Amazon: Easy Double Beat In Q1 (NASDAQ:AMZN)

Article Thesis

Amazon.com, Inc. (NASDAQ:AMZN) reported strong first-quarter earnings results. The company beat estimates easily and margins improved nicely. While the Q2 revenue growth outlook was worse than expected, Amazon’s performance is still appealing from an operational perspective. On the other hand, the stock is far from cheap today; thus, investors should consider AMZN’s valuation before buying.

Past Coverage

I have covered Amazon.com, Inc. several times in the past, most recently last year when the company reported its Q1 2023 results. I gave the company a neutral rating back then, which has not been the best call — AMZN has rallied substantially since then. Thus, a bullish call would have worked out better. My main reason to stay on the sidelines a year ago was Amazon.com’s high valuation, but as it turned out, the stock performed nicely despite trading at a high valuation even a year ago. In today’s article, I will focus on Amazon’s Q1 2024 results and what they mean for the company going forward.

What Happened?

Amazon.com, Inc. reported its most recent earnings results, for its fiscal first quarter, on Tuesday afternoon. We can see the headline results in the following screencap:

The company was able to beat results on both lines, which naturally is a strong result. Revenue came in slightly higher than expected (around 0.5%) and was up by 13% year over year. Compared to the company’s results in the last couple of quarters, that was very solid — revenue growth came in between 7% and 15% over the last two years, thus growth in Q1 was above the average over that time frame.

Earnings per share also were higher than expected and were up massively year over year, despite headwinds from the value decline of Amazon’s stake in electric vehicle company Rivian Automotive (RIVN). Without that non-cash loss, Amazon would have reported even higher profits for the first quarter.

The market appreciated these results, sending Amazon’s shares higher by a couple of percentage points at the time of writing. This could change in the coming days, of course, as investors digest the company’s results and outlook.

Profit Growth Is Excellent

Amazon.com has been a huge company for many years, but its profits were not huge during the vast majority of those years, as we can easily see in the following chart:

Compared to the hundreds of billions of dollars in revenue that Amazon has been generating for some time, its profits always looked rather meager. Companies such as Alphabet (GOOG, GOOGL) have been more profitable despite generating significantly lower revenues — GOOG generated $74 billion of net profit in 2023 with around half of the revenue Amazon is generating.

This rather low profitability was partially due to Amazon’s hefty investments in its operations, but the business model also plays a role. The retail business isn’t very high-margin and not comparable to the businesses of Microsoft (MSFT), Alphabet, or Meta Platforms (META), which all generate much higher margins with better operating leverage in their core business units. Amazon also was hurt hard by inflation in 2022 (and, to a lesser extent, in 2023), which we can see in the above chart — profits nosedived during that time. High fuel costs and high shipping costs due to disruptions to global trade, for example, hurt Amazon a lot more compared to its big-tech peers, where transportation and fuel costs are not really impactful.

The good news is that profitability has been improving a lot at Amazon in the very recent past. This is partially due to easing inflation worries — fuel expenses, for example, are down compared to the peak levels seen in 2022 and 2023. Shipping costs, such as Asia-to-North America container leasing rates, are also down a lot compared to the highs seen over the last couple of years.

But apart from a more benign macro picture, Amazon also benefitted from company-specific items. The company has been focused on bringing down expenses in the recent past, which includes job cuts. Amazon has not only done these over the last two years, but kept cutting employees in different units such as Audible, AWS, and also in its healthcare unit lately. The impact of these very recent job cuts should be fully visible in the coming quarters — investors can count on further profitability improvements in the foreseeable future, all else equal.

Between revenue growth that allowed for some operating leverage, especially in the techy, higher-margin AWS segment, and Amazon’s cost-cutting programs, the company saw its profits soar over the last year. Operating profit came in at $15.3 billion, up more than 200% from $4.8 billion one year earlier. Both in absolute terms and in relative terms, Amazon is still less profitable compared to companies such as Apple (AAPL) or Alphabet, but the profitability improvements over the last year are excellent.

Based on the company’s guidance for the current quarter, the company’s fiscal Q2, profitability will remain at an appealing level in the near term. Amazon expects revenues of around $147 billion during the current quarter, which is slightly less than the analyst consensus estimate. But the profit outlook — Amazon expects operating profits of around $12 billion — is compelling. After all, this would represent a major improvement of well above 50% compared to the second quarter of 2023, when Amazon’s operating profit was $7.7 billion.

Considering Amazon’s guidance can be conservative at times, actual results for the current quarter may be better than what the company is guiding for right now. The company had guided for $141 billion in revenue for the first quarter, for example, but actual revenues came in more than $2 billion higher. Amazon also beat its Q1 operating profit guidance by a hefty $5 billion, as Amazon had guided for “only” $10 billion in operating profit for the first quarter.

Is Amazon.com Stock A Good Investment?

Amazon.com has a strong brand and an excellent market position. In its core markets, including North America, Amazon is the biggest and most dominant e-commerce player by far. While the retail business isn’t growing at the rates it was growing at when Amazon was a smaller and younger company, growth is still appealing. Amazon also has a strong market position in cloud computing, although it is not among the AI leaders — others, such as Microsoft or Nvidia (NVDA), offer more exposure in that area.

Amazon’s recent profitability growth is highly compelling, and with ongoing headcount reductions in some areas, Amazon could see further profitability tailwinds in the coming quarters.

On the other hand, waning inflation pressures and declining fuel and shipping costs were major profit drivers in the recent past. It is far from guaranteed that fuel and shipping costs will decline further, thus profit growth in the coming quarters could be weaker compared to what we have seen in the first quarter.

Amazon has a healthy balance sheet, but it is not as strong as the balance sheets of Amazon’s big tech peers. Amazon’s $73 billion of cash and equivalents are mostly offset by $58 billion of long-term debt, while companies such as Meta or Alphabet have significantly larger net cash positions.

Amazon’s shareholder returns are also not as attractive as the shareholder return programs of Amazon’s peers — Amazon does not pay any dividends and its share count continues to climb, while other big-tech companies are mostly offering dividend payments and significant buybacks as well.

From a valuation perspective, Amazon.com, Inc. stock looks rather pricey. Shares trade for 43x net profits today, although it is possible that the earnings per share consensus estimate will rise in the next couple of days as analysts adjust their models due to Amazon’s better-than-expected profitability during the first quarter. But even if the consensus estimate rises slightly, Amazon would still trade at a significant premium compared to companies such as Alphabet, Meta, or Apple, which are trading with earnings multiples in the 20s. Alphabet and Meta also have stronger business growth compared to Amazon, making them look like more favorable investments, I believe.

Looking at Amazon’s valuation from a cash flow perspective, we see that the company generated free cash flows of $46 billion over the last twelve months, accounting for the repayment of finance leases. The company is valued at $1.9 trillion today, making for a free cash flow multiple of roughly 40. This makes for a free cash flow yield of around 2.5% at a time when treasuries and CDs are paying way more than 2.5%. We can thus conclude that plenty of future earnings and cash flow growth is baked into Amazon’s stock price already.

I do not believe that Amazon is way overvalued here, but I also do not believe that the current valuation is especially attractive. Other big tech names look more compelling to me, relative to Amazon, which is why I give this retail giant a neutral rating today.