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Amazon - rising investment sees profits fall

Nicholas Hyett, Equity Analyst | 29 October 2021 | A A A
Amazon - rising investment sees profits fall

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Amazon.com Inc Com Stk USD0.01

Sell: 143.53 | Buy: 143.54 | Change 2.91 (2.07%)
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Amazon reported third quarter revenues of $110.8bn slightly behind market expectations despite rising 15% year-on-year. All divisions showed progress, but growth was particularly strong in AWS following a wide range of customer wins.

Operating profits came in at $4.9bn, a 21% decline compared to the same period last year. That was well behind the $5.5bn analysts had expected, as the group continues to invest heavily in increased fulfilment capacity.

Amazon shares fell 4.3% in early trading.

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Our view

Having delivered strong revenue growth throughout the pandemic, the growing pains of the last 18 months have finally caught up with Amazon.

Rising operating costs outpaced revenue in the third quarter in most areas - reflecting increased investment in fulfilment capacity, higher wages and some effects from supply chain disruption. Some of that cost may be temporary, but a lot will linger.

An unexpected reversal in margins, down from 6.4% a year ago to 4.4% this quarter is never welcome. But Amazon has never been overly focussed on the bottom line.

We're happy to give newly installed CEO Andy Jassy the benefit of the doubt for now. The group has a sizeable cash pile on hand to fund investment and newer products are still showing very steady growth. The relatively new advertising proposition grew something like 50% year-on-year. We also take comfort from the fact AWS is already showing rapid and profitable growth following investment earlier in the pandemic.

That's part of a broader shift in the overall revenue mix towards services. Total services, which includes things like Prime as well as AWS, accounted for 50.5% of revenues. These should be far higher margin, although you wouldn't know it from Q3 results.

Amazon's approach has always been to pour internally generated cash into new investment opportunities wherever possible. That's more important than ever now, because we suspect the US retail business is increasingly running up against the law of large numbers. When you're only selling $1,000 of product a year, boosting sales by 40% is relatively easy. When your annualised sales reach $400bn, finding an extra $160bn of sales is pretty difficult.

That could be one reason we're approaching the end of Amazon's golden age. With high streets shut Amazon has been a natural home for consumers' spare cash, AWS services remote working, which has suddenly become the norm, and tech wizardry is all the more useful when we can't see friends and family in person. It's possible we're starting to see those tailwinds unwind - making growth more of a challenge in the years ahead. If costs consistency climb too that may make investors jumpy - especially given the stock's valuation.

Amazon is a veritable Pandora's box of excellent businesses. Conventional retailers are going to have to deliver some dramatic changes to compete with the uncontested king of e-commerce going forwards, while cloud computing provides long term opportunities to service the remote working and data revolutions. The big question over the next 12 months is whether it can capitalise on those opportunities at a reasonable cost.

Amazon key facts

  • Price/Earnings ratio (next 12 months): 54.3
  • 10 year average Price/Earnings ratio: 126.9
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. 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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Third Quarter Results

Amazon reported revenue growth across all three of its operating segments, although retail profits went backwards. North American sales rose 10.4% to $65.6bn, while operating profits of $880m were well behind the $2.3bn reported last year. International reported sales of $29.1bn and an operating loss of $911m, that contrasts with $25.2bn and $407m profit reported last year respectively. Amazon Web Services (AWS) reported sales of $16.1bn, up 38.9%, and operating income of $4.9bn up 38.1%.

Total operating costs rose 17.8% year-on-year, with spending on Marketing, Technology & Content, General & Administrative and Fulfilment all out pacing revenue growth.

Capital expenditure rose 42.3% to $15.7bn. Together with a significant increase in inventories and payments due, that resulted in a free cash flow falling from a $901m inflow last year to a $8.4m outflow. As a result net cash, excluding leases, fell from $52.6bn at the start of the year to $28.9bn.

Fourth quarter sales are expected to be between $130bn and $140bn, between 4% and 12% ahead of the same quarter last year. Operating profit is expected to be between $0 and $3.0bn - compared to the $6.9bn reported in the same period last year.

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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 Refinitiv. 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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