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Investors Business Daily
Investors Business Daily
Technology
PATRICK SEITZ

Amazon Gets An Earnings Lift, But Is It Back On The Growth Track?

Amazon.com faces a boatload of challenges as it navigates uncharted waters to regain its mojo and find its way back to strong growth and sustained profitability. The fate of Amazon stock — not to mention its many businesses such as cloud computing — hangs in the balance.

AMZN stock has struggled since late 2021 when a pandemic-fueled growth spurt came to an end for the e-commerce behemoth. The company's troubles leave open the question of whether Amazon — long considered a Wall Street juggernaut — can right itself.

Amazon's second-quarter earnings report late Thursday provided evidence of improvement but it's not out of the jungle yet. The Seattle-based company delivered better-than-expected sales and earnings and said its cloud-computing business has stabilized. It also offered an outlook higher than Wall Street's estimates for the third quarter.

During the pandemic, Amazon doubled the size of its warehouse network in just 24 months before realizing it needed to rethink its operations. The company was forced to pull back on its aggressive warehouse expansion plans, and to re-evaluate its spending on numerous business bets that had yet to pay off.

Meanwhile, growth in its Amazon Web Services cloud-computing business, also known as AWS, decelerated materially. AWS has been considered a key growth engine for Amazon, helping to drive results to stratospheric levels, but those sales are slowing.

As a result, Amazon posted a loss for fiscal 2022 — its first since 2014 — as online sales slowed and costs ballooned. Further, Amazon stock has trailed its Big Tech peers this year amid its efforts to rekindle growth and improve its profitability.

"Amazon has gone through a massive de-rating," Evercore ISI analyst Mark Mahaney told Investor's Business Daily. The stock's "multiple has come down a lot over the last couple of years."

Amazon Stock Down 29% From Peak

Amazon stock peaked at a split-adjusted 188.65 in July 2021; shares underwent a 20-for-1 split in June 2022. Amazon shares ended July 2023 at 133.68, a drop of 29% from their all-time high.

Amazon's multiple fell from about 20 times enterprise value to adjusted earnings to about 11 times that metric, Mahaney said.

The post-Covid downturn also has affected AMZN stock's fellow cohorts in the once-formidable "FANG" group. Two of them are recovering at a faster clip, though.

After a series of strategic moves, Facebook parent Meta is down just 16% from its September 2021 peak. Google-parent Alphabet now hangs about 12% below its February 2022 high. Netflix, however, has plunged more than 37% since its November 2021 apex.

Meanwhile, Big Tech peers like Apple, Microsoft and Nvidia are near record highs.

Shaking Off The Covid Hangover

That's a far cry from the outlook at Amazon just two years ago. Amazon was riding high from consumers sheltering at home during the Covid-19 pandemic. They bought more products online and had them delivered instead of venturing out to brick-and-mortar stores.

In 2020, the first year of the pandemic, Amazon's core North American retail operations saw e-commerce sales jump 38%, vs. 21% growth in the prior year. But growth slowed to 18% in 2021 and 13% last year. And Amazon's North American retail operating margin went from positive 4% in 2020 to negative 1% in 2022.

Meanwhile, the work-from-home and school-at-home trends from the pandemic boosted its cloud-computing business. AWS sales growth accelerated to 37% in 2021 from 30% in 2020.

But the gains in cloud computing weren't sustainable. AWS sales growth decelerated to 29% in 2022 and is on pace for 16% growth this year.

The most dramatic change to Amazon's business has been to its free cash flow. Its free cash flow turned negative in 2021 and 2022 after being positive for 20 straight years.

Amazon Stock Needs Three Things

Despite its challenges, Amazon stock jumped 59% in the first seven months of 2023.

But for Amazon stock to maintain an upward trajectory, the company needs to do three things, Mahaney said.

First, it needs to reaccelerate sales growth for AWS and cloud computing. Second, it must restore profitability for its e-commerce business. And third, it needs to return to positive cash flow.

"You need all three of those things to turn," Mahaney said. "But if they do turn, I think the stock can go up a lot."

Amazon representatives declined a request for an interview.

AWS: A Key Driver Of Amazon Stock

While Amazon is best known to the general public as a go-to online store, it's the company's cloud-computing business that's been a driver of Amazon stock for the past decade.

But AWS is facing increased competition from Microsoft, Alphabet's Google and others in the cloud-computing space. Plus, AWS customers have been looking to cut their spending by optimizing workloads and even seeking price concessions. That has led to decelerating sales growth for AWS.

"AWS growth has slowed materially," said Mahaney, who rates Amazon stock as outperform. "It was well north of 30% (year over year) for a long time and now with the most recent data point, in the month of April, it grew 11%."

In the second quarter, AWS revenue grew 12% year over year to $22.1 billion. That was slower than the 16% growth in the first quarter, but topped estimates for 10% growth.

AMZN stock analysts hope to see AWS growth bottom out in the third quarter and reaccelerate in the fourth quarter. And the company's push into generative artificial intelligence is seen as a tailwind in the first half of 2024.

Generative AI can create content — including written articles, images, videos and music — from simple descriptive phrases. Artificial intelligence systems analyze and digest vast amounts of data to create new works. Generative AI also can write computer programming code.

Amazon showcased its advancements in AI and machine learning at its AWS Summit in New York City on July 26. Amazon's offerings include Bedrock, a service for building generative AI applications in Amazon cloud computing. It also has tools for automated data extraction and analysis, chatbots and virtual agents, and software coding and review.

CEO Andy Jassy Taking Corrective Actions

Amazon Chief Executive Andy Jassy acknowledged that the company overspent to expand its e-commerce fulfillment center network during the pandemic. It has since cut spending by canceling some planned warehouses and postponing others.

At the same time, the company reorganized its fulfillment network into eight regions in the U.S., instead of one national network, to be more efficient.

In a letter to shareholders in April, Jassy said management "took a deep look across the company" and shuttered certain businesses that didn't have sufficient potential to drive profits.

For instance, it stopped pursuing physical store concepts like Bookstores and 4 Star stores and closed its Amazon Fabric and Amazon Care efforts. All told, Amazon closed over 40 businesses as part of the assessment.

Also, Amazon eliminated 27,000 jobs at the company after examining its operations.

AMZN Stock: Advertising Is A Profit Driver

Jassy, who marked his second anniversary as CEO on July 5, is focused on improving the company's profitability, CFRA Research analyst Arun Sundaram told IBD.

He noted that Jassy took over at a difficult juncture for Amazon, when the company was reacting to the impact of the pandemic. Jassy replaced company founder Jeff Bezos, who remains executive chairman. As Bezos' longtime lieutenant, Jassy started and ran the AWS business.

Sundaram seems confident Jassy can right the ship.

"We are expecting significant operating profit improvement in Q2 and expect that to continue throughout 2023 and into 2024," he said before the second-quarter report.

Amazon's high-margin advertising business should help drive profits, he added. Amazon sells product sponsorship advertising on its website as well as video ads in its Amazon Prime Video service.

"Advertising has been the fastest-growing business segment for Amazon over the past few quarters," Sundaram said.

Amazon 'Pursuing Too Many Ideas'

In June, Amazon stock analyst Mark Shmulik from Bernstein wrote an open letter to Jassy and the Amazon board of directors telling the company to rein in spending on new business development.

Amazon is "pursuing too many ideas, with weaker ideas taking away the oxygen, capital, and most importantly, focus, from the truly disruptive initiatives that 'only Amazon can do,' " Shmulik said.

Those business opportunities include multibillion-dollar bets on health care, robotaxis, and broadband internet service from low-Earth-orbit satellites. For instance, the company's Project Kuiper aims to launch a constellation of satellites to provide global internet access to regions of the world that aren't connected today.

Shmulik called for more disclosure from Amazon about spending on those projects and expectations for a return on investment. He'd like to see details on spending plans and revenue projections.

In his shareholder letter, Jassy expressed his support for Amazon's investments in new businesses.

"While it's tempting in turbulent times only to focus on your existing large businesses, to build a sustainable, long-lasting, growing company that helps customers across a large number of dimensions, you can't stop inventing and working on long-term customer experiences that can meaningfully impact customers and your company," Jassy said.

Jassy reiterated his commitment to "big long-term opportunities" on the company's second-quarter earnings conference call with analysts.

Requires A Balancing Act

Amazon needs to balance managing expenses with investing in the potential next big thing, Baird analyst Colin Sebastian told IBD. He rates AMZN stock as outperform.

"You don't want Amazon to lose its culture of innovation," he said. After all, AWS started off as one of Amazon's big bets.

Still, Sebastian agreed that Amazon should provide more transparency about its emerging businesses, such as Kuiper.

Another area that investors want to hear more about from Amazon is its play in artificial intelligence.

"Amazon has a pretty compelling portfolio of artificial intelligence and machine learning services out there," CFRA's Sundaram said. Its offerings include Bedrock, a service for making generative AI applications, and CodeWhisperer, an AI software coding companion.

Amazon has disclosed that more than 100,000 of its AWS customers are already using its machine learning and generative AI services, he said. That's out of more than 1 million AWS customers, so it has room to grow, CFRA's Sundaram said.

Wall Street expects Amazon to detail its AI initiatives at its AWS re:Invent conference Nov. 27-Dec. 1 in Las Vegas. On the second-quarter earnings call, Jassy predicted that generative AI would jump-start growth for AWS. He called the technology "transformative."

"We're a few steps into a marathon," Jassy said. "AWS is poised to be the customers' long-term partner of choice for generative AI."

Amazon Stock Ranks Fifth In Industry Group

One area of concern for Amazon is a possible major antitrust case from the Federal Trade Commission. News site Politico reported July 25 that the FTC is finalizing an antitrust lawsuit that could seek to break up the company.

The lawsuit reportedly focuses on Amazon's e-commerce business practices and their impact on third-party merchants. The suit will also focus on Amazon's Prime subscription service, Politico said.

However, the threat of FTC action has cooled recently after the agency's recent court losses in cases against Meta Platforms and Microsoft, Baird's Sebastian said.

In the meantime, investor focus is on Amazon's second-quarter earnings report and third-quarter forecasts. Amazon stock surged after the company beat sales and earnings expectations for the June quarter and offered a better-than-expected outlook.

Amazon stock ranks fifth out of 59 stocks in IBD's Retail-Internet industry group, according to IBD Stock Checkup. It has a decent IBD Composite Rating of 86 out of 99.

Follow Patrick Seitz on Twitter at @IBD_PSeitz for more stories on consumer technology, software and semiconductor stocks.

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