Amazon Earnings Preview: Web and Prime Services to Drive Growth

Amazon (NASDAQ:AMZN) will release its Q2 2014 earnings on July 24. The stock has recovered slightly in the last two months, which may be indicative of expectations among investors ahead of the second quarter earnings. We expect strong growth in electronics and general merchandise segment to continue, whereas the media segment will remain relatively slow. Additionally, web services will post stellar growth driven by new product launches and continued adoption of existing products among clients. Amazon’s broader story will be that of a company wanting to dominate everything, which implies that top line growth will continue to remain a priority for now. Let’s take a more detailed look at what to expect from Amazon’s upcoming earnings announcement.

Our price estimate for Amazon stands for $341, implying a discount of 5% to the market price.

See our complete analysis for Amazon

Strong Growth in Electronics and General Merchandise to Continue

We expect another strong quarter with Amazon growing its revenues by more than, or at least close to, 20%. The retailer saw its sales jump by 23% in Q1 2014, which was closer to the high end of its guidance. This has been the pattern for the last few quarters as the company continues to leverage its size, strong vendor network and technological advantage to expand its presence both in the U.S. and international markets. The flipside is that higher spending and investments are likely to push the retailer’s margins down in the near term. Amazon’s EBITDA margins deserve a special attention as the improvement in this metric has been instrumental in fueling positive investor sentiment in recent years. The fact that the figure is just around 7% implies that the stock is extremely sensitive to any change in its value, which puts Amazon at risk should the profits on its merchandise and services fluctuate.

While Amazon’s domestic business is doing well, the company could do better internationally. The international operations picked up in the first quarter of 2014, barring the media segment. While the electronics and general merchandise business is growing at a rate of more than 25%, media segment’s growth hasn’t been exactly stellar. Amazon’s media sales in the U.S. increased by a little more than 12%, whereas the figure for international markets stood below 5% in Q1 2014. Even though there is a clear shift to digital products in the media segment, the lack of local content continues to be the major hindrance.

Web Services to Benefit from Continued Product Launches and Small/Medium Enterprise Focus

Amazon’s web services business just keeps getting bigger, and will play an integral role in improving the company’s overall profitability going forward. It enables cloud storage and computing for corporate and small businesses, thus creating an infrastructure to drive more data on the Internet. This fits into Amazon’s intent of enabling the online shift of businesses and consumers, which will help further its interests.

It is because of the growing contribution of this business that Amazon’s EBITDA margins have seen a slight increase in the past two years. The company launched a bunch of products to strengthen this segment during the second quarter of 2014. It introduced an SSD-backed storage service that saves money for customers without sacrificing on speed. The service is aimed at personal users and small/medium sized enterprises. While targeting large enterprises is important, there is a huge opportunity for Amazon to expand its cloud storage and computing business by going for smaller companies which tend to be more flexible. The retailer launched two more new products including new capability for mobile developers. In Q1 2014, Amazon’s ‘Other’ segment revenues jumped by 58%. Most of the sales from this reported segment can be attributed to Amazon’s web services.

Amazon Prime Would Have Gotten Stronger

We expect Amazon Prime service to have continued to add new subscribers despite the price hike that the company announced earlier this year. The price elasticity is low, which suggests that there may be more room for price increases. This holds true for Amazon’s core business too, as many of the studies conducted by the company show that the price elasticity for its products is low. Despite this, it hasn’t resorted to price increases across its general merchandise and media segments. Amazon Prime service is getting a boost from improved streaming content and the benefits of free shipping attracting frequent buyers. The service has complimented the retailer’s core business well and will continue to be one of the key differentiators going forward. The value of this differentiation will only widen as Amazon expands globally. The company also announced unlimited access to more than 1 million songs (ad free) in Q2 2014 to its Prime members. This strengthens a very attractive service package that includes free shipping on more than 20 million items, streaming of movies and TV shows, and access to more than half a million books that can be borrowed for free by Kindle users. All this, at a price tag of $99 per year.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)