Amazon: Q2 Earnings Impressive, Except For AWS

Shares of Amazon.com (NASDAQ:AMZN) have seen a real sign of relief after the company posted very strong second quarter results. This comes after I concluded in May that AWS was a shocker, following the release of the first quarter results.

The company has now seen a very strong second quarter set of results, both in terms of sales and margins, despite continued pressure on AWS. That said, with growth in AWS stabilizing, or perhaps accelerating in the coming quarters, real cash flow generation and earnings power is seen here and the near future, rightfully supporting shares here, even as they remain pricey by all means.

Some Perspective

It has been a long time ago, but important to remember, that Amazon.com was $280 billion business in 2019, that is pre-pandemic. At the time, the company posted operating margins in the mid-single digits, after real earnings had not really been seen for a long period of time.

While revenues have seen significant growth, and the profitable AWS business has seen above-average growth, overall margins have been a bit lackluster. 2020 was a booming year with revenues up nearly 40% to $386 billion, with operating profits of $23 billion translating into margins of around 6%. This translated into earnings of just over $2 per share, that is after adjusted for a 20-for-1 stock split, which took place thereafter.

Revenues rose by 21% to $469 billion in 2021, as operating profits rose in a much less pronounced manner to $25 billion, for operating margins just over 5%. 2022 has been a tough year with the pandemic on its retreat, and inflationary pressures driving economic uncertainty. Revenues for 2022 rose by just 9% to $514 billion although operating earnings of $12 billion and change worked down to margins of 2% and change, the worst margin profile in quite a period of time.

This came as the business has massively overbuilt its footprint and was hurt by less demand, higher shipping costs, and other factors. Furthermore, the company did not guide for sales acceleration and a general recovery at the start of this year.

First quarter sales grew 9% to $127.4 billion, with sales coming in far stronger than guided for, as operating profits of $4.8 billion marked a big sequential improvement, although that margins were still lower than historical standards. The recovery was driven by a big profit recovery in the North American retail operations, flattish losses in the International retail operations, in part offset by AWS operating margins which fell from 35% of sales to just 24% of sales.

The company guided second quarter revenues up 5-10% to a midpoint of around $130 billion, with operating profits seen at $2.0-$5.5 billion, although I recognize that Amazon traditionally guides in a conservative manner. Based on the guidance, I saw no reason for operating earnings not to come in around $20 billion a year, translating into earnings of around $2 per share.

That would be based on operating margins of around 3%, still trailing historical margins of around 5-6%, with earnings power coming in at $2 per share. This made the valuation high, but Amazon is known for focusing on customer relationships, innovation and long term value creation, making it a very hard business to bet against.

Up She Goes

Like the rest of the FANG stocks, or better said ¨ Magnificent Seven¨ these days, shares of the company have seen a massive re-rating and have risen to $140 here. As it turned out, second quarter sales growth accelerated to 11%, with revenues reported at $134.4 billion, despite inflation cooling down, as adverse currency moves have less of an impact here with the dollar recently giving up some ground.

While an 11% increase in North American retail sales to $82 billion and change, and a 10% increase in International sales to nearly $30 billion, were relatively strong, a 12% increase in AWS sales to $22 billion was quite a shocker.

While the sales beat was strong, the real strength was seen in the margins, with operating profits of $7.7 billion coming in far ahead of the higher end of the guidance. The North American retail operations swung from a $0.6 billion loss this quarter last year to a $3.2 billion profit, as international losses were cut in half to $0.9 billion. On the negative side was AWS again, and while a $5.4 billion profit was huge, it was down a little bit compared to this period last year.

Following the huge quarter, operating margins came in around 5.5%, in line with the historical performance, as net earnings of $6.7 billion worked down to an earnings number of $0.65 per share, annualized trending at $2.60 per share, that is ahead of a seasonally stronger fourth quarter.

Furthermore, momentum is set to continue as Amazon guides for a strong third quarter in which revenues are seen up by 9-13% to $138-$143 billion, with operating earnings seen between $5.5 and $8.5 billion. This suggests that second quarter performance can be replicated, or even slightly exceeded, which is quite comforting as earnings power is quite strong here. That said, the strength is really driven by the retail operations, as AWS is showing dismal results in terms of sales growth and margin pressure.

Going Strong

Right now, shares of Amazon have seen a meaningful recovery from lows in the $80s, as they have advanced towards the $140 mark. Despite the move higher, shares are still a long way off from the 2021 highs around $180 per share.

Trading at $140 per share, the 10.3 billion shares outstanding in Amazon give the company a near one and half trillion valuation, while the company operates with a rather flattish net debt load. The issue for the shares is that the recovery is largely driven by the retail operations, as AWS is faltering, in the sense that growth continues to dramatically slow down, as the same applies for its margins.

That said, easier comparables are on the horizon up as Amazon has indicated that quicker growth is seen at AWS. In such a case, AWS could become a renewed driver to overall sales and earnings growth of Amazon, as it has done in recent years.

The reality is that even if annual sales might approach the $600 billion mark here and margin might revert to a historical range of 5-6%, that yields earnings of $2.40-$3.00 per share, or thereabouts. This still translates into high valuations here, at close to 50 times earnings at the higher end of the earnings range.

That said, investors have always attached high multiples as the company continues to focus on customer service, making many believe that Amazon.com is able to post higher margins over time. While the current multiples are not cheap, they never are, this remains a very dangerous business to bet against.

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