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Amazon Web Services, the Key to Amazon's Earnings Beat?

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Amazon (AMZN - Free Report) started breaking out AWS as a separate segment in the first quarter and in just a few months, it’s clear just how important this business is.

Going into the quarter, the segment was running at a $6 billion revenue runrate, but from where we are standing today, it looks like it could generate a billion more than that.

Management said that AWS operates in 11 regions right now, of which the EU (Frankfurt) region, which opened in Oct 2014 remains the fastest-growing international region to date. India (to launch in 2016) will be the 12th region, which Amazon says will enable customers to run workloads in India with Indian users seeing improved latency.

Management was also positive about usage rates, which they said were much higher than the revenue growth rate. While there remain some unfavourable pricing comps here that should alleviate in the second half, it’s probable (and likely) that management’s aggressive pricing policy will continue. This isn’t a bad thing when taking market share, but could be an undue pressure on profits. So let’s see what the numbers say:

2Q Numbers

Revenue of $1.82 billion grew 16.5% sequentially and 81.5% year over year. The revenue runrate is in the neighborhood of $6.78 billion, so unless there is a major pressure in the back half, Amazon’s initial projections will be busted.

Compare these numbers to total revenues, which grew 2.1% sequentially and 19.9% year over year and it’s apparent that this segment has done most of the heavy-lifting.

The story is similar on the operating margin line as well. This is Amazon’s most profitable segment, so it turned in a 21.4% margin in the last quarter compared to 5.1% and -0.3% for the North America and International segments.

But let’s also look at the dollar value. The segment generated operating profit of $391 million, which is up 47.5% sequentially and 407.8% from last year. What this boils down to is that despite generating just 8% of sales, the segment generates 36.4% of operating profits.

And that’s not all: AWS is positive in terms of FX, meaning that it is at the moment acting as a natural hedge to the stronger dollar. To understand this impact, we may look at the International segment operating loss, which includes a negative FX impact of $89 million. Note that this is almost totally offset by the positive FX impact of roughly $72 million in the AWS segment.

Innovation Continues

While the revenue and margin implications of this business are great, investors should also keep in mind that this is a capital intensive business, meaning that it will take significant investment at several levels. Amazon will be expanding in new geographies and will also invest in new products to drive adoption. Some of the initiatives it took in the last quarter (as announced in the press release) include

  • AWS Educate, a free program that helps educators and students use real-world cloud technology in the classroom to prepare students for the cloud workforce.
  • AWS entered into separate agreements to support the construction and operation of Amazon Solar Farm U.S. East and Amazon Wind Farm U.S. East. These are expected to generate approximately 170,000 megawatt hours (MWh) of solar power and 670,000 MWh of wind energy on an annual basis. The energy generated from these facilities will be delivered into the electrical grids that power both current and future AWS data centers.
  • AWS announced Amazon API Gateway, a new fully managed service that makes it easy for AWS customers to create, publish, maintain, monitor, and secure APIs at any scale.
  • AWS Device Farm is a new service that helps mobile app developers quickly and securely test their apps on smartphones, tablets, and other devices to improve the quality of their Android and Fire OS apps.

Recommendation

Amazon shares have a Zacks Rank #2 (Buy). Other stocks worth considering at the moment include Expedia (EXPE - Free Report) , which has a Zacks Rank #1 (Strong Buy) or even Groupon (GRPN - Free Report) and Petmed Express which have the same Zacks Rank #2 as Amazon.

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