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Manager insights: What's the upside in Amazon or Tesla?

Given how hard some stocks have rallied, is there still benefit in holding them?

The defining characteristic of the market recovery since the coronavirus crash has been how narrow it has been.

Across global markets, the majority of stocks are still in bear territory. Only a handful of counters have rebounded.

Most notably, the world’s largest listed company, Apple, has gained more than 70% since the market bottomed on 19 March. Put another way, it has added nearly $800bn in market capitalisation in a little over four months.

That is around 80% of the JSE’s entire market cap.

According to Bloomberg, Apple is now trading on an historic price-to-earnings (PE) multiple of around 32 times, and a price-to-sales of 6.8.

Based on long term market averages, those look a little stretched. They are, however, far from the numbers being displayed by two of the US market’s other high-flyers – Amazon and Tesla.

Amazon, the second-largest listed company in the world, is up 68% since 19 March. Bloomberg data shows the company now trading on a PE ratio of around 122 times, and a price-to-sales of 4.9.

These extraordinary figures are, however, far surpassed by Tesla. The electric car maker is up nearly 300% in the 19 weeks since the market bottomed. Bloomberg puts its price at over 600 times earnings, and 10 times sales.

Given these metrics, it’s not unreasonable to question how much upside there can be from here. If asset managers have been holding these two stocks, are they still holding them, and can they reasonably expect to make more money?

Citywire asked three asset managers – two holding Amazon and one holding Tesla – to explain their current thinking around these stocks and when the time would come to take profits. Their answers were fascinating.

Scroll through the slides to read their views.

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The defining characteristic of the market recovery since the coronavirus crash has been how narrow it has been.

Across global markets, the majority of stocks are still in bear territory. Only a handful of counters have rebounded.

Most notably, the world’s largest listed company, Apple, has gained more than 70% since the market bottomed on 19 March. Put another way, it has added nearly $800bn in market capitalisation in a little over four months.

That is around 80% of the JSE’s entire market cap.

According to Bloomberg, Apple is now trading on an historic price-to-earnings (PE) multiple of around 32 times, and a price-to-sales of 6.8.

Based on long term market averages, those look a little stretched. They are, however, far from the numbers being displayed by two of the US market’s other high-flyers – Amazon and Tesla.

Amazon, the second-largest listed company in the world, is up 68% since 19 March. Bloomberg data shows the company now trading on a PE ratio of around 122 times, and a price-to-sales of 4.9.

These extraordinary figures are, however, far surpassed by Tesla. The electric car maker is up nearly 300% in the 19 weeks since the market bottomed. Bloomberg puts its price at over 600 times earnings, and 10 times sales.

Given these metrics, it’s not unreasonable to question how much upside there can be from here. If asset managers have been holding these two stocks, are they still holding them, and can they reasonably expect to make more money?

Citywire asked three asset managers – two holding Amazon and one holding Tesla – to explain their current thinking around these stocks and when the time would come to take profits. Their answers were fascinating.

Scroll through the slides to read their views.

 

Citywire + rated Rory Spangenberg - Manager of the Northstar Global Flexible fund (holder of Amazon)

 

Following its gains this year, it is only natural for investors to be questioning the sustainability of the rally in Amazon’s share price. 

While it would not be altogether surprising to see some consolidation, given moderately elevated forward cash flow multiples, investors focused on the fundamentals behind these out-sized gains will be encouraged by the fact that they remain closely tied to the single most important driver of long-term value for Amazon: cash flow per share.  

Amazon, more than any other company we follow, has maintained an almost maniacal long-term disposition and focus on cash flow. As a mark of this commitment, CEO Jeff Bezos, includes a copy of his founding 1997 Shareholder Letter with each subsequent instalment, wherein he made the following defining statement: ‘When forced to choose between optimising the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.’ 

This statement goes to the heart of the debate on how to value a group of dominant companies for which internally-generated intangible assets have become the most significant economic driver. An increasingly outdated accounting framework, which requires that the overwhelming majority of the investment in these assets be expensed, has rendered income statements and balance sheets virtually useless, resulting in a systematic under-valuation of these assets. 

Certainly, investors who have weighed accounting over economics, fixating on a price earnings ratio which has remained stubbornly above 100 times for most of Amazon’s twenty-three years as a public company, have missed out. Underlying cash flow per share growth, meanwhile, has almost entirely explained the 37% annualised gain since listing, while the numbers over the past 10 years are almost identical. 

By avoiding a point estimate approach, we have been able to integrate bull and bear case scenarios into a probability-weighted valuation for Amazon, which we believe takes appropriate account of the opportunities and risks inherent in fast growing e-commerce and cloud computing markets, which it has come to dominate. 

While pretty fully valued at $3,000, we see upside in a scenario where Amazon builds market share more meaningfully in cloud computing, which may itself continue to enjoy greater penetration of enterprise software spend, while the dowsed scenario has waned somewhat with the likelihood of a Biden (vs Warren) presidency. 

 

Baillie Gifford (holders of Tesla)

 

Having initially invested in Tesla for our Long Term Global Growth portfolio in 2013, we berated ourselves a year later.

This may sound odd given that the share price had quadrupled in value during those 12 months. Instead, we were upset because we felt our initial blue sky scenario for Tesla’s operational progress had been strikingly feeble.

The best we could manage in our initial 10 Question Stock Research note was that Tesla could one day become a BMW, with sales of two million units per annum, at 10% margins, and potentially a market capitalisation of $45bn some 15 years later. Thanks to our increasing understanding of the company in the years that followed, including its market opportunity and its ability to execute, we recalibrated our probability-adjusted upside scenarios as our confidence grew. 

Looking to the future opportunity from now, it’s not overly heroic to imagine that Tesla could command a 10% to 15% share of global vehicle production per annum over the coming decade.

That might seem like a far stretch from its tiny share today (its 367,500 deliveries in 2019 accounted for roughly only 0.5% of the 75 million cars sold that year globally). Yet, on the other hand, it may be terribly feeble if we consider that Tesla already commands nearly 20% of the plug-in hybrids and fully electric vehicles (EV) market worldwide, and nearly 30% of the EV market alone.

With the global EV market growing exponentially and the impending decline of the internal combustion engine against a backdrop of climate change, Tesla is remarkably well positioned to take share of the global auto market in years ahead. Moreover, with vehicles becoming increasingly computers on wheels, might it not be possible that we see a few large key players emerge as we have seen in the smartphone market? 

Isn’t the traditional auto industry unusually fragmented and ripe for consolidation? To jog our memories, GM once had an over 50% US market share in the 1950s and its business model was far less differentiated than Tesla’s is now. Whichever way one looks at it, Tesla is a deeply immature business in a vast industry. 

So, in thinking about upside, a 10% to 15% market share in the coming decade could imply around 10 million vehicles. Assuming an average selling price of $50 000 at 15% operating margins, this gets to $75bn in operating profits. At a 20 times multiple, this gets us to well over a $1tn market capitalisation.

This scenario ascribes no value to the autonomous driving opportunity that could see Tesla’s margin profile transform to something akin to a software business. It also entirely omits the renewable energy solutions in terms of storage and solar.

Pushing the bounds further, Tesla talks of producing 2TWh of battery capacity in the long term. The 10 million vehicles scenario described above would account for just 0.6TWh, so are we being too conservative (as we were in 2013)?

We can of course slice and dice the numbers and arrive at many very different potential outcomes. But we think there is a growing probability that Tesla could be worth far more than 5 time more from here within a decade. As ever, the biggest long-term risk at a portfolio level is that of missed opportunity. 

 

Humaira Surve - Co-portfolio manager on the Coronation Global Equity Select feeder fund (holder of Amazon)

 

Every few decades within retail you have paradigm shifts, whether it was the growth of small-format grocery stores in the 1920s like the A&P stores or supermarkets in the 1950s. We are still in the early stages of the shift of retailing online. 

Global e-commerce penetration of retail is in the mid-teens. For context, in China, which is one of the more mature e-commerce markets globally, e-commerce penetration of retail is 27% and is still growing in the mid-teens. The secular shift has a long way to go. 

Amazon is the e-commerce leader outside of China, with a market share of about 22% and it has been steadily gaining more. That is the sign of a business which is well-positioned competitively. 

From the initial physical goods e-commerce base, Amazon has continued to start new businesses – be it a fast-growing advertising business where it earns high margin revenue from merchants, similar to Google, or Amazon Prime video and music where it serves consumers’ digital content needs.

With free delivery as a cornerstone, Amazon keeps adding services to Prime, adding more value for end consumers and more sticky revenue for Amazon. 

Amazon Web Services, the first cloud computing service globally, was invented to serve the e-commerce business’s computing needs and then opened to serve third parties. Cloud computing brings scale benefits to companies and is taking share of IT spend.

Like the growth of e-commerce, the shift of IT spend to the cloud still has a long way to go. We think the addressable market is under 20% penetrated. The current pandemic has accelerated companies’ plans for using technology to increase efficiency and reach customers and Amazon Web Services (AWS) will be a lead beneficiary as the leading cloud provider, globally. 

Stripping out AWS and the advertising business from the current market cap, Amazon’s retail business is trading at a little over 1.3x gross merchandise value (value of products sold on the platform). This is reasonable for arguably the best business in the world.

For context, Dollar General’s current price is 1.5x its sales and it will grow its revenue at less than a quarter the rate of Amazon next year. Amazon has a long-term oriented management team, a start-up culture and the resources of a giant, and we are convinced that more valuable businesses will be created in the future.

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Related Fund Managers

Rory Spangenberg
Rory Spangenberg Average Total Return:
70.19%
1/11 in Mixed Assets - Flexible USD (Performance over 3 years)
Humaira Surve
Humaira Surve Average Total Return:
9.5%
71/125 in Equity - Global (Performance over 3 months)
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