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Amazon - costs up but profits still better than expected

Sophie Lund-Yates, Equity Analyst | 31 January 2020 | A A A
Amazon - costs up but profits still better than expected

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Amazon's net sales rose 21% in the fourth quarter to $87.4bn, which was slightly better than analysts expected. That reflects a 33% increase in service revenues.

Despite a 43% increase in shipping costs, operating profit increased 2.5% to $3.9bn, which was also better than the market hoped for.

The shares rose 9.8% in after-hours trading.

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Our view

For a company with sales of $280bn last year, Amazon makes surprisingly little profit. That's because the bulk of sales come from the retail business, which generates a comparatively modest profit margin, made worse recently by the massive investment in next day delivery.

But then CEO Jeff Bezos has never been all that worried about the bottom line. Amazon's focus is on revenue growth, cash generation and investment opportunities.

From a revenue perspective the retail business continues to go from strength to strength. While Amazon sources and sells many of its own items, many of the products sold on the website are actually third-party sales. Over a billion third-party items were sold over Christmas, and accounted for $53.8bn in sales last year. 'Fulfilment by Amazon' means many of these vendors pay Amazon for warehousing and delivery - generating extra fees too.

But while we all know about Amazon's retail operation, there's a far more profitable business hidden below the surface.

Jeff Bezos wants a culture of constant innovation and improvement to flow right through the group. While there've been numerous failures along the way (billions of dollars' worth, in fact), successes like Amazon's web services business (AWS) have far outweighed them.

AWS was born from one individual's frustration with the limitations of IT infrastructure. After being given the freedom to create a solution and run with it, it's since morphed into a $35bn+ business specialising in cloud computing. This gives partners storage space or extra computing power on demand.

There are other exciting areas to keep an eye on too. The Marketing business, rather unfairly lumped under 'other', looks to be beating the cloud business when it comes to growth, and as the business scales up and becomes more efficient it should be pretty high margin too.

The growth potential means, at the time of writing, the shares trade on a lofty 68.2 times expected earnings, making the share price particularly sensitive to disappointment. We should add that because of Amazon's focus on reinvestment in the business, there's no dividend on offer.

We think investors should focus on the big picture, which includes Amazon's enormous scale, cash resources and penchant for innovation. We believe that should stand the company in good stead in the longer-term, but it could still be a rocky ride in the meantime.

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Fourth quarter trading details

North American operating profit declined 16% to $1.9bn as costs rose, and net sales increased 22% to $53.7bn. In the International business, net sales were up 14% to $23.8bn, and operating losses decreased to $617m from $642m.

Within the retail business sales by third parties and subscription revenues were the stand out performers up 30% and 32% respectively. The group reported a record quarter for Prime customer registrations, and now has 150m Prime subscribers.

Amazon Web Services (AWS) AWS sales rose 34% to $10.0bn, with operating profits up 19.2% to $2.6bn.

The group generated $12.5bn in free cash during the quarter, which was up 48% compared to last year.

Looking ahead, Amazon expects net sales be between $69bn - $73bn in the first quarter of 2020. Operating profits are due in the range of $3bn - $4.2bn.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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