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Yukon in J.T. Marlin,

Yet Another Chance to Go Long Amazon

We initiate coverage of Amazon.Inc (NASDAQ:AMZN) with a strong BUY recommendation. The key assumption underlying our positive view on Amazon is continued growth in Electronics and other general merchandise (EGM) segment and high levels of Amazon Prime subscribers delivered in recent years. We expect that these positive factors won’t be offset by concerning issues such as slowdown of sales in Media segment.

We expect EGM revenue that accounted to 76% of total revenue in 3Q 2015 to be a key driver of Amazon’s future growth that is supported by the success of Prime Now services and international expansion of Amazon. As more and more retailers switch to e-commerce, the competition is getting tough and result in profitability margin squeeze for market players. We consider services such as Prime Now as an opportunity to gain an advantage in this highly competitive environment by offering customers ‘value added’ such as quick delivery options. The growing number of Prime subscribers fuels Amazon’s top line, especially in EGM segment.

According to Thomas J. Szkutak, CFO of Amazon, Prime members tend to buy more since it's more convenient and they are getting their physical products faster than when they are not Prime members. The number of prime subscribers shows solid growth both in absolute terms and relative to total number of Amazon customers (Prime penetration rate).

Source: Company Annual Report 2014

The other key driver that supports EGM revenue growth is Amazon’s international expansion. For instance, Amazon’s active customer accounts in India plunged 230% YoY in 3Q 2015, with revenue almost tripled during the same period. According to Q3 2015 Financial Results, Amazon continues to be India’s largest store with over 30 mn products. In 2015, it has been adding an average of over 40,000 products a day.

Despite the fact that Media segment remains the significant contributor to Amazon revenue, its importance to the company’s top line is diminishing. Since the share of Media segment in total revenue decreased from almost 45% in 2010 to 21% in 2015 and we expect it is to go down further, we believe investors should not be concerned about slowdown in Media sales.

In conclusion, we believe that the Amazon stocks has a significant growth potential, largely due to lucrative growth opportunities in EGM segment that offset weak performance of Media business. Even AWS segment that accounts for less than 5% of Amazon revenue should be considered as a star business that can be scaled up by introducing newer and cost effective solutions, such as Amazon Aurora and QuickSight. Therefore, we put strong BUY recommendation on Amazon stocks.