Amazon's (NASDAQ:AMZN) stock fell in the after-hours trading following its Q2 2014 earnings announcement. The company reported losses and the growth in its web services business slowed down compared to what it was in the first quarter. Does that warrant some caution? Amazon has been primarily focused on growing its revenues, or in other words, gaining share of global e-commerce market. As a result, management has never paid much attention to improving margins and has continually invested any profits to fuel the future growth. If we look closely, Amazon's losses in the second quarter were driven by increased investments that led to higher depreciation expense. In fact, EBITDA margin (earnings before interest, taxes, depreciation and amortization) for the first half of 2014 has increased slightly compared to the same period a year ago. This figure is a better indicator of Amazon's profitability. Overall, we feel that second-quarter losses shouldn't be a cause of alarm for investors. Although there is likely to be some short term pressure on cash flows.
Our price estimate for Amazon stands for $348, implying a premium of less than 10% to the market price.
Revenue Growth Outlook Is Promising
Amazon saw its global revenues jump by 23% in the second quarter of 2014, amounting to $19.34 billion. This includes 1% growth contribution from favorable currency impact. As expected, electronics and general merchandise grew much faster than media segment, thus increasing its contribution in the retailer's revenues to 69%. Amazon now has more than 250 million active customer accounts which suggests that average quarterly revenue per active customer is roughly $80. In contrast, the figure for eBay (NASDAQ:EBAY), which is one of Amazon's key competitors, stands at roughly $160. Does this mean that Amazon isn't doing enough? We don't think so. This goes to show that Amazon has a lot of opportunity to grow its commerce volume and it can certainly do so given its price advantage, wide selection and efficient delivery service. While average spend per active customer for eBay has been more or less stagnant in recent years, it has been growing for Amazon. This suggests that the latter may be gaining some market share.
Why Web Services Business Slowed Down?
The growth in Amazon's web services business came down this quarter, although it still remained strong. In Q1 2014, Amazon's 'Other' segment revenues jumped by 58%. This growth figure declined to 37% for the second quarter. Most of the sales from this reported segment can be attributed to Amazon's web services. However, this does not indicate that Amazon is not expanding fast enough. The slowdown in growth was primarily due to price cuts rather than a slowdown in customer acquisition. The company resorted to significant price reductions in the second quarter which ranged from 28% to 51%. However, the usage of AWS (Amazon Web Services) increased 90% year-over-year.
We are bullish on Amazon's web services business and believe that it will play an integral role in improving the company's overall profitability going forward. With this service, the company enables cloud storage and computing for corporate and small businesses, thus creating an infrastructure to drive more data on the Internet. This fits into its intent of enabling the online shift of businesses and consumers, which will help further its interests. The company launched a bunch of products to strengthen this segment during the second quarter of 2014. It introduced an SSD-backed storage service that saves money for customers without sacrificing on speed. The service is aimed at personal users and small/medium sized enterprises. While targeting large enterprises is important, there is a huge opportunity for Amazon to expand its cloud storage and computing business by going for smaller companies which tend to be more flexible. The retailer launched two more new products including new capability for mobile developers.
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