Amazon (AMZN) recently reported financial results for the third quarter of fiscal 2019.
Revenues increased 24% to $70 billion, with strong double-digit growth in each of the company’s reporting segments (North America, International, and Amazon Web Services, or AWS). Notably, this was an acceleration in the growth rate compared to what we’ve seen in the past few quarters.
That acceleration largely reflects improvements in the North America segment, where revenues increased 24% year-over-year. As shown below, Amazon has seen a significant reacceleration in paid units’ growth in the past two quarters (after falling to +10% in the first quarter of the year).
Management noted on the conference call that this has largely been due to their one-day delivery efforts (“unit growth has reaccelerated in the last two quarters… we do attribute it to one-day”).
But while this is leading to strong results on the top line, it’s coming at the expense of profitability. According to management, these efforts were an $800 million headwind to profits in the second and third quarter, with that number expected to climb to $1.5 billion in the holiday quarter. As a result, operating income fell by 15% year-over-year in the third quarter (it is still up by 34% over the trailing twelve month period), with year to date operating income in the North America segment only climbing 2% despite a 20% increase in revenues.
Looking at the other segments, AWS revenues were up 35% in the quarter to $9.0 billion. Through the first nine months of the year, segment operating income (EBIT) has increased 29% to $6.6 billion, with operating margins contracting 170 basis points to 26.3%. As CFO Brian Olsavsky noted on the conference call, the short-term margin pressure reflects continued investment to support and grow the business:
“We continue to feel really good about not only the top line, but also the bottom line in that business, but we are investing a lot more this year in sales force and marketing personnel, mainly to handle a wider group of customers. We continue to add thousands of new products and features a year, and we continue to expand geographically. The biggest impact that we saw in year-over-year in AWS was tied to costs related to sales and marketing and also to a secondary extent, infrastructure… there has been a step up in infrastructure costs to support the higher usage demand.”
While there can be short-term swings in any given quarter, particularly in terms of the profit margin, the long-term results clearly show that Amazon continues to see success in the cloud business.
In the International segment, revenues increased 18% in the quarter, pulling the year to date growth rate to +13%. Amazon continues to lose money outside the United States (a year to date loss of $1.1 billion), but encouragingly the operating margin has improved by 120 basis points through the first nine months of the year.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Conclusion” data-reactid=”40″>Conclusion
Based on the results, it’s clear that the shift to one day delivery is pleasing customers and leading to additional business. But as noted above, it’s coming at a cost on the income statement.
In terms of valuing Amazon, I think the most logical approach is to try and estimate forward results for each of the three segments (and assume some level of “normalized” margins in the areas where they are making investments in the short-term to create long-term value).
When I go through that exercise, I get to normalized profitability of roughly $100 – $110 per share five years out. Assuming a low-to-mid-twenties terminal multiple and a 9% discount rate, I end up with a fair value estimate of $1,400 – $1,700 per share. That’s a long way of saying that the stock is trading at a level that I think may prove reasonable – and generate acceptable returns – over the long run.
I don’t own shares of Amazon, but I have a lot of respect for what this company and management team have achieved over the past twenty years. That said, if the stock fell below the low end of my value range, I would seriously consider the chance to become a long-term owner of this business.
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