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Amazon Smashes 1Q Earnings Estimates, AWS Still The Star

Amazon.com’s AMZN first-quarter EPS of 1.07 was way ahead of the Zacks Consensus Estimate of $0.61. The North America and AWS segments were strong contributors to profits while investments in international continued. Non operating income also increased. Shares soared 12.6% in after-hours trading.

Highlights

FX: The FX impact on revenue was small in the last quarter at around $210 million. As far as impact on operating profit is concerned, the International segment’s 2 point negatuve impact was more than offset by the 9 point favorable impact in AWS. Management has said that the positive FX impact on AWS was because revenues were dollar-denominated while a lot of the assets were located in low-cost regions.

International/North America/AWS Mix: The segment contribution to revenue was positive in the last quarter, with the highest-margin AWS business growing 208 points, while North America and International segments declined 180 and 28 points, respectively. The North America retail business being mature, generates higher margins, while the international business, being accompanied by expansion costs including infrastructure, headcount and inventory generates very weak margins (contribution to operating profit was around 1% in the last quarter). AWScontributed 9% of revenue and 43% of profits in the last quarter. Combined segment operating income jumped 135.1% from last year.

Prime: Management didn’t mention Prime membership numbers, but they have been growing strongly at over 50% the last two years. The Prime membership has rolled out to some international markets like the UK and Japan, but is in various stages of implementation in other geographies. Even in the UK and Japan, it doesn’t include the entire product selection that is available in the U.S. Management stated that Prime rollout in other geographies was in various stages of implementation through various programs for faster delivery. FBA is increasing third-party sales and also increasing selection, but it tends to pressure fulfillment centers in heavy selling seasons as was seen in the December quarter.

Cash Flow: TTM cash flow and FCF as reduced by lease principal repayments jumped 101% and 134% on a year over year basis. They were down 13.2% and 26.5% respectively from the December quarter due to ongoing capital investments mainly in AWS and also in fulfillment centers for the retail business. 

The numbers in detail- 

Revenue

Amazon reported revenue of $29.13 billion, down 18.5% sequentially and up 28.2% from the year-ago quarter. Excluding the $210 million FX impact, revenue would have been up 29% year over year. This was better than the guidance range of $26.5-29.0 billion (down 22.4% sequentially and up 22.2% year over year at the mid-point) and well ahead of the Zacks Consensus Estimate of $27.94 billion.

Both product and service sales were down sequentially because of seasonality. Services grew much stronger than product sales from the year-ago quarter (they were up 51.7% compared to product sales growth of 20.5%). Revenue distribution between the two was 71%/29%.

Active customer accounts increased 6 million to over 310 million (285 million excluding those with free orders). Third-party units were 48% of total units in the quarter, up 1 percentage point from the previous quarter.

Segment Details

The North America segment accounted for around 58% of sales, representing a sequential decline of 21.0% and year-over-year growth of 43.3% and 26.8%, respectively. The International segment accounted for 33%, declining 19.2% sequentially and growing 23.5% year over year (up 26% in local currency). AWS segment grew 6.7% sequentially and 63.9% year over year with the revenue share up to 9%.

North America: Media was down 18.4% sequentially and up 8.0% year over year. EGM was down 22.0% sequentially and up 31.8% year over year. Other was up 13.1% sequentially and 48.1% year over year.

International: Media was down 24.7% sequentially and up 6.9% from last year (up 9% ex-FX). EGM sales were down 17.2% sequentially and up 30.8% from last year (up 33% ex-FX). Other revenue was down 10.3% sequentially and up 10.6% year over year.

AWS: The business continues to grow very strongly with the last quarter’s $2.57 billion taking the revenue runrate to over $10.2 billion. The company added 214 new features to AWS last quarter on top of the 722 in 2015 (in the first quarter of 2015, 170 new features were added). Amazon ended the quarter with 33 available zones and intends to add 11 more over the next year. Amazon remains the cloud infrastructure leader, well ahead of Microsoft (MSFT) and Alphabet GOOGL.

Gross Margin

The gross margin expanded 332 bps sequentially and 300 bps year over year to 35.2%. Sequential variations in gross margins are usually largely mix-related, although increased investments are an offsetting factor. AWS growth is having a positive impact. Pricing is an important factor, given the increase in product categories all over the world and Amazon’s strategy of heavily discounting products and services when it is building a position in any market. Third party sites are doing better than retail, which is also having a positive impact. Rising content costs are a negative.

 

Net shipping costs of 5.0% of sales were up from 5.2% in the December quarter and 4.4% last year. Management didn’t mention FBA contribution to total third party units, but it was 50% at the end of 2015.

Gross profit dollars were down 10.0% sequentially, but more significantly, they were up 40.2% from last year. The consistently rising gross profit dollars from year-ago periods is evidence of the success of Amazon’s strategy.

Operating Metrics

Amazon’s operating expenses of $9.19 billion were down 10.7% sequentially and up 30.0% from the year-ago quarter. Amazon’s heavy investing activities (headcount, fulfillment centers, content, etc) over the past few quarters have been driving up its costs. The sequential decline in sales in the last quarter had a negative impact on all expenses, with only COGS declining significantly as a percentage of sales. Fulfillment and marketing were differed marginally and technology & content and G&A increasing significantly. Fulfillment and marketing increased from last year as a percentage of sales.

The net result was an operating margin of 3.7%, up 58 bps sequentially and 255 bps from the year-ago quarter. Amazon reported an operating profit of $1.07 billion compared to $1.11 billion in the previous quarter and $255 million in the year-ago quarter.

The North America segment operating margin of 5.4% expanded 77 bps sequentially and 158 bps from the year-ago quarter. The International segment operating margin of 0.2% shrank 30 bps sequentially but expanded 119 bps from the year-ago quarter. The AWS operating margin of 27.9% shrank 66 bps sequentially but expanded 1,098 bps year over year. AWS improvements come from operating efficiencies and increased utilization of assets but margins will tend to be lumpy according to management because of levels of investing, price reductions and cost efficiencies.

Consolidated segment operating income (CSOI) was down 5.1% sequentially but up 135.1% from the year-ago quarter.

Net Income

Amazon generated first-quarter net income of $513 million, or 1.8% of sales, compared to $482 million, or 1.3% in the previous quarter and loss of $57 million, or 0.3% of sales in the same quarter last year. There were no one-time items in the last quarter. Therefore, the GAAP EPS was the same as the pro forma EPS of $1.07 compared to $1.00 in the previous quarter and -$0.12 in the year-ago quarter.

Balance Sheet and Cash Flow

Amazon ended with a cash and short-term investments balance of $15.86 billion, down $3.95 billion during the quarter. The company used $2.16 billion of cash in operations, spending $1.18 billion on fixed assets (including internal-use software and website development costs) and $16 million on acquisitions. Principal repayments of capital lease obligations were $801 million.

Amazon saw inventories drop 6.5% sequentially, with turns up from 9.5X to 7.9X. Receivables were up slightly in the quarter, with DSOs flat at around 16.

Guidance

Management provided guidance for the second quarter of 2016. Accordingly, revenue including 70 bps positive FX impact is expected to come in at around $28.0-30.5 billion (up 0.4% sequentially and 26.2% year over year at the mid-point, better than the Zacks Consensus Estimate of $28.1 billion). Operating income (including $825 million for stock based compensation and other operating items) is expected to come in at approximately $375 to $975 million.

Recommendation

The first quarter numbers are a clear indication that Amazon is driving value across all its businesses. So Amazon’s retail business remains very hard to beat on price, choice, convenience, you name it. The company has a solid loyalty system in Prime and its FBA strategy and content addition continue to add selection to Prime memberships. If Amazon is able to replicate its domestic success internationally, investors could see far more growth. At the moment, international contributes a third of revenue but generates just a fraction of profits.

The current strength in AWS profits is coming from efficiencies and increased utilization, so here too, it’s enjoying some leverage. Current margin expansion rates don’t look sustainable, and management said this could be somewhat lumpy going forward.

One area of potential growth is devices and IoT. And it’s probably not right to ignore the growing capabilities of Echo and Alexa in this regard and how they are being received by hardware partners. IoT devices/technologies aren’t likely to have a very big impact on results right now (revenue contribution won’t be material near term), but they could very well supplement the rest of the business by making it that much easier to buy from Amazon.

Amazon shares carry a Zacks Rank #3 (Hold). Better-ranked stocks in the sector are Mercadolibre MELI with a Zacks Rank #2 (Buy) or Travelport TVPT, which has a Zacks Rank #1 (Strong Buy).

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