- Amazon.com,Inc. stock has outperformed the broader markets, up 60% from its Feb 2016 lows.
- What are the key trends driving the stock higher?
- Are these trends sustainable? Will Amazon.com stock continue to trend higher?
Amazon.com, Inc. (NASDAQ:AMZN) stock has been on a bull run, gaining over 40% in the last one year and over 11% year-to-date. This compares against a 2.3% YTD gain in the Nasdaq Composite (INDX:COMPX). Amazon has many things going for it, but the key trends driving the stock higher can be boiled down to the following.
Amazon Web Services Growth
Amazon Web Services (AWS) revenue has been growing rapidly. The segment's revenues have grown from an annualized run rate of $4.2B in Q1 2014 to $11.5B in Q2 2016, which equates to a 22% QoQ growth. While that has been the past, can the company continue its run in the cloud space?
AWS is operating in a market which is expected to grow rapidly over the next few years. As per an IDC report quoted by Forbes, Worldwide spending on public cloud services will grow at a 19.4% compound annual growth rate (CAGR) from nearly $70B in 2015 to more than $141B in 2019. IaaS, the segment from which AWS generates most of its income will do even better with a 27% CAGR up to 2019.
The string of YoY growth rates reported by Amazon over the last 6 quarters (since it started to disclose cloud segment performance) read 49%, 81%, 78%, 69%, 64% and 58% from Q1 2015 to Q2 2016, respectively. While it appears logical that the growth rate will continue to slow as the base becomes larger, AWS is outgrowing competitors in dollar terms.
With the AWS segment riding a secular trend, the fundamental story for the segment looks good for the long-term. The segment should continue to contribute a larger share to Amazon's top line for the foreseeable future.
Amazon 3rd Party Sales
Another key trend powering Amazon ahead has been the gradual shift from first-party sales to third party sales in its retail operations. The share of third party units to total paid units sold came in at 49% in Q2 2016, up from 40% in Q2 2013.
The bright side of this is again the positive impact this shift is having on Amazon's profitability. It is no secret that Amazon's third-party sales are far more profitable to the e-tailer than first party sales.
Amazon profitability has taken a turn for the good.
One of the arguments often put forth by Amazon bears has been the lack of a stable bottom line. However, this seems to have changed with the AWS segment operating at margins above the expectations of most analysts and Amazon's retail operations shifting their sales mix to include more third-party units.
The operating margins of the AWS segment have only gotten better, climbing from 12% (adjusted for stock compensation) in Q1 2015 to 25% in Q2 2016. To put things in context, consider this: AWS contributed 9.5% to Amazon's top line while contributing 55% of operating income in Q2 2016.
Apart from the contribution to Amazon's top line, the rapid growth of AWS has also had a positive impact on Amazon's profit margins, something which was always a sore spot for the company.
Also, Amazon's retail operations in North America have steadily increased their operating margins. Operating income grew 102% YoY in Q2 2016, coming in at $702 million. On the international front, Amazon has cut losses steadily. It shouldn't be long before the scale of operations begins to drive operational profitability in international operations.
Amazon has several key trends powering it ahead. The growth of AWS is adding to top line growth, while also significantly driving profitability. The shift of sales to third party units has also contributed to an improved margin profile for the retail operations. The result: Amazon has reported 5 straight quarters of being profitable, at the net level. Put this in contrast with the fact that Amazon has had a history of being in the red, and you know why Amazon stock is rising higher. With these underlying trends continuing over the coming quarters, it will be no surprise if Amazon continues to improve its earnings, which could drive the stock higher and help to sustain its current valuations.