Amazon Outpaces Peers

 

• Second quarter numbers showed the success of several innovations
• Amazon has solidified its place as the online retailer receiving the most internet traffic
• Financials remain strong and emphasis on managing costs expected to contribute to future gains

Amazon.com, Inc. (AMZN) continues to ride its wave of success following a surprising second quarter in 2015. The company managed to increase revenue, sales, and net income with two of its most prominent divisions—Amazon Web Services and Amazon Prime—showing robust success and pointing towards strong growth in the future. Amazon shares have reflected this optimism, and despite a slightly high P/E ratio, still reflect a solid potential long term investment. Fears remain that the company cannot rein in its spending on what some consider unnecessary projects and developments, a practice that cuts into revenues and has been responsible for Amazon’s inconsistent income and margins. Amazon’s insistence on focusing on growth might also give pause to some investors, but recent moves by management and the company’s continued trajectory towards profitability point towards a strong end to 2015 and great potential long-term positions for investors.

The Fundamental Perspective

E-commerce giant Amazon recently beat most analysts’ predictions for the second quarter, in a development that has investors excited and has sent prices soaring. The company reported a 2% increase in net sales growth from the first to second quarter, as well as an increase in operating margins to 5.1% from 3.9% in the first quarter. More importantly, Amazon revealed a huge leap in free cash flow, up 300% year over year to $4.37 billion, a number greatly aided by the 20% year over year growth in sales. The company also managed to increase revenues from the previous quarter by a large margin, rising $468 million during the period. This resulted in the company posting $92 million in net income, returning to profitability from the previous quarter.

These superb numbers helped boost share prices to their highest levels of 2015 where they have largely trended, sitting now around $517. The second quarter success for Amazon comes on the back of great quarters for both the company’s cloud computing infrastructure service AWS and its customer loyalty service Amazon Prime. AWS in particular has shown incredible growth potential in its second reporting quarter, increasing sales 81% year over year and up nearly 16% over the previous quarter. This led to operating profits skyrocketing by 45% from the previous quarter to $391 million. While still not a major part of core businesses even with its $1.82 billion quarterly revenue, it is very encouraging and a division that should become a major revenue stream over the long-term if the business grows further.

The Most Trafficked Online Retailer

On the e-commerce side of the company, business is thriving for Amazon. The company is already the largest online retailer in the world, the most visited online retailer, and the fifth most visited webpage in the US. This is without accounting even for the company’s region-specific domains (such as amazon.de, amazon.jp, etc.). When viewed as a whole, the company averages upwards of 1.6 billion global visits monthly. The US only accounts approximately 770 million of the visits, or 48% of total usage. Amazon is currently planning to roll out its Prime service to Japan, which could open the door for a much larger global footprint, and a solid lock on global market share.

The company’s Prime service offers users a one-stop-shop experience, including heavy shopping incentives, free shipping, as well as a $7.99 one hour shipping service in select locations.  Other ancillary benefits include video streaming services and original programming. The latter has placed Amazon in direct competition with Netflix (NFLX) and though the media streaming giant still holds an advantage in the US, Amazon is quickly gaining on the back of its international business. In terms of e-commerce, the company reported growth in sales from the previous year while maintaining a high level of user loyalty through the Prime subscription service.

Spending Remains a Concern

While broadly speaking the trend is positive for Amazon and its underlying fundamentals, Amazon is not without some concerns. Some analysts see many of the projects Amazon has initiated in previous years as frivolous and not cost effective. Initiatives such as drone delivery and other R&D innovations have previously cut into the company’s cash flow and profits, taking them from revenue to loss. Many see this as lack of discipline on the part of Amazon’s management even though this philosophy has resulted in the development of several key strategic monetization channels for the company such as Prime, AWS, and its growing media division. Even so, the company has recently stated its intention to become more focused with their R&D spending, a positive sign for those investors on the fence.

There are lingering concerns that Amazon’s focus on growth over profitability is holding the company back from realizing its true potential in terms of earnings. This approach nevertheless has created a durable consumer base for the company and allowed them to continue focusing on growing sales numbers through innovative initiatives. Finally, there are concerns that growing shipping costs could start to eat into the company’s revenues. However, Amazon has been actively seeking out solutions, including its one hour shipping service and evaluated a crowd-sourced approach similar to Uber. This is still a hypothetical, as the process could be much more complex simply in terms of vetting new drivers.

The Target

Amazon is among the best performing stocks of 2015, posting gains of over 66% year-to-date.  This comes on the back of a substantial pullback in shares from its record close, with the stock having retreated nearly 11% from 52-week highs.  Should the current pullback continue, shares could easily find themselves transitioning towards a more bearish bias, especially if the stock should enter a 20% correction from highs.  Shares are currently sitting near a critical level especially after the recent turbulence which saw the stock fall as low as $451 per share before rebounding.  A failure to close above resistance at $523 could mean another retest of $500 per share and spell a retrace towards the most recent plunge.  However, with many strong core businesses contributing to revenue growth and emphasis on managing costs, there is strong potential for Amazon shares to outperform other major market benchmarks by a wide margin, rising back towards highs at $580.57 in the near-to-medium term while long-term prospects remain biased to the upside.

Conclusion

Amazon seems to be on a very positive upward trend. Despite some concerns, the company has shown itself resilient to economic downturn even while traditional retailers struggle to keep up in times of recession. The company has become the number one e-commerce site in the world, and with new innovations is looking to diversify its revenue stream. Initiatives such as AWS are great ways for the company to increase its profitability and ensure it will remain a giant in the technology and retail industries. While prices are at a relatively high entry point, the stock could be a great buy for investors looking to build core long positions and add structure to long-term portfolios.