Amazon Earnings Preview: AWS To Continue To Drive Growth

Amazon (NASDAQ:AMZN) is scheduled to report its second quarter results on Thursday, July 27. The company made headlines this quarter for multiple reasons ranging from the Whole Foods deal, to introducing Prime Wardrobe, venturing into the home appliance services space, and exploring the idea of the meal-kit home delivery business. While these business could help drive future results, the company’s current growth is expected to come from existing businesses, including core e-commerce as well as Amazon Web Services. While Amazon is expected to continue its growth spree, with double digit growth across segments, its operating profits (particularly for the international segment) are expected to remain relatively modest over the next few quarters.

We have an $890 price estimate for Amazon’s stock, which is around 10% lower than the current market price. Amazon’s stock price has risen by over 15% in the last three months following a number of positive developments for the company, including the $13.7 billion acquisition of Whole Foods.

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Q2’17 Guidance

In the second quarter, Amazon expects overall revenue to grow around 20% on a y-o-y basis to between $35.5 billion. Despite revenue growth, the company expects operating income (GAAP) to fall by 20-60% on a y-o-y basis and fall between $425 million and $1.1 billion, compared to $1.3 billion in Q2 2016. Consensus estimates for Amazon’s earnings per share for June quarter stands at around $1.50, as compared to around $1.80 in the prior year period.

Amazon Web Services Key To Growth

Over the last few years, Amazon Web Services (cloud services) has been the fastest growing and most profitable business for the company. AWS revenues have surged from under $1 billion in 2011 to $12.2 billion in 2016, a compound annual growth rate of over 65%. This trend continued through the March quarter, with AWS revenues increasing 42% over the comparable prior year period to almost $3.7 billion.

Similarly, Amazon’s adjusted operating margin has steadily improved from 6.3% in 2011 to over 10% in 2016. A key driver for this improvement has been the AWS business, which has seen its adjusted EBITDA margin increase from 21% in 2011 to over 32% in 2016. In the same period, AWS’ contribution to the company’s top line has increased from 2% to 9% while its contribution to adjusted operating profit has increased from 7% to 29% in 2016. In line with historical trends, AWS contributed over 10% of Amazon’s revenues, but the majority of its profits in Q1 2017.

International E-Commerce Could Struggle To Make Profits

Through the March quarter of this year, Amazon’s company-wide operating margin worsened by 90 basis points to 2.8%. The decline was mainly due to a 300 basis point decline in international segment operating margins, partially offset by rising profitability in AWS. The operating profit margin in the global marketplace business has fallen due to rising marketing and selling expenses in international markets, especially India, as well as increased investments in acquiring and licensing digital media content for the Prime video offering. Furthermore, Amazon has also incurred higher warehousing and shipping expenses in North America attributable to 26 new fulfillment centers that were opened in 2016.

These factors were partially offset by gross margin improvements due to growing third-party business and marketplace efficiency improvements. While the company should continue to see improved profitability going forward, Amazon’s margins could witness some pressure in the near term, owing to increased investments in AmazonFresh, Amazon Video (digital media content including movies and series), Amazon Music, Alexa, Whole Foods and other services. While the company should continue to see improved profitability going forward, Amazon’s margins could witness some slight compression in the near term owing to increased investments.

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