A couple of weeks ago, online retail giant Amazon (NASDAQ:AMZN) disappointed the Street when it missed on earnings and issued weaker than expected Q4 guidance. While the company has continued to see its top line grow nicely in recent years, perhaps the biggest driver of this growth has been Amazon Web Services, or AWS. Today, I wanted to examine this segment in more detail, because if a slowdown in this major segment is coming, 2020 might not be as great a year as some are hoping for when it comes to Amazon.
For Q3 2019, AWS came in with revenues of just under $9 billion, which was about $200 million below Street expectations. This segment of the company has been a tremendous success story in recent years as cloud computing has taken off, since it was in early 2014 that the segment was only doing around $1 billion in quarterly revenue. For a time, AWS was the revenue leader in the cloud space.
In the latest period, AWS had revenue growth of about 34.7% over the prior year period, but this is the lowest number we've seen since Amazon started breaking out results for the segment. Part of that is the law of large numbers, because it is certainly harder to grow at $9 billion a quarter than it is at $1 billion, but there are some other items to consider. Take a look at the following charts detailing the revenue situation.
(Chart data sourced from Amazon quarterly results, seen here)
It's the second chart where things get really interesting. The Q3 2019 top line number for AWS was up $2,316 million over the prior year period. While that's still better than two or three years ago, for instance, it's actually about a million dollars under the year-over-year peak increase from Q4 2019. This is the first time where the dollar increase over the prior year period has not been a new record for three straight quarters.
The other interesting item is that in the current period, Amazon is facing one of its toughest comparisons yet. In Q4 2018, the sequential increase of $751 million (from Q3 2018) was the largest sequential jump that we have on record in dollar terms. Even if Amazon matches that number in this quarter, the AWS growth rate will decline sequentially by about 350 basis points. However, if we only match the Q3 2019 value of $614 million, the growth rate will dip below 30%, and a number like a $300 million sequential increase could put the growth rate down around 25%, approaching half of what it was just a year earlier.
Perhaps the worst part of the Q3 report for AWS was the segment's margins, however. Operating margin of 25.1% in the period was down 600 basis points from a year earlier, and was the lowest figure reported since Q2 2017. As a result, despite the 35% year-over-year revenue increase, operating income for the segment was up a paltry 6%. Since the segment is the most profitable for Amazon overall, that's a major issue, and it likely was a reason why the Q3 bottom line came in a bit worse than the Street was expecting. Margin issues for AWS may be a key reason why EPS numbers for this year have come well off their highs as seen below.
(Source: Yahoo! Finance analyst estimates page)
For those that still think Amazon is the cloud leader, well, Microsoft (MSFT) did pass it by last year. In its latest quarterly results, Microsoft reported $10.8 billion in Intelligent Cloud revenues, up 27% year over year, with Azure revenue growth up a whopping 59% year over year. If Amazon doesn't see its growth rates level off in the next few periods, the gaps between the two companies could widen a bit.
As the chart below shows, Amazon shares are barely above the flat line over the past year, while the Nasdaq index has rallied in the low-double digits. While many analysts have price targets for the stock in the $2000s, and the stock did top that value for a short time, there hasn't been much traction to get to new highs like other major tech names and the overall market. In the end, for the stock to get going again, it is going to need some progress from AWS in the coming quarters.
(Source: Yahoo! Finance)
