an EBITDA margin of 8.8%, which was well below margins of other retailers. For the same time period, we note that HD’s EBITDA margin was nearly double that of AMZN at 16.6%. Fast forward to 2021, AMZN’s EBITDA margin was 13.7% with HD’s margin for the year estimated to be roughly 17.1%. Street estimates put AMZN’s EBITDA margin ahead of HD’s by fiscal 2024. In fact, AMZN is expected to achieve EBITDA margins of 20% by fiscal 2025.
Exhibit 2. AMZN vs. HD EBITDA Margin Comparison (2015-2025E)
While AMZN’s recently announced annual increase in its Prime membership (from $119 to $139) should help to offset inflation (including increased energy and transportation expenses), it is the company’s Web Services (AWS) business that is really driving margins. AWS witnessed robust revenue growth in the quarter of 40% and is now a $71 billion annualized run rate business (up from $51 billion). AWS’ operating margin is now roughly 30% and is expected to trend higher as growth in higher margin Platform-as-a-Service becomes a larger piece of the AWS revenue pie. AWS has had some major contract wins including Nasdaq, Meta and Best Buy to name few.
Ratings Could Trend Higher
AMZN witnessed an upgrade by all three ratings agencies in 2021, reflecting its strong operating performance. We note that Moody’s is the only agency that still rates the company in the single-A category. While Moody’s maintains a stable outlook on the rating, it did note that it would consider an upgrade if AMZN’s investments continue to generate good profitability and retained cash flow/debt is maintained around the 65% area. Given the continued growth in both cash on hand and net cash, coupled with management’s conservative financial policies with respect to shareholder remuneration, Moody’s may need to reconsider its current A1 rating. Additionally, further robust growth in the AWS segment, leading to a higher overall margin profile, should support an upgrade.
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