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Amazon - profits beat expectations despite COVID costs

Nicholas Hyett, Equity Analyst | 31 July 2020 | A A A
Amazon - profits beat expectations despite COVID costs

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Amazon.com Inc Com Stk USD0.01

Sell: 143.21 | Buy: 143.23 | Change -0.37 (-0.26%)
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Amazon's second quarter net sales came in at $88.9bn, up 40% year-on-year and ahead of analyst expectations.

Despite additional coronavirus related costs, operating profits in the quarter rose 89.5% to $5.8bn, well ahead of market expectations.

The shares rose 5.2% in pre-market trading.

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Our view

Coronavirus is a huge tailwind for Amazon's retail sales, but was also a potential problem for profits. Keeping its huge workforce safe and serving thousands of extra orders has cost billions.

In the event, the surge in demand has more than compensated for the extra costs and the group's delivered a record quarterly operating profit. Capital expenditure has more than doubled too, as Jeff Bezos sticks to his long term policy of investing cash back in growth.

It will come as no surprise that the retail business continues to go from strength to strength. While Amazon sources and sells many of its own items, lots of the products sold on the website are actually third-party sales. These made up $53.8bn in sales last year and are growing faster than Amazon's own product sales. 'Fulfilment by Amazon' means many of these vendors pay Amazon for warehousing and delivery - generating extra fees.

But while we all know about Amazon's retail operation, there's a far more profitable business hidden below the surface - and one that can grow pretty much uninterrupted despite the outbreak.

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 and 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 additional storage or computing power on demand and has attracted customers ranging from HSBC to the Bundesliga.

The growth potential means, at the time of writing, the shares trade on a lofty 102 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.

Amazon is a veritable Pandora's box of goodies. The group is in a great position to cater for the huge spikes in online shopping coronavirus has afforded. We hesitate to use the term category killer, but conventional retailers are going to have to deliver some dramatic changes if they're to compete with the uncontested king of e-commerce. Meanwhile cloud computing provides long term opportunities to service the remote working and data revolutions. The only question is whether the price is right.

Amazon key facts

  • Price/Earnings ratio: 102.0
  • 10 year average Price/Earnings ratio: 125.2
  • Prospective yield: 0%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

The revenue beat was driven by a very strong result in both North American and International Retail, with sales rising 43% and 38% respectively to $55.4bn and $22.7bn. Amazon Web Services (AWS) saw sales rise 29% to $10.8bn.

Covid-19 related spending topped $4bn during the quarter, and the group has created over 175,000 new jobs since the start of March. Capital expenditure more than doubled year-on-year, reflecting increased coronavirus related costs but also investment in fulfilment, transportation and AWS as demand increased.

Operating profits rose across all three divisions with North American Retail up 36.9% to $2.1bn, International posting a $345m profit compared to a $601m loss this time last year and AWS profits were up 58.3% to $3.4bn.

Free cash flow in the quarter came in at $31.9bn, compared to $25.0bn a year ago. As a result net cash at the end of the first half rose to $38.3bn from $31.6bn at the start of the year.

Amazon expects net sales of $87-$93bn next quarter, with operating income of $2-$5bn despite a further $2bn of coronavirus related costs.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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