Amazon Q3: Double Beat Makes Shares Jump

Summary:

• Amazon.com, Inc.’s results beat expectations, especially on the bottom line.
• The company’s business growth was weaker than that of Meta Platforms, Google, and Microsoft, however.
• Amazon is trading at a relatively elevated valuation, with earnings and free cash flow multiples of more than 40.

Article Thesis

Amazon.com Inc. (NASDAQ:AMZN) reported a double beat on Thursday afternoon. There were many things to like in the report, but Amazon.com’s high valuation accounts for that already. Overall, I remain neutral on this e-commerce giant, as solid business growth and a high valuation balance out each other.

Past Coverage

I have written about Amazon.com Inc. in the past, most recently in April. I gave the company a neutral rating back then, which has worked out fine, as AMZN only saw its shares rise by 3% over the last half-year. Half a year has passed since my last article on the e-commerce and cloud computing player, and with AMZN reporting healthy results on Thursday, it is time for an update on the company.

What Happened?

Amazon.com reported its Q3 earnings results following the market’s close on Thursday. The headline numbers looked like this:

The company did deliver a double beat, which was an improvement from the previous quarter when the company had missed the consensus revenue estimate. Before that, AMZN had delivered several double beats in a row. This week, other Mag 7 stocks have delivered strong double beats as well, namely Meta Platforms, Inc. (META), Alphabet Inc. (GOOG), (GOOGL), Microsoft Corporation (MSFT), and Apple Inc. (AAPL). It thus looks like Wall Street analysts were severely underestimating large parts of the big tech sector — good news for investors.

Amazon’s revenues were around 1% higher than expected, with year-over-year growth being in the low double-digit range. Earnings per share beat estimates by a much wider margin, coming in around 25% higher than expected. Since earnings per share growth is closely tied to share price performance over the long run, the big earnings beat is more important than the much smaller revenue beat, I believe.

The market reacted positively to these results, with AMZN climbing by 4% in after-hours trading at the time of writing.

AMZN’s Q3: Many Things To Like

Let’s delve into the details of Amazon’s Q3 report. Looking at the revenue growth rate, we see a healthy year-over-year improvement, although it is worth mentioning that some other Mag 7 companies outperformed Amazon:

• Meta Platforms generated revenue growth of 19% during the quarter.
• Alphabet generated revenue growth of 15% during the quarter.
• Microsoft generated revenue growth of 16% during the quarter.

NVIDIA Corporation (NVDA) will surely deliver a better revenue growth rate when it reports its quarterly earnings results in November, but Amazon at least beat the performance of both Tesla, Inc. (TSLA) and Apple Inc. (AAPL). On a relative basis, Amazon’s business growth was thus a bit of a letdown, but the absolute growth rate was still compelling, at more than 10%.

Revenue growth was, not surprisingly, unevenly distributed over Amazon’s different segments. The e-commerce business in North America experienced growth of 9% compared to one year earlier, which was the weakest growth rate of the three main segments. That is not really surprising, however, as this is also the largest segment by far in absolute terms. The North American e-commerce business generated revenues of $96 billion during the period, thus growing this number at a fast pace requires many billions of dollars in additional revenue. The international e-commerce business is much smaller, with Q3 revenues of $36 billion, thus a higher relative growth rate is somewhat easier to achieve — the unit grew by 12% during Q3.

The Amazon Web Services, or AWS, segment, arguably the “best” or most important of the company’s business units, achieved growth of 19% compared to the previous year’s quarter. The fact that this unit grew at the fastest pace is not surprising, as this is in line with recent trends. Since margins in the AWS business are better than in the e-commerce business, an above-average growth rate for the AWS business has a positive impact on Amazon’s company-wide margins.

It is essential to note that some of AWS’ competitors grew at a faster pace, with Google Cloud revenue soaring 35% during Q3. Microsoft’s Azure also grew considerably faster than AWS, reporting a revenue increase of 33% during the most recent quarter. While AWS achieved highly compelling growth in absolute terms, it looks like some competitors made inroads and were able to better capitalize on the growing cloud computing market. I believe this is not a reason to worry about for AMZN’s shareholders, but a trend that is worth watching going forward.

Revenue growth is important, but earnings growth is even more important. On that front, Amazon performed quite well during the third quarter. Company-wide operating income jumped by a hefty 55% compared to one year earlier, thanks in part to the revenue increase, but even more so due to expanding margins. The better product/sales mix (rising AWS contribution) plays a role in Amazon’s margin expansion, but the company also managed to become more profitable in its e-commerce units. Easing inflationary pressures and declining energy costs (lower fuel expenses) help explain how Amazon was able to generate higher profits from its e-commerce segments in both the North American market and the international part of its operations.

In fact, the international e-commerce business managed to move from a small loss in the previous year’s quarter to a solid profit of $1.3 billion. Relative to the overall company-wide operating profit of more than $17 billion in Q3, that’s still a pretty minor amount of money, but there was a nice improvement compared to the past. It will be interesting to see whether this is a trend that will remain in place in the upcoming quarters, or whether this is more of a one-time margin jump due to inflation (and thus cost pressures) coming down in markets such as Europe.

Looking at Amazon.com’s guidance for the current quarter, Q4, which is Amazon’s best quarter of the year due to the holiday impact, things look solid but not excellent. The company guides for revenues of $181.5 billion to $188.5 billion, or $185 billion at the midpoint of the guidance range. This represents a big improvement on a sequential basis, but due to the holiday impact in Q4, that is the case every year. Analysts were expecting slightly higher revenues, with the consensus estimate standing at a little north of $186 billion.

It is, of course, possible that Amazon’s management gave out somewhat conservative guidance, and they may very well outperform the guidance midpoint. Looking at expected profits, Amazon guides for operating earnings of around $18 billion in Q4, which would represent an increase of 36% versus last year’s Q4. This would be a very nice earnings growth rate, but considerably less than the earnings growth rate of 55% in the just-reported third quarter.

Amazon’s business model requires massive investments in warehouses and other physical assets, thus scaling up operations can be costly and require a lot of capital. When we look at the company’s cash flows, we see that capital expenditures stood at a hefty $65 billion over the last year, or more than $16 billion per quarter. Still, thanks to a big improvement in operating cash flows, Amazon was able to generate free cash flows of close to $48 billion over the last twelve months, which is a massive amount in absolute terms. Factoring in Amazon’s current valuation of a little more than $2 trillion, this means that shares are trading at a free cash flow multiple of a little more than 40, however, which equates to a free cash flow yield of just above 2%.

Relative to the hefty market capitalization Amazon trades at, the free cash flow number thus does not seem very large. The other Mag 7 stocks that reported earnings this week all have equal (Microsoft) or better (Alphabet, Meta Platforms, and Apple) free cash flow yields compared to Amazon according to YCharts’ data.

Is Amazon A Good Investment?

The valuation comparison to the other tech giants can tell us whether Amazon is an attractive investment right here, or whether that is not the case. While I believe that AMZN’s Q3 report was pretty good in absolute terms, the fact that the majority of the other Mag 7 stocks are experiencing better business growth is noteworthy. In particular, Alphabet and Meta Platforms are also much cheaper than Amazon, trading at just 22x and 27x this year’s earnings, respectively, while Amazon trades at a pretty high 41x forward earnings.

Amazon has an excellent market position in the e-commerce space both in the US and many foreign markets, and it also is well-positioned with AWS, although Azure and Google Cloud are growing faster. But compared to the other Mag 7 stocks, Amazon does not stand out as an especially attractive pick, as it is rather pricey while its growth is not overly strong on a relative basis. I thus remain neutral on Amazon but would be more bullish at a lower valuation (which may or may not come).

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOG, META either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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