By: Yourstockresearch.com 1 st September 2023
Is It A Good Time To Buy Amazon After The Quarter?
Amazon’s second quarter results came in stronger than expected with a net sales increase of 11%. CEO Andy Jassy reiterated that Amazon was focused on improving its cost structure, and explained how the company continued to streamline costs and improve profitability. In recent times, Amazon’s operating profit had declined and during the past quarter the company was able to bring its operating profits margins back up to historical levels of around 6-7%.
Despite weakening consumer sentiment, both North American sales and international sales have increased at a similar pace – with international sales increasing by 10%, and North American sales increasing by 11%. AWS sales, on the other hand, increased by 12% to 22 billion, with an operating profit of around $5.1 billion.
In terms of retail – home, fashion, and, beauty remained the top-selling categories, and these categories are slightly more resilient to overall economic sentiment than other segments.
Taking a Closer Look at AWS
AWS continues to be the biggest factor in Amazon’s valuation, but its slowdown may also trigger a correction of the stock. Previous years have witnessed 30% growth, drawing investors increasingly more toward Amazon. This may no longer be the case.
AWS’ growth has slowed down in the middle of the third quarter as inflation and economic uncertainty continued to take hold. While Amazon has done well to continuously increase its product offerings vis a vis AWS, it has not been immune to lower capital expenditure on cloud. Cloud spending now amounts to a total of 18% of overall global IT spending, and AWS has become a central part of the global cloud infrastructure. Amazon has reiterated that the benefit of AWS is that you can adjust capacity for your business anytime you like, which can save costs during economic upswings and downswings. While this helps customers save costs, it will continue to negatively affect AWS.
AWS should continue to grow at relatively steady pace – with global cloud spending continuing to grow in the low double-digits with a total growth of around 12% in 2023. Most IT companies have been paring back their spending as increasing pressure from higher interest rates continues to affect outlook. Since SaaS companies – who are often clients of Amazon – may be more suspect to pricing and inflationary pressures, thereby affecting their own spending outlook. AWS currently maintains around 33% of the market share, followed by Microsoft and then other major competitors such as Google, Oracle, etc. The top-3 maintain around 65% of the market share.
AWS’ market share lead primarily stems from its pricing and the wide net it has cast in terms of targeting users while continuingly offering new services.
AWS total revenue rate came in at $82-86 billion, while operating income is expected to come in at $22-24 billion. AWS has continued to add multiple integrations – including the integration of a Linux-based operating system, along with many other types of features – which it believes will drive customers. It also now has a key data encryption integration known as S3, which is helping to drive automatic encryption of data.
Global Consumer Sentiment Key to Amazon’s Fortunes
U.S. consumers have continued to struggle in recent times, with high credit card debt, and inflation eating into savings. But on the other hand, the likes of the UK and Europe have also seen significant slowdown due to high inflation. German manufacturing is falling off a cliff, and overall sentiment remains weak.
Other regions such as Asia continue to perform better and is expected to grow around 4-5%, and with their economies a lot more robust than developed economies their own growth would supportive of Amazon’s growth in the next few quarters.
Operating Income Falling, Retail Continues to Struggle
The long-term operating profit margins of Amazon in previous years as afore-mentioned was supposed to be heading towards 5-6%, mainly due to the economies of scale, and Amazon’s efficient backend. But during previous quarters, operating margins came in at 1.8% – and although they recovered during the current quarter it remains to be seen whether Amazon can once again head back to previous highs for the rest of the year. Amazon had previously projected that its operating profits would increase, and they clearly are delivering in the short-term.
Amazon is cutting employees and faced a one-off severance cost of $640 million during the previous quarter. It is likely beyond the 18,000 headcount reduction, and there will further cuts down the road. Furthermore the write-offs from previous quarters, due to Amazon Fresh and Go stores weren’t an issue during the current quarter. Some of the employees laid off will continue to affect profitability, but eventually the increase will be reflected in the P&L.
In terms of sales, Amazon is still highly dependent on the American market – with current US sales comprising of a total of 61% of total sales, and international sales at about 23%. This means Amazon is highly exposed to the US economy, which has been robust, but consumer sentiment remains low, with falling purchasing power. Global retail still remains unprofitable, and Amazon continues to see losses – both in North American and internationally. It remains to be seen when Amazon will make money on its retail business where it has been increasingly putting money into, in order to gain market share. Furthermore, continued investment into the infrastructure for retail and low product pricing is leading to losses. Amazon might have to eventually increase the pricing model slightly – which it has been reluctant to do – but that is the most likely scenario.
Amazon currently has 38% of the online market share, but the market share in retail sales is slightly lower at around 6% and Amazon’s hoping to retain this. Meanwhile, their international e-commerce market share stands at around 14%.
In terms of valuation, Amazon price-to-sales remains relatively okay at around 2.65x. This could make investors vary despite profitability no longer being an issue. But regardless, the stock could be heading down if the coming quarters continue to show weakness. The stock currently trades at around $136 a stock, and the stock could be heading down towards to $80, with a 10-15%, correction. This is likely the most prominent scenario, as the next few quarters will continue to be weak.
How Will Amazon Perform Through the Third and Fourth Quarter?
Amazon will continue to use the current global outlook to streamline their operations, and with inflation, revenue could finally slow down. Subsequently margins may be affected and fall back down to historical levels – this means that profitability will likely be more moderate than expected.
Two key factors continue to affect the company – firstly, AWS sales are decreasing, and secondly, inflation is continuing to remain strong. Early indications show consumers are finally slowing down in spending, and the third quarter might be the quarter where the slowdown is finally apparent. Spending out of developing markets may mitigate some of Amazon’s slowdown, but since developed markets still make up a significant portion of spending, it remains to be seen whether overall international sales will perform. North American sales will likely similarly witness a slowdown, with the United States retail market likely to slowdown in ‘higher end’ spend category.
I expect operating margins to fall back to around 4-5% for the quarter and this could affect end-of-year profitability.
Forward-Looking Financials for Amazon Stock
End-of-year profitability should come in around $22 billion, which would put FY23’ forward price-to-earnings at around 65x, which might be too rich for investors. This would mean that the stock could see a correction of around 10-15%. The current price-to-sales are around 2.67, which itself is reasonably high and has been hinging on growth and margins AWS to justify the current valuation range. AWS itself is slowing down, and could be the catalyst for correction if growth doesn’t pick up.
Should You Invest in Amazon?
Amazon’s long-term prospects remain strong, and cloud spending won’t fall off a cliff, but it won’t grow at the levels it has in the recent past, either. Regardless, once interest rates and inflation steady out, and economies – especially the likes of Europe, where the economy is facing a significantly larger slowdown – and to an extent the U.S. steadies out in terms of rate rises and economic realignment from the rate increases, Amazon will be facing headwinds. Therefore, especially with the stock increasing to levels that might not be sustainable, in the short-term, Amazon’s investor might wait out the current exuberance period. Any investment into Amazon should be seen from a long-term perspective, as the overall long-term themes are playing out well, and returns over a 10-year period could be closer to around 10% per annum.
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