Amazon: AWS Is A Shocker
Contributor since 2011 / 23721 Followers
Summary:
- Amazon has seen a relative solid first quarter.
- Margins have recovered a bit after a tough year on that front in 2022, even as they trail margins posted in recent years.
- While this is comforting, the dynamics of growth, including a big slowdown in AWS and a big decline in its margins, makes me very cautious.
Daria Nipot
In December, I thought that shares of Amazon.com (NASDAQ:AMZN) were selling off for the right reasons. This came after the company saw slower growth in combination with margin pressure, as earnings have fallen at roughly the same pace as valuation multiples. I believed that appeal was improving, yet found it too early to get involved.
A Recap
Pre-pandemic Amazon.com was a $280 billion business in 2019, posting operating profits of around 5%. The size of the business, its margins, and a net cash position of $32 billion looked pretty decent, as the runway for growth was still evident, despite its size.
As it turned out, 2020 was a great year for Amazon as growth was driven by the pandemic of course, with revenues up nearly 40% to $386 billion, increasing by more than a hundred billion in dollar terms. Operating earnings rose to $23 billion, for margins around 6%, as the company posted earnings of $42 per share. This was of course ahead of a 20-for-1 stock split which has been performed in 2022.
Revenues rose by another 21% to $469 billion, marking another solid year. Operating profits rose just a bit to $25 billion, as margins saw some pressure. Net cash balances rose further to $50 billion, a very comfortable position.
2022 has been a softer year as the company was seeing slower growth and margin pressure. Sales rose by 7% in the first two quarters of 2022, as slower growth and margin pressure in the retail segment was actually resulting in lower profits. Third quarter sales growth accelerated to 15%, despite intensifying currency headwinds, with continued margin pressure seen.
With 10.3 billion shares trading at $90 in December, the company was awarded a $927 billion equity valuation, as net cash balances have been largely depleted following poor working capital conversion, large capital spending requirements and some share buybacks. While I believed that the company should see revenues surpass the half a trillion mark for 2022, operating margins should likely fall from $25 billion to about $10 billion, translating into a sky-high 90 times operating earnings multiple, although it came down to 36 times operating earnings based on the 2021 margins.
The issue is that Amazon was facing hurdles with regard to margins on the back of inflation, the fact that it overbuilt capacity and it saw slower economic growth. Amidst all this, I felt that the valuation still a bit too rich and while shares had seen a huge pullback, I believed it was still a bit early to pull the buy trigger just yet. The company has been trying to address these concerns as it announced some layoffs and in fact it shut down some expansion projects, while it sub leased warehouse space as well.
Finding A Bottom
Since December shares have traded in an $80-$110 range, with shares now trading at $105 per share as it appeared that the shares have found a bottom. In February the company posted its 2022 results, but the fourth quarter trends were more interesting of course. Fourth quarter sales rose 9% to $149 billion, including a five billion currency headwind. For the year revenues rose 9% to $514 billion as operating earnings of $12.2 billion were a bit stronger than I feared.
The worst margin headwind came from the North America retail operations. Revenues rose 13% to $316 billion yet a $2.8 billion operating loss was highly disappointing, down ten billion on a sequential basis. International sales fell 8% to $118 billion, with half the sales decline being the result of adverse currency moves as a $7.7 billion operating loss was huge. AWS was the bright spot with a 29% increase in sales to $80 billion as operating earnings rose in a solid fashion to $22.8 billion.
For the first quarter of 2023 the company guided for sales between $121 and $126 billion, up 4-8% on an annual basis, as this estimate includes about a 2 point headwind from the strong dollar. Operating earnings were seen between flat and $4 billion.
Promising is that the company delivered on this guidance with sales up 9% to $127.4 billion, coming in comfortably ahead of the guidance. Perhaps more important is that operating earnings of $4.8 billion were far stronger as well. This was driven by a big reversal in the North American retail operations, flattish losses in Europe, and actually a decline in AWS margins. Notably the latter segment has seen huge margin pressure, with operating margins down from 35% this quarter in 2022 down to just 24% in the first quarter of this year.
Promising is the second quarter guidance, a quarter in which revenues are seen up 5-10% to a midpoint of $130 billion as currency headwinds are largely subsiding. Operating profits are seen between $2.0 and $5.5 billion, at the midpoint at $3.7 billion, as we know that the company traditionally guides conservatively. Hence, I see a real roadmap for operating earnings could come in at $20 billion or more, which could yield pre-tax earnings of around $2 per share.
This still makes is hard to see great fundamental support here, as net cash has been depleted by now. Part of the lower earnings power comes as $20 billion operating profits work down to margins of just 3% and change, while historically it came in closer to 5-6%. This is driven by lower retail margins, but notably lower AWS margins as well in recent times.
What Now?
It is comforting to see the company delivering on slightly stronger sales and earnings in the first quarter, but the AWS slowdown and margin pressure are concerning. The reality is that even if $20 billion in operating earnings are seen this year, margins are slim and earnings only come in at $2 per share on a pre-tax basis.
That said, this is Amazon, and it is all about the long term value creation, and thus focus on customer relationship, as Amazon has been traditionally operating near break-even levels for years now.
For me, the main takeaway is that AWS is performing softer than expected as shares have actually risen a bit since December, making me extremely cautious to get involved here, despite some better (near term) margins as it is evident that golden eggs of AWS are not immune to the macro picture and intensifying competitive landscape.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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