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Amazon Will Join the Trillion Dollar Club

Mark R. Hake

Amazon’s (NASDAQ:AMZN) market value is likely to climb over $1 trillion within the next two quarters. Right now, AMZN stock is worth $886 billion. That’s down 7.7% from late July when it announced its second quarter results, but impressive nonetheless. In fact, Amazon is making so much free cash flow that it will easily reach a trillion-dollar valuation.

On July 26 Amazon reported that its last 12 months free cash flow (FCF) was $25 billion. AZMN presented an amazing slide — its FCF had skyrocketed 140% year-over-year:

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Over the last year, AMZN stock price and its market value has stayed flat, down 0.1%. This is very interesting. First consider the fact that in the prior 12 months to June 2018 AMZN’s free cash was up only 9%. Here is the presentation AMZN gave a year ago:

But the interesting thing is that for the year prior to July 2018 when AMZN reported these mediocre figures, the stock rose 86% from Aug. 16, 2017 to Aug. 16, 2018.

Do you get it? The market anticipated the gigantic increase in FCF up to two years ahead. In effect, during the year between June 30, 2017, and June 30, 2018, the stock rose because investors anticipated the massive increase in FCF for the year ending June 30, 2019.

AMZN investors who saw the mediocre 9% increase in FCF were not looking at that small increase. They accurately saw FCF rise up to two years ahead. They starting pushing up Amazon stock, which rose 86% in the year ending June 30, 2018.

What Does That Mean Going Forward?

First, AMZN has been accelerating its free cash increases. This can be seen in this chart taken from Amazon’s quarterly presentation:

This chart shows AMZN has grown its annual free cash flow over the past six quarters. The growth rate has slowed slightly this past quarter, but the level of FCF is still very high. Investors can likely expect AMZN’s annual FCF to continue to grow, albeit at a slower pace.

Projecting AMZN’s Free Cash Flow

Fortunately, AMZN provided some guidance about its upcoming Q3 results, which we can use to forecast its FCF.

Based on this guidance we can a simple forecast for the next year, given that the correlations between AMZN’s sales gains, free cash flow and net cash increases. For example, AMZN has done a good job of converting its sales into free cash flow at a ratio of about 39% a year.

Using that ratio, the table below forecasts the free cash flow in one year will be $29.7 billion.

Estimates based on company guidance for Q3 and historical conversion ratio

Why Does This Matter?

Historically AMZN has converted about 20% of its free cash into higher cash balances on its books. That means AMZN’s net cash balance (after all debt) will more than double from $18 billion to over $42 billion:

Estimates based on historical relationship between FCF and increases in Net Cash

For example, at the end of Q2 2019, AMZN had $22.62 billion in cash, $18.85 in marketable securities, or total cash and securities of $41.47 billion. After deducting $23.2 in long term debt, its net cash and securities position was $18.22 billion.

Our forecast shows that in one year AMZN could have increased its cash and securities position by $24.4 billion to $65.9 billion (before deducting long-term debt). This assumes that AMZN does not make a major acquisition.

The market is going to notice this for three reasons. First, it will lead analysts to expect AMZN will eventually hit $100 billion in cash and securities sometime in the near future.

Second, if the market anticipates that AMZN will reach $66 billion in cash securities the stock will tend to rise. The market will likely start to compare AMZN’s cash position to Apple (NASDAQ:AAPL). Nine months ago AAPL had $66 billion in cash and securities and about a $1 trillion market cap. Now it has a $95 billion in cash and securities and a $1.4 trillion market value.

Third, if cash and securities hits $66 billion within a year, expectations will grow that AMZN will start to either pay a dividend or begin buying back shares, both of which Apple is doing. Or AMZN could do something very large, like a major acquisition, a special dividend, or some use of its higher cash and securities that directly benefits shareholders.

In any case, having over $66 billion in cash will almost certainly push the AMZN stock price much higher, well above the trillion dollar mark.

The AMZN stock price equivalent at $1 trillion is $2,021.61, or 11 % higher. I have shown that this seems very likely given AMZN’s huge free cash flow generation.

Bottom Line on Amazon Stock

All in all, expect AMZN to continue to show growth in free cash flow, which really seems to be what is driving the stock on a fundamental basis. Expect AMZN to hit $1 trillion sometime before the end of this year or in Q1 2020, as its free cash flow and net cash balances increase.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities.

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