Amazon’s Stock Shoots Up On Solid Earnings Report

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Amazon

With net sales growth at 20%, Amazon (NASDAQ:AMZN) delivered a stellar performance in the second quarter of 2015. Its stock is up by more than 15% post the earnings release. These results were driven by strong performance across both the North American and international regions, which was further powered by rapid growth in the electronics and general merchandise category. In addition, the top-line growth of over 81% in the Amazon web services (AWS) segment came in above market expectations, together with a surprise increase in the segment’s margins. As a result, the overall operating margin (in GAAP terms) improved by 210 basis points annually to 2.0%. These results call for an upward revision in our model forecasts — the company’s growth outlook continues to look strong, owing to expansion opportunities in the global e-commerce and cloud services market. In addition, we believe the company’s recent improvement in margins, which have come on top of efficiency improvements, looks promising and reflects a new trend at the online retail giant. However, we will continue to track growing expenses on international expansion and on the Prime program, as these could somewhat hinder profitability down the road. [1]

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Faster-Than-Expected Top-Line Growth In North America Also Resulted In Healthy Margin Expansion

The net sales growth within the North American region, accelerated from 24% in Q1 2015 to 26% in Q2 2015. The high growth was fueled by 31% growth in the electronics and general merchandise (EGM) category. Hence, Amazon’s results outpaced the broader e-commerce market during the quarter, helping it gain additional market share.

In addition, the operating margin within this segment rose to 5.1% in Q2 2015, as compared to 3.9% in the prior quarter. We believe the latest results indicate efficiency improvements and operating leverage at the company.  In addition, the rapid growth in third-party seller business also contributed to this margin improvement, due to the rise in gross profits. Amazon’s margin performance in this area over the past three quarters, looks encouraging, especially since the company continues to spend heavily on its Prime program. While the margin improvement could continue in year-over-year terms in the future, we believe these results could also show some volatility in the coming quarters.

International Results Showed Acceleration In Demand; Amazon Will Continue To Invest Heavily In This Area

Though international sales were impacted by currency headwinds during the second quarter, they showed significant acceleration in FX-neutral terms. The net sales growth within the international geography rose to 22% in Q2 2015, as compared to 14% in the prior quarter (in currency neutral terms). While softer year-over-year comparisons were one factor that caused this acceleration, high demand in the Prime program was also responsible for this performance, in our view. With 31% top-line growth, EGM category captured the high growth within the segment.

However, the operating loss within the international segment widened to $19 million in Q2 2015, as compared to $2 million in a similar period a year ago. This was caused by foreign currency translation losses as well as increased expenses in certain developing geographies. With  management expected to enhance their investments in geographies such as India, we believe this segment will continue to weigh on the overall margins of the company.

Amazon Web Services (AWS) Segment Represents A Sweet Spot In Amazon’s Stock

Another promising aspect of the earnings report was that operating income rose by over-400% in the AWS segment. This was driven by 81% revenue growth and 1,370 basis points expansion in the operating margin (both in year-over-year terms). Usage growth of over-90% and less-aggressive price cutting resulted in this performance, in our view. [2] Amazon is now expanding this business across international geographies such as India.

We believe this segment could grow to over $18 billion business in the long-run, driven by the immense market opportunity in the global cloud services market. Moreover, we believe this segment will see high margins resulting in strong cash flows. However, the requirement for capital expenditure very high in this segment in the coming years.

We are in the process of revising our $360 price estimate for the company’s stock.

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Notes:
  1. Amazon.com Announces Second Quarter Sales up 20% to $23.18 Billion, Amazon Investor Relations, July 23, 2015 []
  2. Amazon.com (AMZN) Q2 2015 Results – Earnings Call Transcript, Seeking Alpha, July 23, 2015 []