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Amazon: Revenue accelerates, while growth investments weigh on 2Q19 profits

29 July 2019

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by Nick Dennis, Anchor Global Equity Fund

Amazon reported 2Q19 results on Thursday (25 July), with earnings coming in below expectations at $5.22/share vs the Refinitiv consensus estimate of $5.57/share, while sales rose 20% YoY (c. 21% YoY in constant currency terms) to $63.4bn vs a $62.5bn Refinitiv estimate. Its North American sales were up 20% YoY, while International sales rose by 17% YoY (in constant currency terms) and Amazon Web Services (AWS), which remains its most profitable segment, saw revenue jump 37% YoY to $8.4bn.

Amazon’s operating profit (OP) advanced 3.3% YoY, with an operating margin (OPM) of 4.9% – down from 5.6% in 2018 and 7.4% in 1Q19. By segment, North America’s OPM came in at 4.0% (vs 5.7% in 2Q18), with International OPM of -3.7% (vs -3.4% in 2Q18). AWS OP growth was 29% with an OPM of 25.3% (vs 26.9% in 2Q18).

Online stores (first party) sales rose 14% YoY (up 16% YoY in constant currency terms) and accelerated sequentially for the first time in a while. Third-party sellers’ sales increased by 25% YoY (also accelerating sequentially). Physical stores, however, reported only a 1% YoY rise in sales and we question whether these are working? Subscription services’ (including Amazon Prime, kindle, video, music, Twitch etc.) revenue jumped 39% YoY. The Other segment (mostly advertising) revenue was up 37% YoY – sequential acceleration occurred, but we note that it was bumping up against a bigger base and also an accounting change.

There was a significant acceleration in paid unit volumes (+18% vs +10% in 1Q19), accompanied by a spike in shipping costs which rose 36% YoY and by $814mn QoQ – in line with previous guidance. Marketing expenses grew 48% YoY because of adding to the AWS sales and marketing teams and adding more advertising as Amazon rolls out more devices and Prime Video (particularly internationally). In addition, 2Q19 saw higher stock-based compensation. Marketplace sellers now account for 54% of unit volumes, while the employee count grew 13% YoY (the technical headcount grew twice as fast). Big investments were made in AWS, devices, and video. Amazon also stepped up investments in infrastructure, including leases. In the quarter, Amazon’s invested $800mn in improving its delivery speed and increased regulatory scrutiny into its business practices.

Our key takeaways from these results are:

  • We believe that Amazon is entering a period of accelerating revenue growth and decelerating profit growth. This was the potential scenario outlined last quarter and is the inverse of the trend of the preceding few quarters.
  • As an imperfect analogy, think of a river flowing into a dam. The dam represents Amazon’s future profit potential. The river represents investments – in whatever form: data centres, warehouses, engineering staff, marketing etc. The investments accumulate over time, building up latent revenue and profit potential. Once the dam is full, the sluice gates open and profits coming gushing out. After allowing for profits to explode for several quarters, Amazon is aggressively reinvesting those profits back into the business to grow its future profit potential.
  • Post results, the market seems to be focusing more on the depressing impact these investments have on profitability. However, in our view, this is not a concern.

 

 

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