Amazon Falls on High Spending, But Topline Growth Remains Strong

Amazon (NASDAQ:AMZN) recently released its Q1 2014 earnings and based on the disclosed financials, we have updated our price estimate to $341. Our current price estimate implies more than 10% premium to the market price. While the revenue growth remained strong, the expenses increased which resulted in the stock plummeting by almost 10%. Amazon’s shares have fallen by roughly 25% since the beginning of the year but much of it can be attributed to broader market correction. The company’s fundamentals remain strong as it continues to increase its presence in the global e-commerce market. Additionally, its web business and Amazon Prime service continue to be key growth drivers and differentiators, and are going to be increasingly valuable going forward. Here is what you should know about Amazon’s first quarter earnings.

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General Merchandise Growth Was Stellar But Media Segment Remained Slow

Amazon saw its revenues 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. However, the stock still fell almost 10% following the earnings announcement due to higher spending that could weigh on the retailer’s margins in the near term. Improvement in EBITDA margin in the last two years is something that has fueled positive investor sentiment. Amazon’s EBITDA margin is very low, which implies that the stock is extremely sensitive to any change in its value. The stock’s history suggests that the market has placed a high premium on revenue growth while ignoring the company’s profitability. However, that may not continue to be the case as the business matures. Sooner or later, Amazon will need make strategic decisions to improve its profit margin.

We have previously stated that while Amazon’s domestic business is doing well, the company could do better internationally. As it turned out, the international operations picked up this quarter except for 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%. Even though there is a clear shift to digital products in media segment, the lack of local content continues to be the major hindrance. This issue, while fixable, will take sometime to resolve.

Amazon Prime Service And Cloud Business Will Be More Valuable Going Forward

Amazon mentioned that its prime service continued to add new subscribers for trials despite the recently announced price hike which indicates low price elasticity and therefore, 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 attract 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.

Amazon’s ‘Other’ segment revenues jumped by 58%. Most of the sales from this reported segment can be attributed to Amazon’s web services. The company’s web services enable cloud storage and computing for corporates 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 it further its interests. Additionally, the web services business is hugely profitable and the company can invest the profit from this segment to expand its core retailing business. To Amazon’s delight, it is ahead of other competitors in the race to become one of the biggest cloud services providers in the world. The company has frequently reduced its prices in order to bag deals. As a large chunk of corporates are expected to change their technology vendors over the course of next few years, Amazon has a distinct competitive advantage to leverage this development. ^[1] Some analysts have estimated Amazon Web Services to be $5 billion a year business with gross margins north of 90%. ^[2]

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1. Amazon.com, Inc (NASDAQ:AMZN)’s Cloud Has More Than Just A Silver Lining [↩]
2. Amazon set to flex its cloud-computing arm, MarketWatch, Mar 24 2014 [↩]