Amazon Q4 14A – The EBIT question

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Q4 14A margins may not be sustained into 2015E.

• Amazon reported good results as management seems to have finally decided that it was time to make a profit.
• Q1 14A Revenues and profits were $29.34bn / $0.45 compared to consensus at $29.73bn / $0.17.
• Although profitability was far ahead of expectations, it still represents net margins of only 0.7%, a far cry from where a business with this valuation should be reporting.
• Q4 14A GAAP operating profit (EBIT) was robust at $591m compared to guidance of LOSS $50m (LOSS $570m – $470m).
• North America was the main driver of profits reporting an operating margins on 5.4% compared to 0.6% in Q3 14A.
• The large increase in revenues combined with greater restraint in terms of investment, was responsible for profitability coming comfortably ahead of both guidance and consensus.
• For the entirety of 2014A management has been investing in other areas and this has had a significant and deleterious effect on the profitability of the whole company.
• Consequently, these results are a reflection of operating leverage from seasonally higher revenues and the hope that management will now exercise greater restraint going forward when investing the profitability of the core business.
• Hence, the question from here is what happens now?
• For Q1 15E, management expects revenues / EBIT of $20.9bn – $22.9bn / $0m – $500m which is broadly in line with consensus estimates of $23.2bn / $490m. (EBIT figures exclude stock based compensation and amortisation of intangibles).
• Amazon Prime members increased in number by 53% YoY (28m users) but this is below RFM’s forecasts for the Amazon ecosystem which were at 29.9m users for Q4 14A.
• In order to compete effectively in the consumer ecosystem, RFM thinks that Amazon needs to win at least 100m users to be viable.
• The fact that users have to pay an entry fee of $99 per year to get any benefit from the few Digital Life services that Amazon continues to be a major hindrance to its uptake.
• Pricing of Amazon Prime needs to be completely rethought if Amazon wants to have any hope of becoming a major consumer ecosystem.
• Consequently, I continue to believe that Amazon has not really internalised what it means to create a digital ecosystem and as a result its strategy remains haphazard at best.
• The market is now hoping that the focus will be on profitability but I am not so confident as I expect the somewhat random and expensive forays into the ecosystem to continue in 2015E.
• At 83.7x 2015E PER, investors are already paying-up for large improvements in profitability that may not materialise.
• I am not inclined to join them.