Amazon Earnings A Smash Hit: Cloud Brings Silver Lining Around Tepid Profits

  • What shocked analysts about Amazon’s second quarter report was its cloud revenues, which could top $7 billion this year.
  • North America sales also grew substantially for the company.
  • Expect a drift down from here as bears get back to work on its small profit.

Boy is my face red. I suggested recently that “short-term” investors might want to dump Amazon stock, before the Amazon (NASDAQ:AMZN) earnings release, figuring that even an earnings “beat” would send the stock down, as it sent down Apple (NASDAQ:AAPL) earlier in the week.

Well, I was wrong. Amazon shares skyrocketed after earnings, rising from $482 to over $565 in overnight trading, thanks to a profit of $92 million, 19 cents per share, on quarterly revenue of $23.18 billion.  Analysts had been predicting a loss of about 16 cents, and revenue of $22.44 billion.

So what happened?  The cloud happened.

Amazon was very early to the game of selling cloud capacity to other companies. It scaled and pushed prices to the floor, aiming to push competitors to the sidelines. This strategy has now succeeded, and how. Revenue for Amazon Web Services, which were first broken out just a quarter ago, came in at $1.82 billion, up from $1.57 billion during the last quarter, and $1 billion just a year ago.

While competitors like Microsoft (NASDAQ:MSFT) and IBM (NYSE:IBM) sent out press releases bragging about cloud profitability, mainly because they were bundling software and support services into their cloud revenue models, Amazon’s Infrastructure as a Service offering simply kept its prices fairly level and, as the low cost provider, grew like topsy.

North America sales were another highlight for Amazon. Sales in the U.S. and Canada were up 20%, to nearly $13.8 billion, against barely $11 billion a year ago. Profits more than doubled, from $329 million to $703 million. And none of this is counting the company’s “Prime Day,” which it announced for July 15, when like any conventional merchant it put discount prices on leftovers and remainders in its online store, creating an event it said rivaled “Black Friday” in terms of sales.

I made over $8,000 on all this action. I have 100 shares, acquired for my retirement account about a year ago at prices averaging $330/share. I watched as the Amazon stock price fell below $300 early this year, for the second time, even as self-appointed “experts” predicted the company was about to go broke because it tries to run at break-even, in order to maximize growth. I counseled patience, and was richly rewarded when the shares rose $8,000 in overnight action.

At that price Amazon now has a market cap of over $263 billion, against about $236 billion for Wal-Mart (NYSE:WMT), which is coming off a year of $486 billion in sales. And this is the problem for Amazon bulls. Let’s assume for a moment that Amazon reaches $100 billion in sales for the full year – it’s presently at about $46 billion so that’s reasonable. You’re still looking at a price-to-sales ratio of 2.44, which for a retailer is ridiculous. (WalMart books about $2 in sales for each $1 in market cap. So does Costco (NASDAQ:COST).) Amazon bulls are pricing the stock based on about 5 times its cloud sales, plus 2 times its Prime subscription revenue of about $46 billion, figuring that this creates both synergies with its store and a direct competitor to Netflix (NASDAQ:NFLX), which is selling at nearly 2.5 times trailing 12 months revenue.

Amazon price to sales ratio
Amazon price to sales ratio by Amigobulls

Maybe that’s right. The verdict of the market is always right, that’s what things are worth. But will Amazon hold that $565/share price through the coming quarter? My own guess is it will drift down slowly from here, given the fact that bears who have never believed a company that deliberately sets out to run at break-even in order to grow may possibly be a good investment.

But Amazon is.

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