What’s Fueling Amazon’s Incredible Revenue Growth?

Amazon’s (NASDAQ:AMZN) revenue growth in the recently reported quarter stood at 22%. Although the figure came down compared to last year, it is still impressive for a company that’s garnering $16 billion in quarterly revenues.

There is no doubt that the overall e-commerce growth is propelling revenue growth for Amazon, but there are other finer points to consider. The company has been pushing its Kindle tablet which can act as a catalyst in promoting its merchandise sales. In addition to this, Amazon’s management seems clear about its focus on absolute cash flows rather than percentage margins. This strategy essentially implies that the company will continue to offer deep discounts to push its sales. As far as margins are concerned, growth in Amazon’s Web Services business should help support the company’s profitability.

See our full analysis for Amazon’s stock here

Growth In E-Commerce Market

Market research firm Forrester expects U.S. online retail sales to grow rapidly and take market share away from physical stores. This is clearly evident from the comparison of Amazon’s growth with that of traditional brick-and-mortar retailers such as Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), Target (NYSE:TGT) and Best Buy (NYSE:BBY). Forrester further predicts that the U.S. online retail market will reach $262 billion in 2013, registering 13% growth over 2012. ^[1]

Although the online channel still accounts for just 8% of total retail sales in the U.S., the future growth is going to be healthy with Amazon leading the way. This growth will be further complemented by traditional stores investing in web businesses to support a multichannel strategy as well as the global adoption of Internet and mobile devices. The research firm forecasts a compounded annual growth rate (CAGR) of 9% for the next 5 years. ^[1]

While the U.S. growth outlook certainly looks promising, international markets can offer even higher potential in the long term. A lot of growth for Amazon will come from these markets where its presence is low. According to eMarketer, B2C (business to consumer) e-commerce sales in the Asia-Pacific region increased by more than 33% in 2012, amounting to $332 billion. ^[2] The figure is expected to grow by more than 30% this year amounting to $433 billion and accounting for more than one-third of the global B2C e-commerce sales. ^[3]

Growth In Kindle Shipments Will Attract More Online Traffic

The growing popularity of Android devices can help Amazon promote its Kindle Fire device range. These devices can help the company capture a major share of Internet traffic as the traffic’s source shifts from desktops to mobile devices such as tablets and smartphones. Amazon had launched a revamped range of Kindle devices with features closely matching those of tablet device pioneer Apple’s iPad in September 2012.

An estimated 200 million tablets have been shipped worldwide since 2009 and another 1 billion are predicted to ship over the next five years. Market intelligence firm ABI Research estimates that 22% of the U.S. tablet users spend $50 or more per month and 9% spend $100 or more – much higher than the spending levels observed for smartphone users. ^[4] The growing popularity of Amazon’s Kindle Fire range could mean that a major share of this spending will be re-directed to Amazon’s online storefronts. Since Kindle devices are optimized to run on Amazon’s services, we expect them to drive greater adoption of Amazon’s services. We believe that the content business comprising eBooks and movie/music streaming will be the biggest gainer from the trend.

Focus Is On Cash Flow Vs. Margins

Although Amazon’s diversified product portfolio and growing e-commerce business will support its strong revenue growth, there are other factors that suggest there could be margin pressure going forward. The company, which is in the middle of setting up a number of fulfillment centers to roll out same day delivery, is battling growing competition in the cloud/web services front and is spending heavily towards the development of its content library. All of these activities are cost-intensive and will negatively impact its already thin margins. This suggests that it may try to control its revenue growth and focus on becoming more profitable.

However, that is not the intent of the company, which leads us to believe that the fast revenue growth may continue. In an interview with The Harvard Business Review earlier this year, Amazon’s CEO stated: “Percentage margins are not one of the things we are seeking to optimize, it’s the absolute dollar free cash flow per share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that’s something investors can spend.”

Our price estimate for Amazon stands at $241, implying a discount of about 10% to the current market price.

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1. US Online Retail Forecast, 2012 To 2017, Forrester Research, March 13 2013 [↩] [↩]
2. Ecommerce Sales Topped $1 Trillion for First Time in 2012, eMarketer, Feb 5 2013 [↩]
3. ref:4 [↩]
4. U.S. Consumer Tablet On-device Spending Soars with 22% of Users Spending More Than $50 per Month, ABI Reasearch, January 2013 [↩]