Amazon Mid Year Review: Stock Up 40% In Last Year On Improving Profitability

Amazon‘s (NASDAQ:AMZN) stock is up about 10% year-to-date (YTD) and over 40% in the last year following solid first and second quarter results. The company significantly outperformed expectations in the first six months of 2016, in terms of both top line and bottom line results. Amazon registered 30% growth in revenue to about $60 billion in the first six months of 2016, driven by solid growth across divisions especially Amazon Web Services (AWS), the company’s public cloud division.

Operating income more than tripled to about $2.4 billion and the company’s operating margin improved by 240 basis points to 4% in the first half of 2016. This helped Amazon post extraordinary 4000% year-over-year (y-o-y) earnings growth in the period to $2.90 a share. In this note, we discuss Amazon’s performance in the last six months and its areas of potential growth for the near future.

1. Solid Top Line Growth Across Divisions, Geographies: Amazon’s sales in North America rose 27% to about $35 billion in the first six months of 2016, while International sales were also up 27% to $19.4 billion. Top line growth across the North America and International segments was driven by robust growth in the Electronics, Merchandise & Others category. Amazon Web Services (AWS), the company’s public cloud division, generated $5.5 billion in revenue in the first two quarters, which was up 61% over the same period last year.
   
2. AWS profitability lifts Amazon’s bottom line: AWS contributes less than 10% of Amazon’s revenues but over 50% of its profits. Amazon’s increasing focus on constantly improving and expanding its AWS business stems from the fact that it contributes about 56% of the company’s profits and has a considerably higher operating margin than Amazon’s e-commerce business. In H1 2016, AWS had an operating margin of 24% compared to Amazon’s company-wide operating margin of just 4%.
3. Free Cash Flow Growth: One of the impressive things reported by Amazon this year was its ability to increase free cash flows faster than its top line. Amazon’s free cash flows (ttm) increased 65% y-o-y in the first half of 2016 due to a 42% increase in operating cash flows, partially offset by an 80% increase in cash spent in purchasing property under capital leases. This should help the company continue to make investments into areas such as shipping services, drone technology, cloud services, and new products like the Echo. 
4. Attracting Consumers Through Better Service Over Low Prices: After establishing a strong base of loyal “Prime” customers, Amazon’s strategy to attract and retain customers  now appears to be more focused on better service and faster delivery, rather than just cheaper prices. The company is working on several initiatives to shorten its delivery times, including setting up its own delivery network and providing several benefits to its Prime Members including exclusive video content, music streaming service, free audio books and free photo storage. These perks, along with high quality of service, should ensure the loyalty of its members.  The company no longer needs to compete on price alone to remain competitive.

   Selling products at competitive prices (not deeply discounted, causing losses to the retailer) can positively impact Amazon’s operating margin and its valuation. After posting negative operating margins in 2014, Amazon showed improvement and reported a 2.1% operating margin in 2015. We expect Amazon’s General Merchandise EBITDA margin to increase moderately from around 9.9% in 2016 to 10.6% by the end of our forecast period.

Have more questions about Amazon? Please refer to our complete analysis for Amazon 

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