Quick Thoughts: Amazon and its investors don’t care about earnings

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–          Investors shrugged off Amazon’s unexpected 2Q13 losses in after-hours trading, shaving less than 2% from a stock that is up more than 25% since its 1Q13 report in April.

–          Amazon sales were only in-line, although 22% top line growth is impressive given its size. As usual, Bezos & friends gave little explanation for the EPS miss, vaguely alluding to the impact of FX.

–          This is business as usual for Amazon, and the growth confirms that the long term story of future retail domination, cloud hosting leadership, and streaming media strength remains intact.

–          Amazon’s free pass on earnings is an enormous competitive advantage, allowing it free reign to invest to extend its advantages vs. rivals that must deliver profits to investors.

It was a classic quarter for Amazon with Jeff Bezos and team offering little insight to help guide investors forecasting its future. 4 of the last 5 quarters were also earnings misses, but investors as usual don’t seem to care as top line revenue keeps growing at a healthy pace. Since the late 1990s tech bubble, Amazon has gotten away with delivering low margins and occasional losses, all in the name of building the “Earth’s Biggest Selection.” Unlike its higher margin tech peers, Amazon has plowed its profits back into the business investing in distribution centers, IT infrastructure, and more recently media content. This quarter was a bit unusual as it resulted in the company’s second quarterly loss since 2004, but investors didn’t seem to sell on the news. Bezos has built a special Wall Street credibility that as long as the top line grows, he gets a free pass on EPS. This quarter was certainly no exception.

Amazon delivered healthy top line revenue growth of just over 22% on a consolidated basis between its low margin e-commerce retail operations and high margin cloud service, Amazon Web Services. AWS, which basically created the market for cloud infrastructure services grew revenue a stunning 61% and has a run rate now in excess of $3B annually.  Overall the company has always had low operating margins fluctuating in the 1-3% range. Operating expenses like cost of sales and fulfillment make up about 83% of expenses with investments in technology and content taking a further 10%, and SG&A another 6% leaving little room from profits. While Amazon has made some progress decreasing cost of sales, which includes Prime shipping services, from 73.9% to 71.3% YoY, this category continues to subsidize shipping to customers and represents about 4.6% of sales. Its liberal return and exchange policies in no doubt also impact margin to the detriment of higher margins, but Amazon does this for good reason: its consumer satisfaction scores are unrivalled and keep bringing customers back growing the top line.

But still, there is no answer to what caused this quarter’s operating margin squeeze. A string of new content deals with the likes of Viacom, NBCUniversal, and PBS and in house investments in original programming did increase expenses offsetting cost of sales savings. Technology and content spend is now up to 10.1% of sales up from 8.4% YoY, but Amazon hasn’t disclosed financial terms. Cash used in purchases of property, equipment, and technology was up 54% YoY. While there is a lack of transparency and management’s business case to investors seems to be “trust me”, it is clear the company is investing in future growth and its strategy plays well many themes underway in this once in a generation paradigm shift. Its three main businesses: e-commerce, devices/media, and cloud infrastructure have plenty of runway. For Amazon, earnings didn’t matter this quarter and won’t for some time.

For our full research notes, please visit our published research site.

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