Amazon: Profits have surged again, but massive Capex has "cast a shadow"

On October 30th, after the US stock market closed, $Amazon(AMZN.US) announced its Q3 2024 financial report. Overall, revenue slightly exceeded expectations but was not impressive, mainly due to operating profit exceeding expectations by more than $2 billion, marking Amazon's return to a profit margin expansion cycle, which is the core highlight. Specifically:

1. As one of the market's focal points, AWS's revenue growth rate this quarter was 19.1% year-on-year, only accelerating by 0.4 percentage points compared to the previous quarter, which was slightly lower than the consensus expectation of the sell-side by 0.1 percentage points. Top sellers and buyers expected at least a 20% or higher growth rate to validate the trend of AWS re-accelerating and narrowing the gap with peers, but this was not the case.

The growth rate of AWS, which is nearly flat with no signs of acceleration, combined with the slowing growth of Azure, suggests that the overall demand for cloud computing does not seem to have experienced a significant explosion driven by the AI wave. This casts some shadows over the entire AI investment logic. The unexpectedly strong performance of the smallest GCP appears to be more about marginal improvements in the competitive landscape, capturing incremental market share.

Although growth did not accelerate, AWS's operating profit margin saw a significant increase, rising nearly 2 percentage points to 38%, with actual operating profit close to $10.5 billion, significantly exceeding the expected $9.1 billion. With the gradual decline of the benefits from extended depreciation periods and AWS entering a period of increased Capex, the market's original expectation was that AWS's operating profit margin would gradually decline (the market consensus expectation was 33%). It is essential to pay close attention to how management explains the driving factors behind the increase in profit margin.

2. The revenue growth rate of the retail segment this quarter was 9.5%, slightly up 1.1 percentage points compared to the previous quarter, and slightly stronger than the market expectation of 1.2%. By region, the growth rate of North American retail indeed showed a slight slowdown, dropping from 9.1% to 8.7%. Meanwhile, the nominal growth rate of international retail business surged from 6.6% to 11.7%, which is a major highlight. However, nearly 3 percentage points of this growth change came from currency exchange rate contributions.

In specific business areas, the growth of 3P merchant services and advertising revenue has slightly slowed, while the growth of self-operated retail has seen a significant acceleration. Combined with the official announcement that the proportion of 3P merchant order volume fell from 61% in the previous quarter to 60%, this should mainly be due to changes in the sales structure between 1P and 3P leading to marginal changes in growth. Additionally, the growth rate of subscription service revenue also increased by 1.1 percentage points, likely due to contributions from Prime video ads.

3. In terms of profits for the retail segment, the overseas regions with significantly increased revenue growth also exceeded expectations this quarter, reaching $1.3 billion, which has surpassed one-fifth of the North American segment's profit. The profit margin reached 3.6%, approaching the North American segment's 5.9% In contrast, the profits from retail operations in North America do not show much highlight, with a slight increase in profit margin of 0.3 percentage points, and an actual operating profit of 5.66 billion, just slightly above the expected 5.3 billion. However, considering that the international retail operations have nearly 5% growth driven by favorable exchange rate changes, Dolphin Investment Research speculates that the significantly better-than-expected profits from the international region may also be largely attributed to exchange rate contributions.

Thanks to the contributions from AWS and the international retail segment, Amazon's overall operating profit reached 17.4 billion USD, far exceeding the sell-side expectation of 14.7 billion and the previous guidance upper limit of 15 billion. The overall operating profit margin is 11%, an increase of 1.1 percentage points quarter-on-quarter, re-establishing the trend of profit margin expansion.

4. However, it should be noted that although the company has returned to a profit margin expansion cycle this quarter, the company's Capex has significantly increased to 22.6 billion, an 81% year-on-year growth, nearly doubling the Capex growth rate compared to the previous year, returning to the peak investment period of 2021. The absolute value of the investment has also exceeded the highest point at that time.

This quarter, the company's depreciation and amortization amounted to 13.4 billion, which is only a slight increase from the previous quarter's 12 billion, indicating that the current high investment has not yet reflected in the financial report as a drag on profits through depreciation. However, if this historically high level of investment continues, the subsequent pressure on profits is likely unavoidable, and caution is needed.

5. For the guidance on next quarter's performance, the company expects a revenue range of 181.5 to 188.5 billion, although the midpoint is lower than the market expectation of 186.4 billion, it is not below expectations according to the historical pattern where actual deliveries tend to lean towards the upper limit of guidance.

On the profit side, the company guides operating profit to be between 16 to 20 billion, while the market expects 17.5 billion. According to the company's historical practice, the actual delivered profit will exceed the upper limit of guidance. This guidance implies that the market will once again significantly adjust its profit forecasts for the future.

Dolphin Investment Research's View:

According to Dolphin Investment Research's understanding, the market's focus on Amazon's performance this time mainly revolves around two points: ① Can the AWS cloud business accelerate better than expected? To verify the incremental demand brought by AI and reflect signs of improvement in the AWS competitive landscape; ② Can the overall company (especially the retail segment) continue the previously temporarily interrupted trend of profit margin improvement?

It can be seen that: 1) The vision of AWS accelerating beyond expectations has not been realized, with a year-on-year growth of 19.1% this quarter, only a slight acceleration of 0.4 percentage points compared to the previous quarter, showing no significant signs of acceleration. Combined with Azure's performance, it has not verified the industry's significant incremental demand for computing power brought by AI, nor has it confirmed the competitive improvement of AWS narrowing the growth gap with peers.

2) However, in terms of operating profit margin improvement, Amazon's performance this time is quite impressive. The actual operating profit significantly exceeded market expectations and the previous guidance upper limit by over $2 billion, signaling a return of the trend of profit margin expansion, which could prompt the market to raise its expectations for future profits again.

In particular, the significant increase in profit margins in overseas regions is rapidly approaching the profit levels of North America. Although it is still unclear how much of this is due to non-operational factors such as exchange rate changes. However, if this is sustainable, it suggests that the market may reassess and value the previously overlooked overseas business.

However, Dolphin Investment Research also needs to remind that the current capital expenditure (Capex) investment has already exceeded the record high of over $22 billion in 2021. Although this has not yet reflected pressure on profits in the financial statements, if this level of investment continues, the "Sword of Damocles" is already hanging, and when it will fall to suppress profits is likely just a matter of time.

Detailed comments are as follows:

1. AWS did not accelerate as expected, but there was unexpected profit growth

One of the key focuses of the market is when/if AWS, which has significantly underperformed in this wave of AI, can narrow the growth gap with GCP.

This quarter, AWS's revenue growth rate year-on-year was 19.1%, only accelerating by 0.4 percentage points compared to the previous quarter, slightly lower than the consensus expectation of a 0.1 percentage point decline. According to Dolphin Investment Research, leading sellers and buyers expected at least a 20% or higher growth rate to validate the trend of AWS re-accelerating and narrowing the gap with peers. However, from this quarter's financial report, it did not meet expectations.

The reality is that AWS's growth rate is nearly flat, showing almost no signs of acceleration. Combined with the earlier reported performance of Azure and GCP, it can be inferred that overall demand for cloud computing does not seem to have experienced a real explosion driven by the AI wave so far. Azure's growth is slowing, AWS is flat, and only the smallest player, GCP, seems to have marginally improved its competitive position in this wave, capturing some incremental market share.

However, in terms of profit, AWS's operating profit margin has significantly increased, rising nearly 2 percentage points to 38%, matching the profit margin when the benefit of the extended depreciation period was just released in the first quarter. The actual operating profit was nearly $10.5 billion, significantly higher than the expected $9.1 billion.

According to our understanding, the market's original expectation was that as the benefits of the extended depreciation period gradually wane and AWS enters a period of increased Capex, AWS's operating profit margin would gradually return to previous levels (the market consensus expectation was 33%). However, the significant improvement in profits without a substantial acceleration in revenue is indeed unexpected, and it is crucial to pay attention to how management explains the driving factors behind the increase in profit margins. **

2. Strengthening Overseas Business, Retail Business Growth is Quite Impressive

The revenue growth rate of the retail segment this quarter is 9.5%, slightly up by 1.1 percentage points compared to the previous quarter, and slightly stronger than the market expectation of 1.2%. Combined with industry data, the overall growth rate of online retail in the United States has slightly decreased compared to the previous quarter, but the actual performance is indeed slightly better than expected.

In terms of regional performance, it can be seen that the growth rate of retail in North America has indeed slightly decreased from 9.1% to 8.7%, which is basically in line with market expectations. However, the nominal growth rate of international retail business this season has significantly accelerated from 6.6% to 11.7%. Although nearly 3 percentage points of this growth comes from exchange rate contributions, it still accelerated by 2 percentage points under constant exchange rates. It is evident that the international region is the main highlight of this season's retail business.

Looking at the specific performance of various sub-segments: ① The growth rate of self-operated retail business has accelerated by 2.7 percentage points compared to the previous quarter, while the revenue from 3P merchant services has decreased by 1.7 percentage points. Given that the official announced proportion of 3P merchant order volume has dropped from 61% in the previous quarter to 60%, the main reason should be the change in the sales structure between 1P and 3P;

② The growth rate of subscription service revenue has also accelerated by 1.1 percentage points. Considering the company's promotion of Prime video advertisements, we believe that some users may choose to pay a higher membership fee to avoid ads, providing incremental revenue.

③ The advertising business revenue, which is of most concern to the market, has also slightly decreased by 0.7% this season, which did not bring any surprises. This may be partly due to the decline in the 3P sales structure this season.

Adding together the cloud business and retail business, Amazon achieved total revenue of approximately $158.9 billion this season, a year-on-year growth of 11%, with a slight acceleration. This is slightly higher than the market expectation of $157.3 billion, mainly due to the contribution from the better-than-expected growth in international retail.

3. Profits Greatly Exceed Expectations, Is It Time to Return to a Profit Margin Expansion Cycle?

On the revenue side, due to AWS cloud computing not performing brilliantly and a slight slowdown in advertising revenue growth, overall it slightly exceeded expectations but did not stand out particularly. However, Amazon's profits this quarter once again greatly exceeded expectations, returning to the track of profit expansion, which is the biggest highlight of this performance.

Specifically, Amazon's overall operating profit reached $17.4 billion, far exceeding the sell-side expectation of $14.7 billion and the previous guidance upper limit of $15 billion. The overall operating profit margin was 11%, an increase of 1.1 percentage points quarter-on-quarter, re-establishing the trend of profit margin expansion.

By segment, as mentioned earlier, AWS cloud business's actual operating profit exceeded expectations by nearly $1.3 billion, and the profit margin not only did not decline but instead significantly increased, making it one of the contributors.

In addition, the retail business in overseas regions, which saw a significant increase in revenue growth, also greatly exceeded expectations this quarter, reaching $1.3 billion, which has surpassed one-fifth of the North American segment's profit. The profit margin reached 3.6%, quickly approaching the North American segment's 5.9%. In contrast, the retail business in North America did not have many highlights, with an actual operating profit of $5.66 billion, only slightly above the expected $5.3 billion.

However, considering that nearly 3 percentage points of the growth in international retail business this quarter came from favorable exchange rate changes, Dolphin Investment Research speculates that a considerable portion of the significantly exceeded expectations in international profits may also stem from exchange rate contributions.

4. Record High Capex Investment Needs to Be Viewed Cautiously

From the perspective of costs and expenses: 1) The gross profit margin this quarter was 49.1%, slightly lower than the expected 50.1%. Dolphin Investment Research believes that this may be partly due to the relatively sluggish growth of high-gross-margin businesses such as 3P merchant services and advertising revenue this quarter.

2）From the expense perspective, this quarter also announced the end of the expense contraction phase, with all expenses returning to year-on-year growth. However, apart from the relatively rigid fulfillment expense growth reaching 11%, the year-on-year growth rate of other operating expenses remains only around 1% to 6%. Therefore, under the higher revenue growth, the expense ratio is still passively declining.

However, we would like to remind you that although the company has returned to profit expansion this season, the company's Capex has significantly increased to 22.6 billion, a year-on-year growth of 81%, already exceeding the highest value during the peak investment period in 2021.

Although the company's depreciation and amortization this quarter was 13.4 billion, which is only a slight increase compared to last quarter's 12 billion, it indicates that the increased investment has not yet reflected in the financial report as a drag on profits. However, if this historically high level of investment continues, the subsequent pressure on profits will be inevitable and should be viewed with caution.