• 1Q23 results were within expectations. 1Q23 revenue/normalized PATMI was at 23%/25% of our FY23e forecasts, excluding a pre-tax valuation loss of US$0.5bn from investment in Rivian Automotive.
• Revenue grew 9.4% YoY, beating top-end of company guidance with margin improvements in North America and International segments. AWS was up 16%, but growth is expected to further decelerate to 11% in 2Q23.
• We maintain our ACCUMULATE recommendation with an increased DCF target price of US$120.00 (prev. US$117.00) using a WACC of 6.4% and g of 5%, taking into account a lower planned CAPEX spending.

The Positives

+ Revenue beats guidance. 1Q23 revenue grew 9.4% YoY (11% in constant currency) to US$127.4bn, above the top end of US$126bn company guidance. International segment revenue increased 1% YoY following negative growth since 4Q21 (-8% YoY in 4Q22 and -6% in 1Q22) as inflation in Europe starts to decline. Advertising revenue grew 21% YoY (23% in constant currency) to US$9.5bn (7.5% of total), reflecting continued strong demand for its advertising services. AWS was up 16% YoY, in line with guidance despite facing cloud spending optimisation efforts by customers.

+ Improvements in margins. Operating income was US$4.8bn, up 30% YoY and slightly above company guidance of US$4bn, as margins expanded by 190 bps QoQ and 60 bps YoY, despite incurring severance-related charges of US$0.5bn. North America segment posted an operating income of US$898mn (1.2% margins vs -2% in 1Q22) after recording losses since 4Q21, while International segment’s negative margins also declined QoQ to -4.3% from -6.5% in 4Q22. These improvements were due to revenue growth outpacing growth in fulfillment and shipping costs as inflationary pressure eases with reduction in shipping rates, fuel, and electricity prices. The margin expansion was partially offset by QoQ contraction in AWS to 24% from 24.3% in 4Q22 as customers opted for lower-tier products.

The Negative

- Further growth deceleration for AWS in 2Q23. AWS YoY growth for April was estimated to be ~5% lower than that of 1Q23 as enterprises continue efforts in optimising their spending and management expects this trend to persist at least through 2Q23, implying a further growth deceleration to ~11%. However, Amazon reiterated that its new customer pipeline remains robust and there is a strong ongoing set of workloads that is migrating to AWS. Management also indicated that its existing customers are extending their expiring contracts and will continue to engage with AWS.

• Revenue was in line with expectations at 101% of our FY22 forecast; while earnings were a slight miss with normalized PATMI at 96%, excluding a pre-tax valuation loss of US$12.7bn from Rivian Automotive, due to higher-than-expected operating expenses.
• 4Q22 revenue grew 8.6% YoY, beating top-end company guidance with advertising continuing to buck the industry’s declining trend. AWS remains the fastest growing segment but growth is expected to decelerate to mid-teens in 1Q23.
• We upgrade to ACCUMULATE with a raised DCF target price of US$117.00 (prev. US$108.00) using a WACC of 6.4% and terminal growth rate of 5%. We expect near-term challenges for revenue growth as consumers are more selective in their discretionary spending and AWS customers opt for lower-cost products. However, we expect growth to reaccelerate in FY24e, particularly for AWS as Amazon increases its client base and customers scale up their computing demand as macro improves.

The Positives

+ Revenue beats guidance. 4Q22 revenue grew 8.6% YoY (12% in constant currency) to US$149.2bn, slightly above the top end of US$148bn company guidance. Retail sales were boosted by Prime Early Access Sales in October and Thanksgiving-Cyber Monday holiday weekend sales outperformance. Prime saw record new sign-ups during Rings of Power launch window. AWS remains the fastest growing segment, up 20% YoY, and was the sole contributor to the overall operating income of US$2.7bn.

+ Advertising continues bucking industry trends. Advertising grew 19% YoY to US$11.6bn (7.7% of total 4Q22 revenue) while competitors continue to see advertising revenue decline. Amazon continued to see inflow of advertising demand from sellers, vendors, and brands during the competitive holiday season, even as sellers were being frugal with their marketing budgets in the current macroeconomic environment.

The Negative

- 1Q23 AWS growth expected to decelerate. AWS YoY growth for January 2023 was in the mid-teens as enterprises continue their efforts in optimizing their spending by opting for lower-cost products. Management expects these optimization efforts to be the key headwind for AWS over the next few quarters. However, Amazon indicated that its new customer pipeline remains robust as many are putting plans in place to migrate to the cloud and commit to AWS for the long term.

• 3Q22 revenue was in line with expectations, while earnings were a miss. 9M22 revenue was at 69% of our FY22e forecast, while PATMI came in at 47%, excluding a pre-tax valuation gain of US$1.1bn from Rivian Automotive.
• Amazon Web Services (AWS) continues YoY growth for 3Q22 at 27% while contributing 100% of 3Q22 operating income. 4Q22 management guidance was below our forecast, expecting continued challenges from inflation and 4.6% FX headwinds.
• We cut our FY22e revenue by 3.5% and operating margin from 5% to 3.2% to account for a slower expected growth rate from reduced customer spending on AWS and increasing FX headwinds. We maintain a NEUTRAL rating with a lowered DCF target price of US$108.44 (prev. US$133.00), with a WACC of 6.4% and terminal growth of 5%.

The Positives

+ AWS continues strong YoY growth. AWS remained the fastest growing segment, recording revenue of US$20.5bn, up 27% with customers opting for lower-cost products as they revise technology spending to combat inflation and weakening business performance. AWS generated operating income of US$5.4bn, the sole contributor to the overall operating income of US$2.5bn for the quarter.

+ Advertising bucks industry trends. Advertising grew 25% YoY to US$9.5bn (7.5% of total 3Q22 revenue) while competitors faced advertising pullbacks. Amazon believes its advertising model is attractive to sellers as it operates at a point where consumers are ready to spend, which increases its effectiveness.

The Negatives

- 4Q22 revenue guidance below our forecast. Management guided 4Q22 revenue to be between US$140bn and US$148bn, representing 2-8% growth YoY. The strengthening US dollar is expected to continue to be a major headwind going into the quarter, although FX has more impact on revenue growth than on income due to the investments Amazon has made internationally. AWS growth slowed to the mid-20% towards the end of 3Q22 and this is expected to persist throughout 4Q22.

• 2Q22 revenue beat expectations, but earnings missed modestly. 1H22 revenue at 45% of our FY22e forecasts, while normalised PATMI came in at 38%, excluding a pre-tax valuation loss of US$3.9bn from Rivian Automotive.
• Faced with US$4bn incremental cost from external factors: higher fuel prices, trucking, air and ocean freight rates. Higher energy costs to hurt margins, with 4% FX headwinds in 3Q22.
• We believe that earnings will remain suppressed due to increasing inflationary costs in the near term; our FY22e assumptions remain unchanged. We downgrade to NEUTRAL with an unchanged target price of US$133.00 based on DCF with a WACC of 6.4% and terminal growth of 5.0%.

The Positive

+ Revenue beat top-end of guidance. Amazon recorded revenues of US$121.2bn for 2Q22, slightly above the top-end of its guidance, representing a 7% YoY growth (10% YoY in constant currency), despite surpassing Prime Day event in June 2021 and larger-than-expected FX headwinds. Revenue growth was driven mainly by AWS (33% YoY), with retail and advertising also performing slightly better than expected. Amazon also said that it continued to see an increase in consumer demand for its services.

+ Good progress in adjusting staffing levels, improving fulfilment efficiency. Amazon was able to work through some of its incremental costs, reducing it by US$2bn QoQ to US$4bn in 2Q22 – in line with expectations. Most of these costs included higher fuel, trucking, air and ocean shipping costs. Staffing levels were also more in line with 2Q22 demand, with overstaffing resolved by the end of the quarter. Amazon is also seeing better optimization within its fulfilment network – improving in-stock levels and increasing delivery speeds.

The Negatives

- Higher costs continue to hurt margins in 3Q22. Amazon guided operating margins to be in the range of 0.0% to 2.8%, with the expectation that pressure from high inflationary levels – higher energy costs, will continue to pull down the company’s margins moving into 3Q22. A strengthening US dollar is expected to be a 4% revenue headwind. Operating margins were at 2.7% for 2Q22, down from 6.8% in 2Q21.

- US$3.9bn pre-tax valuation loss from Rivian Automotive. Amazon followed up 1Q22 with another quarter of net losses, posting US$2bn in net loss for 2Q22. The biggest drag on this was a US$3.9bn pre-tax valuation loss from Rivian, and losses in its equity investments. Removing these losses, the company would have had a normalized PATMI of US$3.5bn.

Outlook

Revenue guidance was positive, with Amazon expecting growth of 13%-17% due to Prime Day being in 3Q22 compared with 2Q21, even with an estimated 4% of FX headwinds. Operating margins were similar to 1Q22 guidance, at 0.0%-2.8%, weighed down by continued costs due to inflationary pressures and increasing investments in AWS and additional content for Prime members.

Amazon continues to focus on investing in AWS (~50% of CAPEX for FY22e), with plans on increasing headcount and infrastructure in 24 new geographies to better position itself, and at the same time working on building out a pipeline for AWS bookings – remaining life of current bookings is around 4 years. The company seems to have worked through its over-staffing issues from the last quarter and continues to improve the efficiency of its fulfilment services – increasing delivery density and package deliveries per hour.

• 1Q22 revenue was in line at 21% of FY22e forecast, while adjusted PATMI came in at a mere 15%, excluding a pre-tax valuation loss of US$7.6bn from Rivian Automotive.
• US$6bn incremental cost from external factors: transport rates, higher fuel prices, wage inflation, and internal factors: productivity and overcapacity hurt margins. Internal factors (2/3) may ease next quarter while the external (1/3) will linger.
• Guidance was weaker than expected for both revenue and margins. The focus for the next few quarters will be to work down internal costs and pass on some external costs to sellers. This may take up to three quarters. Our FY22e revenue and adjusted PATMI are cut by 3% and 15% respectively. Maintain BUY with a lower target price of US$3,130.00 based on DCF with a WACC of 6.2% and terminal growth of 5.0%.

Results at a glance

Source: Company, PSR

The Positive

+ Amazon Web Services (AWS) beat estimates. Amazon’s cloud business grew 37% YoY to US$18.4bn revenue, beating our estimate of 35% growth. Demand continued across the board from governments and not-for-profits to start-ups and enterprises. AWS expanded 16 local zones in the US, with 32 more to come across 26 countries.

The Negatives

- Higher costs hurt margins. Operating margin was 3.2%, significantly lower than an estimated 4.6% and at 3-year lows. External factors added US$2bn incremental costs: transport rates are 2x higher; fuel prices up 1.5x and wages are rising. Internal factors are productivity and overcapacity. Reduced productivity added US$2bn costs: Amazon is overstaffed after excess hiring during the COVID-19 Omicron wave which required sick leave replacements. Excess capacity in fulfilment added US$2bn costs in reduced fixed cost leverage: After expanding fulfilment services during the pandemic, consumer demand patterns have stabilized, while fixed costs from fulfilment remain elevated. Of the total US$6bn incremental costs incurred, US$4bn from productivity and overcapacity may ease in the next few quarters.

- Advertising growth was slower than expected. Ad revenue grew 23% YoY to US$7.9bn vs an estimate of 26%. We believe moderating e-commerce growth as the economy reopens and supply chain shortages impacting seller inventories was to blame. The advertising segment, along with AWS, is a key driver of operating income, estimated to have contributed US$7.1bn to 1Q22 operating income of US$3.7bn.

Outlook

Revenue guidance was weak, up to 8% lower than estimated, while the operating margin was up to 5% lower. The focus is to work down internal costs factors in productivity and overcapacity, while passing on some external costs to sellers through the 5% fuel and inflation surcharge announced on 14 April 2022. These will take time, perhaps up to three quarters. Staff numbers were worked down from a peak of 1.7mn to 1.6mn during the quarter, while Amazon’s annual Prime Day in July 2022, where demand usually surges, will help utilise fulfilment overcapacity.

Figure 1: 2Q22 guidance was weaker than consensus estimates

Source: Company, PSR

Maintain BUY with lower TP of US$3,130.00 (prev. US$4,079.00)

Our FY22e revenue and adjusted PATMI are cut by 3% and 15% respectively. Maintain BUY with a lower target price of US$3,130.00 based on DCF with a WACC of 6.2% and terminal growth of 5.0%. Secular growth drivers of AWS and advertising are intact, but Amazon is facing medium-term headwinds from normalising e-commerce growth, lingering inflationary costs and fulfilment overcapacity after the COVID-19 pandemic demand spike.

• FY21 results were in line with revenue and PATMI at 99% and 102% of our FY21 forecasts respectively, excluding a pre-tax valuation gain of US$11.8bn from the initial public offering (IPO) of Rivian.
• Amazon Web Services (AWS) 4Q21 revenue growth accelerated to 40% YoY, above consensus of 35% and our FY21 forecast of 33%. AWS is Amazon’s key growth driver, contributing 75% of FY21 operating income.
• New Amazon Prime membership price increases of 17% in 1Q22 should largely translate to bottom line and add about 10% to FY22e profit before taxes.
• The challenge from the tight US labour market is easing. However, guidance for net sales for 1Q22 was 3-6% weaker than consensus, signalling moderating demand. Amazon’s fulfilment network is no longer running at 100% capacity. As a result, we cut FY22e revenue by 3% and reduce operating margins from 8% to 6% due to still elevated wage and fulfilment costs, which lowers our FY22e PATMI by 31%. The swing factor is in margins from easing supply constraints. Maintain BUY with a lower target price of US$4079.00 based on DCF with a WACC of 6.2% and terminal growth of 5.0%.

The Positives

+ Operating margins above expectations. Despite additional US$4bn in costs from wage increases, higher transport costs and lost productivity due to Omicron, 4Q21 operating margin of 2.5% was better than guidance of 2.3% and consensus estimates of 1.8%. This was due to less than expected increase in staffing of 140,000 vs guidance of 150,000 for 4Q21. The tight labour challenges will improve in 1Q22.

+ AWS growth accelerated. AWS revenue growth accelerated to 40% YoY, above consensus of 35% and our FY21 forecast of 33%, and the 7^th consecutive quarter of increasing growth. AWS is Amazon’s key growth driver, contributing 75% of FY21 operating income. Advertising services, the second key growth driver, grew 55% YoY beating our FY21 forecast of 53%.

+ Huge valuation gain from Rivian. Amazon enjoyed a pre-tax valuation gain of US$11.8bn from common stock investment in Rivian Automotive Inc, which completed an IPO in November 2021.

+ Price increases for US Amazon Prime memberships. Prime membership prices in the US will be increased from US$12.99 to US$14.99 monthly or from US$119 to US$139 annually. This represents a 17% increase. The additional US$3bn in fees should largely translate to the bottom line, which adds a 10% to FY22e profit before taxes. There are about 149mn Amazon Prime members in the US. There was little churn in previous price increases.

The Negatives

- Ecommerce growth moderated. 4Q21 ecommerce sales grew 4% YoY to US$109bn, slower than consensus estimates of 5%. Amazon’s fulfilment network is no longer running at 100% capacity, signalling moderating demand. This has led to US$1bn negative impact on operating income from lower fixed cost leverage. However, CAPEX in fulfilment centres, which represents 30% of CAPEX, is expected to moderate moving forward.

Outlook

E-commerce growth is normalising after a pandemic-induced surge. Guidance for 1Q22 net sales of US$112bn to US$117bn was 3-6% weaker than consensus of US$120bn. In addition, capex is expected to remain elevated in FY22 as Amazon continues to ramp up AWS infrastructure and transportation capacity. However, despite the weaker sales guidance, FY22 will benefit from easier comparables in FY21 vs the previous comparables in FY20. The swing factor in 1Q22 guidance is margins, likely due to the potential moderation of elevated fulfilment and labour costs as supply constraints ease.

• 9M21 revenue and gross profits were in line at 70%/72% of our FY21 forecast. Operating margins down 2% points to 4.4% on higher labour and fulfilment costs.
• Amazon’s cloud and advertising businesses continue to show register healthy growth of 39% and 50% YoY respectively.
• Maintain BUY with revised target price of US$4,157.00, down from US$4,329.00. Our valuations are based on DCF with a WACC of 6.2% and terminal growth of 5%. We revise our FY21e PATMI down 10% on higher guidance of labour and fulfilment costs for 4Q21e.

The Positives

+ Healthy growth for Amazon Web Services (AWS) and advertising. AWS, Amazon’s cloud computing business, revenue jumped 39% YoY to US$16.1bn in 3Q21, strongest growth in the last 8 quarters. Industries whose spend was suppressed by the pandemic, are recovering and accelerating their use of the cloud. Amazon’s advertising revenue (other), grew 50% YoY to US$8.1bn, on track to reach our FY21e target. Supply chain pressures have not impacted advertisement demand.

The Negatives

- Operating margins fell 2% points YoY to 4.4%. On the e-commerce front, Amazon is absorbing higher costs from rising wages and productivity losses from labour shortages, higher steel prices and trucking/container capacity costs. These increased 3Q21 operating expenses by US$2bn (2% of revenue), leading to operating expenses spiking 2x faster than revenue. These costs are guided to approach US$4bn through the 4Q21 holiday season as Amazon ramps up staffing by 150,000 and opens access to new ports and container capacity.

Outlook

As Amazon prioritise its customers’ experience, higher costs will be incurred to ensure fast delivery times and available stock during the holiday season. Higher costs are expected to dampen growth for the next quarter. We also worry the higher cost may linger into the following quarters as the US labour shortage may persist and higher wages take a permanent nature.

Maintain BUY with revised TP of US$4,157.00, down from US$4,329.00.

Our valuations are based on DCF with a WACC of 6.2% and terminal growth of 5%. We revise our FY21e PATMI down 10% on higher than expected labour and fulfilment costs for 4Q21

• Cloud services and advertising to spearhead secular tailwinds with expected revenue growth of 33% and 54% respectively in FY21e.
• Core e-commerce business rapidly scaling up fulfilment and logistics capabilities to further widen its moat. Fulfilment centre square footage is expected to jump 44%.
• Initiate coverage with a BUY recommendation and DCF target price (WACC 6.2%) of US$4,329.

Company Background

Amazon owns the leading e-commerce platform in the US, and the world’s largest cloud computing business - Amazon Web Services (AWS).  Amazon’s online stores generated 51% of FY20 revenue, retail third-party seller services 21%, AWS 12%, retail subscription services 7%, advertising 6%, and physical stores 4%. The US (68% revenue) is Amazon’s biggest market, followed by Germany 8%, UK 7%, Japan 5%, and the rest of the world 12%.

Investment Merits

1. More upside for Amazon Web Services (AWS). Public cloud penetration of IT budgets remains low at 4%. As more companies switch to cloud services to meet their IT  needs, we expect Amazon’s cloud business to capture much of the growth. We believe AWS’ strength is its ability to execute, security and reliability while offering similar pricing compared to no. 2 Microsoft Azure (20% market share). As the largest player (32% market share), AWS has a greater ability to secure larger scale contracts, such as the multibillion-dollar Department of Defense contract awarded by April 2022. AWS is also scaling faster than competitors with the highest hyperscale data centre capex in the last four quarters. We expect AWS revenue growth of 33% in FY21e and margins of 32% to lift the bottom line significantly.
2. Amazon advertising continues to take market share. Amazon’s first-party user data (data collected directly from Amazon.com) is unaffected by Apple’s new iOS 14 privacy update, which may adversely hurt Facebook ad effectiveness in targeting customers. In addition, Google intends to phase out third-party cookies on Chrome browsers by 2022, forcing marketers to instead rely on first-party data providers such as Amazon ads. Amazon is also expanding their ad capacity and services, recently doubling sponsored ads on web pages and adding video ads and sponsored brand posts. Advertising is Amazon’s fastest growing business with margins estimated to be above 50%. We expect Amazon’s ad revenue to grow 54% in FY21e as higher demand drive up prices, which rose 30% to over US$1.20 per-click since the beginning of 2021.
3. Core e-commerce business expanding its moat. Fulfilment centre square footage is expected to jump 44% in the next few years to 578mn square feet as Amazon boosts capex. Stickiness with buyers and sellers keeps rising. Fulfilment by Amazon, Amazon’s logistics service, is a key reason why sellers choose to sell on Amazon. It fulfils orders for sellers, allowing them to scale quickly, save time, and enjoy a wide regional reach with ease of use compared to using multiple delivery carriers. For buyers, Amazon Prime members, a gauge of recurring Amazon shoppers, is expected to top 153mn this year (about 63% of total US households) as more regions offer free 1 to 2-day shipping for Amazon Prime. We expect Amazon’s gross merchandise value growth to continue to outpace US retail market growth, with Amazon’s e-commerce market share increasing.

We initiate coverage with a BUY rating. Our target price is US$4,329 based on DCF valuation with a WACC of 6.2% and terminal growth of 5%.

REVENUE

Amazon has six sources of revenue: online stores (51% of FY20 revenue), retail third-party seller services (21%), Amazon Web Services (12%), retail subscription services (7%), other – ads (6%), and physical stores (4%). The US (68% of FY20 revenue) is Amazon’s biggest market, followed by Germany (8%), the UK (7%), Japan (5%), and the rest of the world (12%). Total revenue has expanded at 30% CAGR over the past 5 years, riding on the growth of e-commerce, cloud, and digital ad markets, where Amazon holds leadership ranks.

Advertising is Amazon’s fastest growing segment, which makes up 90% of ‘other’ revenue. It grew 66% CAGR from FY15 to FY20 and is expected to grow 53% in FY21. We expect AWS to emerge as the second fastest grower at 33% in FY21 as revenue from online stores and retail third-party seller services normalise after spiking from the onset of COVID-19.

EXPENSES

Cost of sales grew at 20% CAGR in the past five years, compared to revenue growth of 30%. Operating expenses grew more in line at 28% CAGR. Operating expenses include fulfilment (15% of FY20 revenue), technology & content (11%), marketing (6%) and general & administrative (2%) costs. Technology & content, marketing, and general & administrative costs have remained in stable ranges of 11.1% to 12.8%, 5.3% to 6.7%, and 1.7% to 2.1% of revenue respectively. However, fulfilment costs have risen from 13.0% to 15.2% due to fulfilment network expansion, higher staff costs and COVID-19 productivity reduction.

MARGINS

Operating margins have gradually risen from 3% to 6% from FY16 to FY20. AWS and advertising are Amazon’s main sources of operating income and margins. AWS operating margins are at 30%, up from 25%, while advertising margins are estimated to be higher than 50%, in line with other large pure-play digital ad companies. We estimate the retail business (merchandise sales) to operate at a negative 0.4% operating margin.

BALANCE SHEET

Assets: Fixed assets have grown by four times to US$113bn in the last five years as Amazon expanded its network of fulfilment warehouses and data centres. It spiked 56% in 2020 as Amazon accelerated fulfilment capacity to meet pandemic demand for online sales. Fixed assets made up 35% of total assets, and is expected to grow an additional 15% in 2021.

Liabilities: Amazon has a net cash position of US$53bn, which grew at 30% CAGR from US$18bn in the past five years (Figure 3).

CASH-FLOW

Cash-flow from operations spiked 72% YoY to US$66bn in FY20 from increased profitability during the pandemic, while capex almost tripled YoY to US$35bn from aggressive expansion (Figure 4). Capex as a % of operating cash-flow is expected to remain above 50% compared to the pre-pandemic average of 41% as Amazon continues to expand fulfilment and AWS capacity