- AWS dominates its market and saw huge growth in operating profit in Q4.
- Third party sellers flocked to Amazon's platform in the fourth quarter. The present logistics problem is temporary.
- Amazon will favor suppliers that give them rock bottom prices. They are "tied" to nobody which should make its platform a real buyers market going forward.
Amazon stock tanked by 14% after the company reported an earnings miss for its fourth quarter of 2015. Amazon (NASDAQ:AMZN) actually achieved its own guidance despite missing estimates on both its top and bottom lines. Amazon's revenues stormed to $35.75 billion and net income came in at $482 million. However with a growth company like Amazon, the main metrics astute investors look at are operating income, gross margin and free cash flow. So much capital is being invested back into this company that the bottom line is immaterial in a sense at the moment.
Nevertheless, Amazon announced diluted earnings per share of $1 which was well below the consensus of $1.61. Analysts are projecting $129.73 billion of revenues in 2016 and a further $154.85 billion in 2017 which is a slightly slower top line growth rate than previous years. However gross margin levels ended up at 33% which was a full 3.5% higher than margin levels in 2014. Furthermore operating income ballooned to $2.23 billion in 2015 which means if the company keeps these growth rates going, it will only be a matter of time before margin growth drops to the bottom line. Here are three areas where I see margins increasing even more.
Firstly Amazon Web Services (AWS) was the star performer of the fourth quarter with revenues growing 69% to $2.4 billion. However what really would have caught investors attention was the division's operating profits which almost tripled to $687 million. The chart below shows how robustly this division is growing compared to media and electronics and this is the area where Wall-Street is pricing in a lot of future growth.
Therefore with Amazon stock trading at $536 a share, don't expect the 20%+ decline in the stock price to continue in 2016 if we continue to see these big leaps in the quarterly year on year profits. Can it continue? Well, investments such as Amazon Aurora & Quick-sight should improve performance and efficiency but essentially I believe Amazon will grow its cloud service because of the following. Firstly the public cloud service market is projected to grow by an annual growth rate of 23% over the next few years which means it won't be far from being a $200 billion market by 2020 (it was recorded at being at $56 billion in 2014).
Furthermore, who do you think is going to pick up the majority of this business? Amazon is the major company in his space as its cloud offerings contain over 400% more computing capacity than its 10 biggest competitors combined. The company currently has a market share of 29% in cloud services and this has to be an advantage when it comes to scale and margins going forward. Why? Well in the last quarter, management noted that costs were slowly being driven out of the process through new designs and inventions. The bigger the division becomes, the more efficient I see these designs going forward.
Efficiency will ultimately move into the company's logistics divisions also. It's a necessity as fulfillment costs rose 33% last quarter primarily as a result of a spike in third party sellers doing business on the platform. This is an excellent problem to have and one you can bet Amazon is working around the clock to resolve as soon as possible. Why? Well, third party sales offer far higher margins than regular Amazon product sales as the company merely takes a commission from the respective third party just for the use of its platform.
Logistics is a separate issue and one that is temporary. Whether Amazon charges more to the third parties for the use of its logistics or it reduces its own costs (I believe it will do both over time), I still can only see margin expansion here. Moreover, the trend is very much with the tech company. Third parties sold 47% of all goods shipped last quarter which was up substantially from 43% a year earlier.
Also, 50% of these products availed of fulfillment by Amazon which was up from 40% a year earlier. Therefore to make these income streams as profitable as possible, expect elevated investment in logistics going forward. Again watch operating income instead of net income in the forthcoming quarters as this will give you a better gauge of how the business is progressing
Thirdly Amazon's revenue grew robustly in the great recession and the larger the company's revenues become, the more clout Amazon will have with its suppliers. This is an area that many analysts don't delve into but I think it warrants attention especially given the general low margins in the retail sector.
For example, Walmart (NYSE:WMT) trailing twelve month revenue number is $484 billion which is still over 4 times Amazon's current revenue. Any improvements on supplier's prices would have a big effect on Amazon's margins and the higher revenues go, the more clout Amazon will have. Having so many suppliers has to be an advantage also in that Amazon can play them as they choose. Almost half of US households now have Amazon prime where the average spend per year is around $1,000. Many of the items bought are recurring which means over time, higher volumes will to lead to lower prices. Then offline retailers will really be in trouble.
To sum up, the market may have taken Amazon's fourth quarter earnings as disappointing but there are many bright spots which will keep growth investors interested. Firstly you have the AWS division which almost trebled its profits in 12 months. Then you have third party sales increasing exponentially and once Amazon sorts its logistics problem, costs will come down a lot. Finally, you have the revenue growth which analysts believe will stay above 20% a year through 2017. Prices will come down even more as Amazon will favor suppliers with better terms.