Amazon Stock Q1 Earnings Preview: What To Watch For

Summary:

• I think that we are near the bottom in terms of expectations for AWS as consensus estimates for 1Q23 AWS numbers reflect flat sequential growth and 15% year-on-year growth.
• Another key factor to watch is the impact of the cost saving measures to the profitability and margin improvement we might see in 1Q23.
• Recently, in the shareholder letter, Amazon CEO mentioned its chip development initiative, which is progressing well and seeing great results.
• While cutting costs, Amazon remains committed to investing in the long-term potential of its business.
• Management has identified several new potential investment opportunities based on its criteria, which I will be looking for more details in AMZN’s 1Q23 call.

I have written extensively on Amazon (NASDAQ:AMZN) and in my last article, I shared with members of Outperforming the Market why I think Amazon is an attractive buy at the moment.

The company has been aggressively improving its cost structure to improve operating margins in 2023 in response to an uncertain macro backdrop. Also, the headwinds faced by AWS are short-term, in my view, caused by the uncertain global macroeconomic environment as customers look to optimize their cloud spend.

In this article, I highlight some of the important points to watch out for and also look into the recent shareholder letter by Amazon CEO Andy Jassy to get some insights into how the 1Q23 results could turn out.

In my view, the company is communicating to investors that Amazon is taking a necessary adjustment in its business today in response to the challenging macro conditions as it has done in previous downturns and challenging environments. With that, it has decided to shut down businesses, reprioritize resources by reducing headcount and improve on its processes as it looks to come out of this a leaner and strong organization.

At the same time, management remains committed to areas within its business it deems are strong investment opportunities for Amazon and will continue to invest for the long-term across cycles.

Views on AWS

I think that for 1Q23, the bulk of the sentiment around AWS is that its growth is slowing, as has been often reported by the media. The consensus on the AWS growth figure for 1Q23 has been de-risked as the current market consensus is at $21 billion revenue for the first quarter of 2023, with flat sequential growth from the $21 billion we saw in the fourth quarter of 2022. This equates to 15% year on year growth expected in the first quarter of 2022, and the actual numbers could surprise the markets to the upside.

I think management made it clear that while AWS has a $85 billion annualized revenue run rate today, the business is still early in its adoption curve. Management sees the current headwinds faced by the business that is causing a slower growth rate to be short-term and continue to like the fundamentals of the business and focus on the customer.

As customers are looking to optimize spending on the cloud given the difficult macro backdrop, AWS is looking to help customers do so to ensure they can weather through this uncertain macro climate. Given the long-term and customer focused approach that AWS is bringing to the table, I think that we will see growth pick up again once the short-term macro headwinds dissipate.

As elaborated by management, AWS continues to have a robust new customer pipeline and active migrations. They are seeing that many companies are looking to move to the cloud in this period of time as they re-evaluate their infrastructure strategy going forward. On top of that, AWS continues to bring new capabilities each year, with more than 3,300 new services and features introduced by AWS in 2022, of which development of chips has been a focus for AWS.

Development of chips

This was one that I picked up from the shareholder letter but I think could be a focal point for the first quarter 2023 results as management has made significant progress in their chip development initiative.

I think Amazon is amazing. It went from a books-only retailer to building one of the biggest cloud computing businesses in the world.

It continues to invest in the future and today, chip development is one of their focuses as part of an initiative that complements AWS.

Amazon has been investing in its general-purpose CPU processors it called Graviton. According to Amazon, Graviton2-based compute instances can deliver up to 40% better price performance than the comparable latest generation x86-based instances.

It is worth noting that thousands of Amazon customers are already running their production workloads on Graviton2-based instances, and they have enjoyed considerable gains in performance and reductions in costs. Some of these customers include Lyft (LYFT), Formula One (FWONA), Epic Games, Intuit (INTU), amongst others.

In 2022, Amazon introduced the latest in its AWS Graviton processor family, its AWS Graviton3 processor.

Its Graviton3 chips are expected to improve on the Graviton2 chips as Amazon expects that it can provide 25% improved performance from the Graviton2 chips.

Amazon is not just stopping there.

A few years ago, based on customer feedback that they would like to have GPUs at a lower cost for machine learning, AWS has been investing in these specialized chips meant for machine learning training and inference.

In 2022, Amazon released AWS Trainium. Trainium is AWS’s second generation machine learning accelerator built specifically for deep learning training at a lower cost while still delivering a high performance. In the shareholder letter, it was shared that “for the most common machine learning models, Trainium-based instances are up to 140% faster than GPU-based instances at up to 70% lower cost”.

Amazon is looking beyond just the training stage to the next stage where its customers move towards large scale production and where inference would make up most of their costs. This is because inferences are happening all the time as their associated application is being exercised.

Amazon launched its first inference chip, Inferentia, in 2019. Since then, Inferentia has helped Amazon saved more than $100 million in capital spend. The Inferentia2 chip was just launched, and it offers “up to four times higher throughput and ten times lower latency than their first Inferentia processor”.

With both Trainium and Inferentia, Amazon is helping its customers with their machine learning journey by providing them with chips designed by AWS that has better performance while at a considerably lower cost.

I do think that the focus on chip development is not just beneficial to the AWS but also building a complementary business and expertise in chip development, which could bring further market opportunities for AWS. As a result, I think that the innovation machine in AWS is very impressive given that they are able to generate new businesses out of an expertise they have gained from improving on their own current business, as in the case of AWS.

This brings me to my next point.

Investing in new businesses

Management has mentioned its criteria it uses to invest in new businesses once in its fourth quarter 2022 results which I covered, but also, this was mentioned again in the shareholder letter. I think that I will be watching further to see what management has to say in where they think their new strategic focus is after streamlining its business and closing businesses that are not profitable or deemed non-core to its long-term strategy.

Amazon has been able to initiate new businesses and innovate in its businesses to be able to survive today. At the beginning, Amazon was just a books retailer that only shipped to the US. Needless to say, the Amazon today sells just about anything and is delivered to many countries globally.

Similarly, in the early 2000s, Amazon saw an opportunity in technology infrastructure services in the cloud and started AWS.

There are many other examples of businesses that Amazon has been able to initiate, like Kindle and Alexa.

Andy’s comment on AWS in 2008 was very telling about how Amazon sees its investments.

In 2008, while AWS was likely not as recognized today and a very small business relative to its e-commerce business, the management team knew that this was going to be something big. However, building the AWS business requires huge capital investment, and during a period like 2008, there were doubts about whether this was even the right thing to do.

As a result of investing in AWS in 2008, it had a head start over competitors.

As a result of investing in AWS in 2008, the business is now a $85 billion annual revenue run rate business today 15 years later.

As a result of investing in AWS in 2008, Amazon became a very different company than if it did not invest in AWS during the Great Financial Crisis.

As a result, what I took away from this was that Amazon is committed to investing for the long-term, especially for projects which they have a strong conviction in.

Cost cutting for the long-term

I think this could be one of the most important aspects investors are focusing on in the first quarter 2023 results.

While the current period of cost cutting may seem ruthless, Amazon has been doing this in the past when macroeconomic conditions were challenging. That is the way it has to be as businesses need to adapt to changes to be sustainable in the long-term.

As a company that has been around since the 1990s, it has been adapting to difficult operating conditions, which includes the 2001 dot com crash and the 2008 Great Financial Crisis.

In the dot com crash, Amazon had to streamline costs and even secure letters of credit in order to buy inventory for the holiday season.

In the Great Financial Crisis, Amazon again took decisive action to improve efficiency and manage its cost structure.

As a result, Amazon needs to respond to changes that it sees before it today given the uncertain global macro backdrop, elevated inflation and restrictive monetary policy.

The management team took a deep look across every business to determine what is their conviction level for each business’s long-term potential. This led to Amazon permanently closing some businesses. This led to decisions to reprioritize resources and making the cost structure leaner, resulting in the 27,000 reductions in corporate roles in the company. This also meant asking corporate employees to be back in the office for at least three days a week.

In addition, there were changes made to meaningfully improve fulfillment costs and speed of delivery. There were also efforts needed to optimize the yield and productivity at its fulfillment centers. With the doubling of its fulfillment center footprint in the two years during the pandemic, as well as the acceleration in building out the last-mile transportation network, it has led to lower productivity levels in its network. As a result, Amazon needed to re-evaluate its fulfillment network, look into each process path of its fulfillment center and transportation network to bring about gains in productivity and reduction in costs in the last few quarters.

All in all, management appears to be confident in being able to bring costs down and lower delivery wait times while continuing to build its retail business and generate healthy operating margins from it.

Amazon’s new investment opportunities

I think I have published some information on how Amazon thinks about their investment opportunities, but management reiterated the questions that they ask themselves when they are faced with new investment opportunities.

The questions that they ask themselves are firstly, whether the business could be big and have a reasonable return on invested capital if successful. The second question is about whether the opportunity is well-served today. The third lies in whether Amazon has a differentiated approach. The fourth being whether Amazon currently has a competence or is an acquisition necessary.

Based on these criteria, management will identify and select new investment opportunities for the company.

Amazon sees opportunities in healthcare today. It began with pharmacy, which was a similar business to its e-commerce business. It then expanded into an online pharmacy in 2020, with the launch of Amazon Pharmacy. The business continues to bring new innovations like the recent launch of RxPass, allowing Prime members to get unlimited eligible prescription medications for just a flat $5 fee per month. It then continued to expand to primary care with its acquisition of One Medical. One Medical was a good fit for Amazon because of its patient focused experience as well as its digital app. Management thinks that Amazon and One Medical can continue to bring innovation to the primary care space in the long-term.

In addition, Kuiper is another investment opportunity for Amazon where it sees strong customer demand. For Kuiper, Amazon plans to develop a low-Earth orbit satellite system to deliver high-quality broadband internet service to areas around the globe without such access. At the heart of the innovation brought about by Kuiper is providing internet service at a low cost and bringing easy accessibility.

The last investment area for Amazon mentioned in the shareholder letter is Large Language Models (“LLMs”) and Generative AI, where Amazon is looking to invest heavily in. Amazon has been using machine learning in its business for 25 years, while the company has been working on its own LLMs for some time. According to the shareholder letter, “LLMs and Generative AI are going to be a big deal for customers, our shareholders, and Amazon”.

Conclusion

When thinking about Amazon’s first quarter results, I think the points above does point towards Amazon adjusting its business to change with the changes we see in the macro environment, while at the same time reprioritizing its investment opportunities and continuing to invest in the opportunities the company thinks has a long-term potential for the company.

At the end of the day, I do think that AWS remains well positioned despite short-term headwinds caused by the uncertain macroeconomic environment, while the productivity improvements and cost savings from the e-commerce business will go a long way to ensuring that the e-commerce business achieves long-term growth and healthy operating margins.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN 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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