Amazon.com Inc. – Improving efficiency through regionalization

 

 

The Positives

+ Retail operating income was driven by regionalization and efficiency. AMZN’s retail operating income improved by 382% YoY. North American/International segment’s operation income increased from -US$0.2bn/-US$2.2bn in 4Q22 to US$6.5bn/-US$0.4bn in 4Q23, primarily driven by cost-cutting and lower transportation rates. North America benefit from regionalisation and expansion of last-mile delivery facilities, increasing same day deliveries by 65% YoY. Improved inventory placement drove faster deliveries and lowered transportation distances (cost to serve declined by >US$0.45 per unit). We foresee revenue growth to continue in the long term as lower costs lowers ASPs, improving affordability. This, together with faster delivery speed, should lead to greater purchase consideration & frequency.

+ Advertising growth remains robust. Advertising revenue grew 27% YoY in 4Q23, primarily driven by sponsored products with higher ads relevancy. AMZN benefits from being able to collect its own first-party data, and has been able to efficiently convert this data into more efficient and relevant ads for consumers, driving up ROI for advertisers. We believe advertising remains AMZN’s great growth opportunity as it has the ability to scale alongside its retail business, advertising only contributes 8% of the company’s total revenue presently.

+ AWS seeing stabilization in growth.  AWS revenue was up by 13.2% YoY in 4Q23, compared to 12.3% and 12.2% YoY in 3Q23 and 2Q23. AWS revenue growth has dipped in previous quarters due to customers moderating their spending. The recent acceleration in growth rate suggests that this effect has bottomed out. Accelerated new deals and backlog conversion is expected to drive growth. Management has indicated that the acceleration in growth will continue into FY24, driven by accelerating demand in Gen AI. AWS’ order backlog grew ~40% YoY in 4Q23.

 

The Negative

- Nil.

Amazon.com Inc. – Margins expansion still the main story

The Positives

+ Margins continue to improve. Gross and operating margins expanded by ~300bps and ~600bps YoY, respectively. Operating income more than tripled YoY to a record level of US$11.2bn, beating the top-end of US$8.5bn company guidance. The retail business benefitted from the lower cost to serve because of its fulfillment network regionalisation initiative in the US, easing inflationary pressure in line-haul, ocean, and rail shipping rates, as well as the strong 26% YoY growth of its advertising business (7% of revenue). AWS operating margin also expanded by 600bps QoQ and 400bps YoY, back to the level last seen in 2Q22, primarily driven by headcount reductions in the business and lower energy costs. 

 

+ AWS growth stabilised. Segment revenue was up by 12% YoY, in line with management’s guidance of stabilising growth. Despite customer cost-optimisation efforts being relatively elevated compared to 2022, it is starting to meaningfully attenuate as more companies shift their focus towards deploying new workloads. Management expects the rate of such optimisations will continue to ease in the next several quarters. Furthermore, AMZN indicated that it signed several deals with customers that will take effect in 4Q23, including those where existing customers expand their AWS deployments and move away from short-term contracts to commitments ranging between 1-3 years. Hence, we expect growth will start to re-accelerate in the near term.

 

+ Strong free-cash-flow. Trailing-twelve-months (TTM) FCF was US$21.4bn, tripling QoQ and a US$41bn improvement YoY. This was driven by the increased operating income in both retail and AWS segments, improved leverage on fixed costs and working capital efficiency.

 

The Negative

- Nil.

Amazon.com Inc. – Efficiency enhancements bearing fruit

 

 

The Positives

+ Revenue beats guidance. 2Q23 revenue grew 10.8% YoY to US$134.4bn, above the top end of US$133bn company guidance. International segment revenue growth re-accelerated QoQ as it was up by 9.7% YoY, from a growth of 1% YoY in 1Q23, as macro conditions continue to improve. Advertising growth also improved, increasing by 22% YoY (vs 21% in 1Q23) to US$10.7bn (7.9% of total revenue), with Amazon’s performance-based advertising offerings being the largest contributor. AWS was up 12% YoY, slightly above company guidance of 11%.

 

+ AWS growth stabilising. Despite customers continuing to optimise costs in 2Q23, management said it has started seeing some customers shift their focus towards innovation and new workload deployments. Amazon sees the trend continuing into 3Q23 and it expects the optimisation efforts to ease further, suggesting that growth has bottomed out. Hence, we believe there is a possibility of re-acceleration in 2H23, particularly in 4Q23, as Amazon rolls out its new AI services while customers gradually increase their spending on AWS.

 

+ Efficiency enhancements drive operating leverage. Gross and operating margins each expanded by ~300bps YoY, with operating income more than doubling to US$7.7bn from US$3.3bn in 2Q22. This was driven by the reduction in the cost to serve (shipping and fulfillment costs) as Amazon is seeing easing inflation headwinds, particularly in fuel prices, linehaul rates, ocean and rail rates. In addition to that, it is also benefitting from the headcount reductions (which fell by 4% YoY or 62,000 employees) and a lower CAPEX. The company’s regionalisation initiative is paying off as it reduced the number of touches for packages by 20% and miles traveled to deliver packages to customers by 19%, resulting in less transportation costs and faster delivery speed.

 

+ Strong free-cash-flow. Trailing-twelve-months (TTM) FCF was US$7.9bn, the first positive FCF since 3Q21. The improvement was driven by increased operating income as a result of higher operating leverage and the moderating inflationary pressure, as well as lower CAPEX.

 

The Negative

- Nil.

 

Amazon Inc. – Retail starting to recover

 

 

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.

Amazon Inc. – Longer term remains attractive

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.

Amazon Inc. – FX inhibiting revenue growth

 

 

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.

Amazon.com Inc. – Cost pressures surpassing healthy demand

 

 

 

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.

Amazon.com Inc – Cost pressures to linger

 

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.

Amazon.com Inc – Normalising sales growth

 

 

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 7th 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.

Amazon.com Inc – Absorbing higher costs

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

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