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Amazon 3Q18 results: A changing growth story

Amazon reported 3Q18 results on Thursday (25 October), which saw the firm beat Refinitiv consensus earnings estimates, but its revenue and 4Q18 outlook disappointed the market. EPS came in at $5.75 – materially above the Refinitiv consensus forecast of $3.14. Revenue of $56.6bn rose c. 29% YoY and was ahead of company guidance of $55.75bn but below the $57.1bn Refinitiv consensus forecasts had expected. Operating profit grew 974% YoY to $3.7bn, far-exceeding consensus estimates of $2.1bn and largely driven by growth of Amazon’s high-margin businesses, including its cloud, advertising and third-party seller services. The firm also gave fourth-quarter revenue guidance (which includes the US holiday shopping season running from Thanksgiving in late November through New Year’s) in the range of $66.5bn and $72.5bn (up between 10%-20% YoY) – below consensus expectations of $73.79 bn.

In terms of segments, North American revenue rose 35% YoY, while the operating profit margin stood at 5.9% and operating profit rocketed 1,700% YoY. Meanwhile, the International business recorded a revenue rise of 13% YoY, while the operating margin came in at -2.5% (vs -5.1% in 3Q17) and the operating loss reduced from -$919mn to -$385mn – an improvement of $534mn YoY. Amazon Web Services (AWS) revenue came in at $6.68bn (+46% YoY) slightly missing the $6.71bn FactSet estimate, while the operating margin stood at 31.1% and operating growth rose 75% (on a constant currency basis). Amazon’s “other” category, mostly comprised of its burgeoning advertising business, jumped 123% YoY to $2.5bn in revenue, or a $10bn run rate – one quarter is the size of third-party services already. Breaking down Amazon’s 3Q18 revenue, we note that its online stores revenue grew by 11% YoY, while third-party services (including commissions, fulfillment and shipping fees, other services) were up 32% YoY. Subscription services (including Prime, audiobook, video, e-book, music, non-AWS subscription and should also include Twitch) jumped by 52% YoY.

Our key takeaways:

1. In our view, the Amazon story is changing, but the market narrative is not yet reflecting that change.

2. We believe that Amazon is moving from a revenue growth story to a profit growth story.

3. There are three main drivers of the change:

Faster growth in high-margin segments, such as AWS (cloud), subscription services, and advertising.

Faster growth in its Marketplace business (where Amazon sells on behalf of third-parties) vs Amazon’s own products. The difference here is largely due to accounting: When Amazon sells (say) Amazon batteries, it records $100 worth of revenue. Let’s say the costs all add up to $90. Amazon will make $10 of profit on the sale. When Amazon sells Duracell batteries, Amazon will earn, for example, $10 of commission, and there won’t be other costs. As Amazon moves from first-party sales to third-party sales, it looks like revenue is falling 90%. However, that is the wrong way to look at it –profit remains the same. If anything, Marketplace is a better business as Amazon doesn’t have its own cash tied up in inventory, and it can charge sellers for storage and logistics.

After years of investments in people and infrastructure, Amazon is now starting to reap material efficiency gains. Operating leverage is driving profitability higher.

4. Amazon will continue to invest aggressively in future projects, but we’ve reached an inflection point, where Amazon’s ability to generate profit will exceed its ability to reinvest in the business.

Amazon’s share price fell c. 8% on the day following its earnings release – predominantly on the back of weaker-than-expected 4Q18 revenue guidance. We’ve made the argument that revenue is less important going forward; nevertheless, on the conference call the company used the following phrases to describe their guidance: “Very high error bars on the quarter”, “It’s always a difficult period for us to estimate” and “We’ll continue to give revenue guidance…to an appropriately conservative level.”

Amazon is arguably the most dominant growth company in the world and we view the current pullback (the share price is down c. 14% since Thursday’s close to Tuesday [30 October]) as a buying opportunity.



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