Amazon: Can Profit Margins Continue to Rise Under Massive Investment? (3Q24 Conference Call Summary)

The following is the summary of Amazon's Q3 2024 earnings call. For the earnings report interpretation, please refer to Amazon: Profits Soared Again, but Huge Capex Has "Clouds Overhead"

1.Core Information Review of the Earnings Report:

2. Detailed Content of the Earnings Call

2.1 Key Information from Executives:

1. Business Progress

① Retail Business

- Sales Growth and Customer Experience Optimization

1. Sales Volume: Sales in North America and international markets increased by 9% and 12% year-on-year, respectively, with unit sales growing strongly by 12%.
2. Promotional Activities: Consumers are price-sensitive and seek discounts; the company successfully saved over $5 billion through large promotional events, driving Prime membership growth.
3. Prime Membership: The company focuses on providing low prices, a wide selection, fast free delivery services, and rich Prime member benefits, such as the new unlimited grocery delivery service from Whole Foods, Amazon Fresh, and local third-party grocery partners for $9.99 per month, as well as a fuel savings discount of $0.10 per gallon at some gas stations in the U.S.

- Logistics Network Optimization and Cost Control

1. Logistics Network Optimization: Opened 15 new inbound buildings, increasing inventory allocation capacity by 25% year-on-year, and continuously advancing logistics network optimization, including regional layout adjustments.
2. Same-Day Delivery: Continuously expanding same-day delivery facilities, with over 40 million customers enjoying free same-day delivery services last quarter, an increase of over 25% year-on-year; this service has become a fast and low-cost delivery method.
3. Application of Robotics Technology: Innovative application of robotics technology, integrating new robotic inventions to simplify processes, reduce handling time, and increase the variety of delivered products, expected to lower costs.

② Advertising Business

1. Advertising Revenue: This quarter's advertising revenue reached $14.3 billion, an increase of 18.8% year-on-year.
2. Significant growth in sponsored product ads; the company will enhance ad effectiveness by improving ad relevance and providing more optimization controls.
3. The newly launched Prime Video ads entered their first broadcast season, performing strongly.
4. Generative AI creative tools also support brands, indicating huge growth potential for the advertising business in the future.

③ AWS Cloud Computing Business

- Business Growth and Customer Collaboration

1. Business Revenue: AWS business revenue increased by 19.1% year-on-year, with an annualized revenue run rate reaching $110 billion, accelerating growth for four consecutive quarters.
2. Collaborative Development: In the Project Ceiba project in collaboration with NVIDIA, NVIDIA chose AWS infrastructure for the development of supercomputers.
3. Innovative Practices: AWS continuously innovates its infrastructure capabilities, launching Aurora Limitless Database and custom Graviton4 CPU instances to enhance performance and optimize costs.

- AI Business Progress and Service Optimization

1. AI Revenue: AI business revenue grew at a triple-digit percentage year-on-year, with a growth rate more than three times that of AWS's own growth during the same period. The number of machine learning and generative AI features released in the past 18 months is nearly twice that of all other leading cloud providers combined.
2. AI Service Infrastructure: AWS's AI service infrastructure provides services for model builders, being the first to offer NVIDIA H200 GPUs through EC2 P5e instances, while also investing in its own custom chips Trainium and Inferentia, with Trainium2 set to launch soon, showing significant performance-to-price advantages and attracting a large number of customers.
3. AI Service Middleware: AWS's AI service middleware provides teams with a wide selection of foundational models and key functional modules through Amazon Bedrock, facilitating customer deployment of generative AI applications, and is continuously expanding model types and optimizing features.
4. AI Service Applications: In AWS's top-level AI service applications, Amazon Q serves as a generative AI-driven software development assistant with a high code acceptance rate, saving customers significant costs.
5. Other AI Businesses: The company widely applies AI technology in other businesses, such as providing AI shopping guides for consumers, launching Project Amelia for sellers to gain business insights, improving Alexa technology, and applying AI technology to enhance note-taking features in the new Kindle Scribe.

④ Other Business Progress

1) Kindle Business:

- Launched a new Kindle product line, with sales exceeding expectations, and global Kindle devices averaging over 20 billion pages read per month.

2) Pharmacy Business:

- Amazon Pharmacy can deliver medications within 2 business days for 95% of first-time customers and within 24 hours for 20% of U.S. Prime members, with plans to expand to 20 new cities next year.

2. Financial Performance

① Revenue Side:

1. Revenue: This quarter's revenue was $158.9 billion, increasing by 11% year-on-year ( excluding foreign exchange impact), exceeding market expectations
2. Operating Profit: Operating profit was $17.4 billion, a year-on-year increase of 56%, exceeding expectations by $2.4 billion.
3. Capital Expenditure: Capital expenditure for the first three quarters was $51.9 billion.
4. Free Cash Flow: Adjusted free cash flow for the past 12 months was $46.1 billion, a year-on-year increase of 128%, up $25.9 billion year-on-year.

② Performance Guidance:

1. Net Sales: Expected net sales for the fourth quarter are between $181.5 billion and $188.5 billion, a year-on-year increase of 7% - 11%.
2. Operating Profit: Expected operating profit for the fourth quarter is between $16 billion and $20 billion.
3. Capital Expenditure: Expected capital expenditure for 2024 is $75 billion.

2.2 Q&A Analyst Q&A

Q: What are the drivers behind AWS's profit margin reaching 38%? How will it be maintained in the future? What is the outlook for capital expenditure (CapEx) in 2025?

A: The increase in profit margin is mainly due to revenue growth, cost control, and adjustments in server lifespan (adding about 200 basis points). Cost control is reflected in recruitment strategies and infrastructure management, with the company striving to maintain efficiency across the board. Future profit margins will fluctuate, influenced by investment levels, innovation intensity, staffing, and customer growth support.

CapEx is expected to exceed 2024, around $75 billion, primarily for AWS, with growth driven by generative AI. The cash lifecycle of the AWS business dictates that as demand grows faster, capital investment in data centers, network equipment, and hardware must also accelerate. However, these assets have a long lifespan, and the company expects to achieve good investment returns through operating income and free cash flow, with a long-term positive outlook on the generative AI business.

Q: The AI business is similar to the early AWS business, where early AWS profit margins were below 15%. Currently, the AI industry is highly competitive, with low pricing and low utilization. As AI business revenue grows, how does its profit margin compare to the existing AWS profit margin of over 30%? How long will it take to close the gap?

A: AWS's experience in managing logistics and capacity challenges helps in understanding the AI business. Although the AI business is in its early stages and more dynamic, the company can manage capacity based on demand signals. The ability of different suppliers to manage utilization and capacity affects profit margins and capital efficiency. Early AWS profit margins are different from now, and as the market matures, the generative AI business is expected to achieve healthy profit margins.

Q: What are the drivers of profitability in the international retail business? What is the future trend of profit margins? What is the progress and next steps for investment in robotics technology in the warehouse network?

A: The operating profit of international business fluctuates quarter by quarter but shows an overall upward trend, with operating profit margins improving year-on-year for the past seven quarters. Factors contributing to profitability improvement are similar to North America, including reduced service costs, increased advertising contributions, optimized product selection, and faster delivery speeds. International business covers mature and emerging markets, with countries at different stages of development. The company expects profit margins in various countries to align with those in North America (North American profit margins are also not static).

The company is a leader in the application of robotics technology but is still in the early stages. Several important robotic functions have been integrated into the new facility in Shreveport, Louisiana, achieving encouraging results. Robotics technology helps accelerate delivery speed, reduce costs, and improve safety. The team focuses on building foundational modules while AI will play an important role in the robotic network, and the company has hired relevant personnel to carry out this work.

Q: What is the relationship between average selling price (ASP) and unit growth in the retail business? How receptive are consumers to low-priced products or discounts? What strategic measures does the company have in place to leverage low-priced products and potential shifts in consumer habits in the long term?

A: Global unit sales grew by 12% in Q3, with consumers seeking bargains and being price-sensitive. The Prime event was popular, driving Prime membership growth and positively impacting the company's business. Although sales of low-priced products affected ASP, the growth in sales of everyday essentials has established stronger customer relationships based on fast delivery, leading to more orders, larger shopping baskets, and repeat purchases. The company focuses on free cash flow, viewing it as a positive signal.

Improved cost service capabilities have created conditions for providing low-priced products. Combined with a wider selection, faster delivery, and localization strategies, the company can meet more customer shopping needs. Although ASP may decline in the short term, the company has the opportunity to continue expanding its business and serve more customers.

Q: What is the reason for the slight decline in the proportion of third-party units in the online store in the third quarter? How well are AI agents developing in AWS and other businesses, and what are the potential directions for the next generation of Alexa based on existing data and agent capabilities?

A: In the third quarter, the proportion of paid units from third-party sellers was 60%, fluctuating between 59% and 61% over the past two years. Sales of everyday essentials tend to be self-operated (1P), which affected the proportion of third-party units, but third-party demand and unit sales remain strong.

Alexa devices are widely distributed in homes, offices, cars, and hotels, boasting a large user base. With the development of generative AI, the company is restructuring the Alexa brain, aiming to become a leader in this field. The next generation of AI assistants will not only answer questions and process data but also take action. Alexa has opportunities for development in this area and is expected to generate revenue by providing a better customer experience.

Q: Does the cloud business face capacity constraints? Can new Trainium or NVIDIA chips drive faster sales growth? What advantages does Amazon have in distribution center distribution compared to store distribution as traditional retailers experience rapid online business growth?

A: Currently, demand for cloud services exceeds existing capacity, primarily limited by chip supply. The company's AI business is growing rapidly, closely collaborating with NVIDIA, being the first to offer the H200 chip, with Trainium2 set to launch soon, showcasing significant price-performance advantages and strong customer demand, prompting the company to increase production With the increase in capacity, the growth rate of AI business is expected to further improve.

The retail market competition is active and healthy, which is conducive to innovation. Amazon's retail business advantages include a wider selection of products, low prices and significant promotions, and fast delivery. Customer testing and analysis show that the faster the delivery speed, the higher the frequency of customer purchases, and the more dependent shopping needs are on Amazon. In addition, the company's customer-oriented culture runs throughout, focusing on customer needs and feedback, combined with technological innovation capabilities, which helps to build long-term customer trust, a significant distinction from other competitors.

Risk disclosure and statement of this article: Dolphin Investment Research Disclaimer and General Disclosure