Can Stock Continue To Exceed Steep Expectations?

  • Amazon beat market expectations on revenue and EPS and upped Q3 guidance.
  • The upward YoY growth and the ongoing investments to increase business further is a positive indicator.
  • For the long run, I’m bullish on Amazon.

The tech giant, Inc. (NSDQ:AMZN) again reported blowout quarterly results last week amid a six-month-long bull market that drove a massive 60% rally in the stock price. The better-than-expected results fueled the phenomenal current positive sentiment in the market towards Amazon, supported by a solid buy rating from the sell-side firms with an average price target of $863 that reflects an additional 13% upside. Amazon approached these earnings when the market held impossibly high expectations from the company to keep the positive bottom line and continue topline growth and hike guidance.

The company has not only met the market expectations but also passed them impressively, and investors clearly love what they are seeing. After many years of net losses, the tech and e-commerce veteran reported its fifth consecutive quarterly net profit. Amazon reported impressive YoY growth in net sales (31%), AWS revenue (58%), and operating profit (177%) while keeping OpEx roughly flat compared to revenue. Amazon is investing great resources in improving its existing e-commerce business while it continually looks for new revenue streams, like the Fire products brand, Amazon Video original content, and Echo to name a few.

With all the balls Amazon throws into the air, to me, AWS remains the biggest success story of Amazon. The cloud business generated $2.8B in revenues, a 58% YoY growth, and continues the uptrend shown in the chart below from Amazon’s earnings slides. A fascinating point about the AWS business is that while it accounts for only 9% of the company’s total sales, it accounts for 55% of the operating profit. This is a trend that was first witnessed when Amazon started publishing AWS performance, and it shows the important role that AWS plays in Amazon’s growth and success.

AMZN_chart 11_080316

Even though AWS is a very significant portion of the company’s growth, Amazon is not leaving e-commerce activity behind and continues investing to expand the business by opening new fulfillment centers, opening Prime service for Indian customers, expanding its delivery service to include leased plans, and buying branded trucks to carry goods and also potentially lower shipping costs. The new fulfillment centers, vehicles, and plans are expected to prevent any capacity constraints as fulfillment capabilities continue to grow. The move into India was expected for a long time, and the company believes it could help boost international sales further, as it currently accounts for 32% of sales.

The second Prime Day was a great success, and according to CFO Olsavsky, it is one of the drivers of the increased Q3 top line guidance. However, operating income is expected to drop slightly in Q3 due to the ramp-up of the fulfillment centers and the seasonal trend of preparing for the holiday peak. Amazon is not only expanding Prime into India but also investing further to expand Prime Now (2-hour delivery) to more metropolitan centers around the world and to add 11 new metro areas to its current total of 27 worldwide. Other Prime services are also in focus as the company invests further in video content in order to have a broader offering and compete more successfully in the very competitive market of video streaming.

Besides progress in e-commerce, Prime services, and AWS, Amazon is slowly changing its devices and software strategy to revolve around Echo and support its ecosystem. The last Prime Day featured the biggest sale of devices including e-readers, tablets, Fire TV, and Echo, and Amazon announced many new partnerships that relate to Echo like Lyft, NBC, Honeywell, Kayak, and more. This is an interesting twist in the company’s devices strategy, following the failed Fire branded smartphones and tablets, to bring the success of Echo to the front stage.

The change in the devices strategy along with the investments in fulfillment services seems that the company is much more attentive to customers’ needs and desires, and it pays off big time. Also, I see a trend of decreasing dependency in AWS that accounted for 66% of Amazon’s operating profit in Q2 2015, and Q2 2016 accounted for only 55%. This is still a very high percentage. However, the fact that Amazon was able to increase operating income while decreasing AWS portion is a positive sign of a slow rebalancing in the right direction.

The progress Amazon presents in AWS, e-commerce, and Prime is pushing the company to seize opportunities driven by growth in demand for cloud and big data services, massive growth in online shopping and online content consumption, and premium local food delivery. The real impressive point is that it is expanding all of its business while delivering an expanding operating margin, increased FCF, and net income. I am bullish on Amazon and believe the company will grow further while seizing opportunities and not compromising on profitability.

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