It’s no secret that Amazon (NASDAQ: AMZN) has rewarded its shareholders with spectacular returns over the past decade. Nonetheless, after last year’s peak of market euphoria, Amazon shares have gradually corrected in line with deteriorating underlying market conditions. In fact, at under $95, Amazon shares are now trading near three-year lows, raising the question of whether it’s time to reconsider its investment case.
In my view, Amazon has the potential to show massive net income margins thanks to its already very profitable Amazon Web Services segment and the economies of scale in its e-commerce segment. However, as long as inflationary pressures keep corporate spending high and the current macroeconomic situation dampens consumer demand, stocks are likely to remain lethargic. Accordingly, I am neutral on the title.
Profitability needs to improve
As I just mentioned, Amazon has the ability to generate huge amounts of net income. We saw this potential in last year’s results when Amazon posted a whopping $33.4 billion net profit. However, with the company already posting an unprofitable first half and barely profitable third quarter, even if the holiday season significantly improves its results, Amazon will likely end up losing money for the year. After all, Amazon’s Q4 guidance is already targeting operating profit of just $0 billion to $4.0 billion.
Moreover, with the macroeconomic environment barely improving lately, this trend could be postponed to 2023. Of course, inflation slowed slightly in October, but it remains at quite high levels. The Fed also remains hawkish, so further interest rate hikes could further increase Amazon’s interest charges. Thus, one should not be surprised if the management slows down its future investments, dragging down the economies of scale of the company in the short and medium term.
Either way, I think for investors to start getting excited about the stock again, Amazon’s profitability must first improve materially.
Can AWS’ growth be sustained?
Amazon’s most profitable segment is its web services segment, as it enjoys fairly high margins. That’s why I think its future outlook is critical in predicting Amazon’s net income recovery.
In Amazon’s most recent third quarter results, AWS generated $20.5 billion in net sales, implying a year-over-year increase of 27% (or 28% in constant currency) . Its operating profit also remained juicy, coming in at $5.4 billion, up 11% from a year ago. Nevertheless, this implies a slowdown from the 33% growth of the previous quarter and the 39% growth of the third quarter of last year.
Due to current market conditions, including global enterprise spending likely to decline as companies aim to reduce costs, AWS growth is highly likely to slow further. I mean, it’s still growing at impressive levels, especially considering the company dates back to 2002. But yeah, given the macro landscape, further downturn is more or less certain – especially with the competition from Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOGLE) (NASDAQ:GOOG) ramp up.
Retail Segment: The Struggle Continues
Despite AWS’ success and strong contribution to earnings, Amazon’s retail business, which accounts for the bulk of revenue, appears to be struggling quite badly.
In North America, segment growth was maintained at healthy levels, with third-quarter revenue up 20% year-on-year, from $65.6 billion to $78.7 billion. However, this growth did little to satisfy investors as the segment posted an operating loss of $142 million compared to an operating profit of $880 million last year. Not only is this a massive drop, but it’s particularly worrying given that Amazon should have realized further economies of scale given its revenue growth. This shows how severe the increase in labor and fulfillment costs has been lately.
The situation in the international segment was even worse, as the current headwinds amid a strong dollar had an additional negative impact on results. While revenue would have increased 12% in constant currency, revenue actually fell 5% to $27.7 billion. Combine that with the continued rise in costs, and you have an operating loss of $2.5 billion, an even bigger loss from last year’s $911 million. With the dollar remaining exceptionally strong, Amazon will find it even more difficult to achieve sustainable profits in the current market environment.
Is AZMN a good stock to buy, according to analysts?
When it comes to Wall Street, Amazon has a strong buy consensus rating based on 33 buys and two blocks awarded over the past three months. At $139.88, the average Amazon stock price forecast implies an upside potential of 50.09%.
Takeaway: Wait for Amazon’s retail outlook to improve
Amazon has great business, but the company is currently in the midst of a storm as its retail segment is highly susceptible to adverse macroeconomic events. Although the stock has already fallen enough to warrant buying, assuming profitability improves going forward, I will stay away until I see retail navigating better in the current environment. .