Growth Stocks: Amazon

Before the results of the second quarter of Amazon (AMZN.US) are known, let's see the keys to its growth based on its business units. AWS (Amazon Web Services) represents a fast-growing and highly lucrative business with strong competitive advantages. Its success is expected to propel Amazon's growth to unprecedented levels. AWS could thrive as a stand-alone entity, but the appeal of investing in Amazon lies in accessing its wide range of capabilities. This company is deeply rooted in innovation and its future potential is limitless, making it unpredictable how it could replicate the success of AWS. Additionally, Amazon has many opportunities to improve its profitability beyond AWS, which prevents its overall profitability in the future.

Statista

Although AWS has experienced a slowdown due to uncertainties in the broader macroeconomic environment, Amazon's other divisions, which have been underperforming, are on track to become catalysts in 2023. As efficiencies take effect and inflation, especially in the fulfillment of orders, decreases, allows us to anticipate a reversal in the decrease in margins. Now, let's focus on the essentials investors should watch when Amazon releases its second quarter 2023 results.

The company has a great position in two huge businesses and has options to add new growth over the long term. No one knows how the market will treat the stock on a day-to-day basis, but we maintain an upbeat rating for Amazon going forward.

U.S. e-commerce retail sales by company in 2022 (Insider Intelligence)

Amazon's achievement in capturing nearly 40% of the US digital retail market is the result of a decade-long effort that involved significant investments worth billions of dollars. This strategic allocation of resources allowed Amazon to build a robust infrastructure capable of serving such a vast market. The company's dominant position has created a significant competitive advantage, making it difficult for others to challenge its position. For example, Shopify tried to compete with Amazon's fulfillment, but finally gave up after just one year, recognizing the formidable advantage Amazon had.

Similarly, in the cloud business, Amazon's AWS has consistently held approximately 33% of the global market, positioning itself as the leading cloud platform. With such a position, Amazon becomes the target of competitors, but the company still shows a position of strength. Microsoft with its Azure, considered one of AWS's main competitors, has jealously guarded its financial results, integrating them into a broader segment called Intelligent Cloud. Although temporarily leaked court documents revealed that Azure revenue was lower than many analysts had expected, Microsoft does not disclose Azure margins, raising questions about transparency.

On the other hand, Alphabet's Google Cloud, another contender in the cloud market, has only recently started turning a profit. In the second quarter of 2023, it reported operating income of $395 million from cloud revenues totaling $8.0 billion. Despite its progress, Google Cloud is still a smaller player compared to AWS, further reinforcing Amazon's position of strength in the cloud industry.

Market consensus on Amazon's results in the second quarter

• Amazon is scheduled to announce its second-quarter 2023 results on Thursday, August 3, after Wall Street closing. There are several aspects that investors should be aware of.

Starting with the highlighted numbers, analysts project Q2 2023 revenue to reach $131.3 billion, indicating a year-over-year growth rate of 8.3%. This number slightly exceeds the midpoint of the company's own revenue guidance for the first quarter, which ranged from $127-133 billion. It's important to note that in the past two quarters, Amazon has surpassed the high end of its revenue guidance, so there's a chance it could happen again.

AMZN revenue guidance, market consensus and latest data release. seekingalpha

However, it is important to recognize that the market takes a forward-looking approach and, consequently, most investors will be keeping an eye on the projections provided by the company for the third quarter of 2023. According to analysts, Amazon is expected to Reach third-quarter revenue of $138.2 billion, representing 8.8% year-over-year growth.

While it is intriguing to note that analysts still see solid growth for Amazon amid economic uncertainties, the reality is that overall revenue growth may not be the market's top concern when the company finally releases its results.

We believe there are two crucial factors that will significantly affect Amazon's stock movement immediately after the results: EBIT (Earnings Before Interest and Tax) margins and the growth trajectory of AWS (Amazon Web Services).

Focusing on the first, operating income where analysts expect Amazon to deliver an EBIT of $4.610 million, which would result in an EBIT margin of 3.5%. This represents an impressive 39% year-over-year increase from Q2 2022. Again, it is noteworthy that this EBIT figure aligns with the high end of the company's guidance range of $2-5.5 billion, provided in the prior quarter. .

AMZN operating income guidance, market consensus and latest data release. seekingalpha

Finally, in anticipation of the third quarter of 2023, analysts project Amazon to achieve an operating income of $5.330 million, which would result in an EBIT margin of 3.9% and a staggering year-over-year growth of 111%. This notable increase in profitability signals a substantial turnaround for Amazon, and shareholders should be excited to see the potential improvement in EBIT margins in the coming years.

1. AWS is approaching single-digit growth rates

Amazon's crown jewel, AWS, has lost some of its luster in the past year. During 2020 and 2021, many technology companies experienced remarkable success and high demand, which in turn galvanized AWS by providing cloud infrastructure and services to these burgeoning companies.

However, things changed in 2022 and 2023 as demand waned, the economy looked uncertain, and cloud computing investments declined, causing a significant slowdown for AWS.

AMZN AWS Evolution, YoY and Quarterly Growth. seekingalpha

Q1 2023 saw decent 16% year-over-year growth for AWS, but what concerned investors was the sequential decline from Q4'22 to Q1'23, indicating a possible continuation of the decline in growth rates. YoY in the current quarter. On the first quarter earnings call, CFO Brian Olsavsky provided some grim early indications, mentioning that revenue growth rates in April were roughly 500 basis points lower than those seen in the first quarter.

If this trend continues through the entire second quarter, it could push year-over-year growth rates to 11%. However, the situation could be even more discouraging. The Zacks consensus estimate for AWS net sales is $21.5 billion, representing only 9% year-over-year growth in the second quarter, which is a significant slowdown. As investors, we expect to see improved quarter-over-quarter (QoQ) growth, as this would serve as a first indication of a gradual recovery in AWS's growth trajectory..

2. Anticipating a rapid improvement in profitability

Fortunately, the positive outlook for Amazon suggests that things should improve overall over the next 12 months, especially if we see improvement in AWS sequential growth this quarter.

Another potential catalyst for AWS is its margins, which have seen a sharp decline in the past year.

AMZN revenue guide and operating margin. seekingalpha

Earlier this year, Amazon CEO and AWS leader Andy Jassy assured investors in a letter to shareholders that the company did not intend to maximize revenue extraction from its AWS customers during challenging times. Instead, Amazon committed to working collaboratively with customers to foster successful long-term partnerships.

Long-term shareholders may understand that this customer-centric approach may have a short-term impact on AWS's growth rates and margins through 2023. However, this strategy has the potential to ease the path to greater future success for AWS. As the pressure on AWS customers eases (which may already be happening), We see substantial momentum in revenue growth and EBIT margin expansion, which will act as significant catalysts for AWS performance and will have a positive impact on Amazon's stock price.

Another promising catalyst for margin improvement, already underway, is the improvement in Amazon's business outside of AWS. The graph below indicates that EBIT margins in North America are likely to have bottomed out in Q1 2022, while EBIT margins for Amazon's International segment appear to have bottomed out in Q3. 2022. This upward trend is promising for the company's overall profitability and could further contribute to its recovery.

Operating margin in the US vs. International. seekingalpha

These margins have been steadily recovering ever since, and it is important to note that North America reported positive EBIT in the last quarter, marking the first time since Q3 2021. We expect these margins to continue to improve throughout 2023 and into 2024, as the headwinds Amazon faced last year, such as high inflation, high energy costs, the strengthening US dollar, and overexpansion during the e-commerce bubble due to lockdowns, will gradually dissipate. In addition, Amazon's cost-cutting measures will likely pay off.

In short, Amazon's shareholders look as if they shouldn't experience any further difficulties in terms of operating income and the company is well on its way to recovery. The non-AWS segments have already shown signs of turning around, and we expect to see signs of turning around on AWS towards the end of 2023, or possibly sooner if we're lucky.

3. Advertising continues to thrive

Another important aspect to consider is advertising, which represents a line of business with higher growth and higher margins for Amazon. We expect it to continue to stand out in 2023 and beyond, especially as the digital advertising market has shown signs of recovery after a challenging 12-18 months. During the first quarter earnings call, CFO Brian Olsavsky highlighted the strong commitment to Amazon's advertising services, with revenue up 23% year-over-year (excluding the impact of exchange rates). He also emphasized the company's ongoing efforts to carefully place ads across its various platforms, including video, live sports, audio and supermarkets, which offer significant growth potential.

Advertising remained the fastest growing revenue source reported by Amazon in the first quarter of 2023, contributing approximately 7.5% of total revenue. As a result, this business line could become another high-growth, high-margin segment in the coming years, generating significant shareholder rewards.

Amazon Valuation

As with all innovative companies, valuing Amazon is challenging. Getting an idea of whether Amazon is currently perceived as overvalued or undervalued is difficult, but with the understanding that business strength and potential are fundamental considerations, it seems that even in a bottom-line scenario, Amazon will continue to do so.

We have maintained a similar valuation model as my previous analysis, with updated numbers for Amazon enterprise value and the latest analyst estimates. Overall, analysts expect slightly higher growth and improved margins, which is in line with the significant excess margin seen in the first quarter.

Taking into account all factors such as current book value and market consensus valuation, as well as margin prospects for the business, Amazon's compound annual growth (CAGR) can range from 1% to 13% to 36%. %, based on negative, neutral, and positive scenarios respectively for 4-5 year projections through 2027. For 2023 estimates, worst case scenario stock would cut as much as $118 per share. In the neutral case, the share could go as high as $143 and in the most optimistic scenario, close the year 2023 above $200 per share.

AMZN.US, D1. Source: xStation

In conclusion, Amazon's second quarter earnings report is likely to be mixed. The market may express concerns about AWS's potential to achieve single-digit growth rates, but on the other hand, we expect Amazon to deliver higher-than-expected returns as the rest of the company is no longer a burden. for the margins.

Dario Garcia, EFA
XTB Spain