AWS To Help Drive Amazon’s Top Line Growth; Margins To Remain Under Pressure

Amazon (NASDAQ:AMZN) is scheduled to report its third quarter results on October 26. The e-commerce giant has reported a strong period of growth in the last few quarters, driven by Amazon Web Services. AWS revenues have grown at a CAGR of over 60% in this decade, with the trend continuing through the first half of the year. During the September quarter, Amazon completed the Whole Foods acquisition in late August and announced various new developments in the AWS business and the consumer business (mainly Alexa and Echo). While some of these developments in the consumer market could help drive long-term results, the company’s current growth is expected to come from existing businesses, including core e-commerce as well as AWS. Amazon is expected to continue its growth spree, with double digit growth across segments, while its operating profits (particularly for the international segment) are expected to remain relatively modest over the next few quarters.

We have an $960 price estimate for Amazon’s stock, which is in line with the current market price. Amazon’s stock price surged from $750 at the beginning of the year to around $1000 by July. Since then it has fluctuated between $940 and $1040.

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Q3’17 Guidance

In the third quarter, Amazon expects overall revenue to grow around 20-28% on a y-o-y basis to around $40 billion. Despite revenue growth, the company expects operating income (GAAP) to fall by 50-180% on a y-o-y basis. As a result, the operating income could come in between a loss of $400 million and a profit of $300 million, compared to an operating profit of $575 million in Q3’16. Consensus estimates for Amazon’s earnings per share for the September quarter stands at around 3 cents a share, as compared to around $0.52 in the prior year period.

Amazon Web Services Key To Growth

AWS revenues have grown at over 40% through the first half of the year. Moreover, AWS is the only segment to report an improvement in operating profit. This trend is expected to continue in the near term, with Amazon likely to continue to reinvest AWS earnings into international expansion and new ventures.

Amazon’s company-wide 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.

International E-Commerce To Continue To Report Losses

In line with historical trends, AWS contributed just over 10% of Amazon’s revenues, but the majority of its profits in the first half of the year. Comparatively, Amazon’s company-wide operating margin has suffered due to low margins in the e-commerce segments. Amazon’s international segment has operated at a loss, and has worsened in recent quarters 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. The company has opened more fulfillment centers in the U.S. this year, including Ohio, Oregon, New York and Michigan. This will likely keep operating margins relatively low in the near future.

These factors were partially offset by gross margin improvements due to growing third-party business and marketplace efficiency improvements. However, 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, Echo, Whole Foods and other services.

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