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Amazon.com (AMZN)

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WHAT HAS CHANGED?

Amazon's (NASDAQ:AMZN) Q3 beat consensus estimates, but the weak guide appears to have led to a 7% crack in post-market trading.

On the retail side

International could see weakness in Q4 due to the Diwali festival shopping in India this time around is spread between Q3 and Q4 versus only Q4 last year. In Japan there has been an increase in consumption tax from 8% to 10%. U.S. retail business could also feel the pinch of competition in a relatively shorter holiday season. The management noted that excluding of Whole Foods, from Q3 to Q4 there is a sequential drop of 300 bps in growth The management believes that its one day shipping program has been able to do a good job in pushing up unit growth. However, Q4 is likely to see another $1.5 billion of incremental investment to support the associated logistics, which going forward may come down as route density improves. Advertising saw an over 45% growth versus over 37% last quarter.

On the Amazon Web Services (AWS) side

Benefits of investments made in 2017 in AWS capacity look to be over and newer infrastructure investments to cater demand are likely to pressure margins. Interestingly, the management noted that they will be invested a lot more on the S&M side to handle a wider set of customers. The Amazon management was very focused on highlighting how much investments in sales they are making especially to attract and retain large enterprise customers. Considering AWS is now targeting the large on-premise customers, AWS is increasingly facing off Oracle's (NYSE:ORCL) Gen 2 and Azure. We think that while AWS' economics of scale has allowed the company to reduce prices in the past, the architectural shift that Oracle has brought about has been causing unseen issues.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are key drivers of Amazon's value that present opportunities for upside or downside to the current Trefis price estimate for Amazon:

Amazon Web Services

  • AWS Revenues: We currently forecast Amazon Web Services revenues to continue to increase rapidly from about $25.7 billion in 2018 to over $140 billion by the end of our forecast period. This represents a CAGR of 24%, which is lower than its historic growth rate. However, given the potential competition in the space such as Alibaba and Microsoft, coupled with the huge base factor, Amazon can witness a lower than anticipated growth rate. We expect the increasing use cases of edge computing to help manage competitive pressures.

  • AWS EBITDA Margin : We currently forecast Amazon's AWS EBITDA margin to reach 48% by the end of our forecast period due to relatively fixed operating expenses and high operating leverage due to economies of scale.

Amazon North America

  • Amazon North America EBITDA Margin: We currently forecast Amazon to consistently add customers for sale and subscriptions in North America leading to improved revenue per customer and resulting high margins due to economies of scale. We forecast North America EBITDA Margin to improve from just below 13% in 2018 to almost 15% by the end of our forecast period.

For additional details, select a driver above or select a division from the interactive Trefis split for Amazon at the top of the page.

BUSINESS SUMMARY

Amazon is an online retailer which sells electronics, books, retail consumer goods, music, games, apparel and other merchandise to consumers in the U.S., Canada, the United Kingdom, Germany, Brazil, France, China, Japan, India Mexico, Netherlands, Italy and other countries. The company also provides web services such as cloud computing and online storage to web sites and web developers.

SOURCES OF VALUE

Amazon Web Services business is the most valuable segment for Amazon due to the company's high growth within this segment. In recent years, consolidated AWS revenues have grown at high double digits. Despite the lowest revenue contribution, AWS is the most valuable segment due to high margins of cloud computing as compared to e-commerce retail business which operates on razor thin margins.

KEY TRENDS

Growing high-margin cloud services business

The growth in Amazon's Web Services has become a critical factor driving the company's expansion globally. Several companies continued to adopt these services in recent years. Besides helping big businesses, the company’s cost efficient web services are also useful for young start-ups that may have cash restrictions.

The growth in the AWS segment has been massive - the annual growth in AWS revenues came in at 70% in 2015, 55% in 2016, 43% in 2017 and 46% in 2018. Apart from this, the company also showed strong profitability in the cloud-services business as margins have improved in this segment in successive years.

Amazon Prime service gaining subscribers

Prime subscriptions grew by 53% and 51% year-over-year in 2014 and 2015, respectively, with stronger growth across international markets than within the U.S. Amazon's total Prime members (not reported by the company) was estimated to be 50 million in 2015, which increased to 65-70 million in 2016 and subsequently to over 100 million by the end of 2018. The subscription offers free shipping along with access to video content. This implies that streaming content is just positioned as one of the key features of the service to attract subscribers. Amazon offers other integrated product and services offerings through Prime membership such as Echo, Amazon’s Fire TV Stick, and Amazon Basic Cables.

While the revenues earned from the Prime service subscriptions account for a small chunk of the company’s total sales, the margins from Prime customers are much higher than other customers. Additionally, according to various reports, Prime customers tend to buy almost twice as much as the regular customers. We believe Prime subscribers will continue to grow rapidly as Amazon is investing heavily in streaming content to lure in more buyers.

Explosive growth in the global e-commerce market

The global e-commerce market is growing rapidly as consumers continue to shift to Internet for their purchases. Much of this is being driven by growing Internet penetration, increasing adoption of Internet enabled devices such as tablets, notebooks and smartphones, and the continuing improvement in online payment systems. The global online retail market was valued at roughly $1.9 trillion in 2015 and $2.3 trillion in 2016, and is expected to grow to over $4 trillion by the end of the decade.

Heavy investments on international expansion could add pressure on profitability

Amazon is making significant investments to expand its presence in regions such as China, India, Italy and Spain. While these investments will enhance revenue growth, however, this strategy could also raise margin pressure. Amazon will invest a couple of billion dollars on its Indian operations, but since the country’s e-commerce market is highly competitive, we believe it will be difficult for Amazon to attain profitability in the region for at least a couple of years.

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