Amazon Stock (NASDAQ:AMZN)
Amazon’s (NASDAQ:AMZN) AWS revenue growth rate was expected to decline as the company faced a variety of hurdles. There was a strong likelihood that AWS will publish disappointing results in Q4 2022 and Q1 2023, resulting in negative sentiment toward the company.
AWS’s growth rate is projected to accelerate as the macroeconomic climate improves. Cost-cutting actions in this category will also result in margin improvement in the coming quarters. AWS can still deliver YoY growth rates of 10% to 25% in the coming quarters, with operational margins ranging from 20% to 30%. Even in the worst-case scenario, it would still post an operating margin of more than $25 billion in 2025. This cash cow should allow other revenue streams, such as advertising, subscriptions, and third-party services, to grow. As indicated in a previous piece, Amazon is playing a long game with its Prime business, which is expected to generate $100 billion in income by the end of this decade based on current patterns.
Even if the outcomes are modest, AWS’s standalone worth should be close to $1 trillion by 2025. Investors with longer time horizons can profit from short-term volatility in the market to find suitable entry points. Despite short-term difficulties, Amazon stock is a buy.
Overhype in One Area
A great number of analysts have already predicted the end of AWS’s growth period. Following the recent earnings announcement, the stock’s Sell rating has rapidly increased. AWS reported a 16% YoY growth rate and a 24% operating margin. This was much lower than the previous range of a 30% to 40% growth rate and close to a 30% margin. The slower rate of revenue growth and lower margins have resulted in a 26% drop in operating margin compared to the previous quarter.
AWS recorded an operating margin of $5.1 billion in the most recent quarter, down from $6.5 billion in the previous quarter.
AWS accounts for more than 100% of Amazon’s total operating income. Amazon reported $4.7 billion in consolidated operating income in the most recent quarter, which was less than AWS’s $5.1 billion operating income. As a result, it is unavoidable that we will witness negativity about Amazon’s overall operations as AWS growth slows.
However, AWS’s current difficulties are expected to be temporary. The macroeconomic environment could improve in the next quarters, providing a tailwind for higher revenue growth. Amazon is also cutting costs aggressively, which should help improve margins by the end of the year. We’ve seen the impact of enormous recruiting on the margins of nearly all major technology companies. The recent rounds of layoffs should allow AWS to return to an earlier 30% margin.
The Worst-Case Scenario for AWS Remains Optimistic
The cloud industry has become an essential component of the technology sector. Lower spending on cloud operations is anticipated to be temporary as inflation is controlled and company sentiment improves. AWS also had difficult comps in this quarter, despite the fact that operational income climbed by 53% year on year. Easier comps and an improved macroeconomic backdrop could benefit the company in the next quarters.
If we assume a 10% to 25% YoY revenue growth in AWS over the following few quarters, this segment should generate annualized revenue of $120 billion to $150 billion by the end of 2025. Cost-cutting measures could assist improve margins, and AWS’s operating margins should be in the 20% to 30% area in the near term. Even under the worst-case scenario of 10% YoY sales growth and 20% operating margin, AWS would have $25 billion in operating income by the end of 2025. This cash cow should give other high-margin segments enough time to raise their revenue share and contribute to Amazon’s bottom line.
Subscriptions, Advertising, and Third-Party Services
Amazon’s advertising business reported $9.5 billion in net revenues, up 23% year on year, while subscription services reported $9.6 billion in net sales, up 17% year on year. The combined advertising and subscription revenue base is $19 billion, which is close to AWS’s net sales of $21 billion. These two significant areas are quite likely to surpass AWS in net sales by the end of this year. Amazon’s emphasis on third-party services is also bearing fruit, with a 20% YoY increase in this area.
The significance of these divisions will grow dramatically when their sales share improves and their contribution to Amazon’s profit is recognized. Wall Street can focus on AWS in the short term because of its position in Amazon’s growth story, but long-term growth and profitability will be determined by other categories such as advertising, subscription, and third-party services.
Long-Term and Short-Term Amazon Stock Patterns
The company’s announced cost-cutting efforts will take some time to show up in quarterly earnings. However, by the end of 2023, AWS should reclaim some of its lost margins and be closer to 30%. The improvement in the economic circumstances should also aid in raising the YoY growth measures above 20%. In the short term, we expect unfavorable sentiment to persist, and Amazon stock may experience some price cuts.
However, Amazon’s long-term growth story remains positive. Investors can profit from the stock movements in the short run. As previously stated, even in the worst-case scenario, AWS will be able to generate a $25 billion operating margin by 2025. AWS could still have a standalone valuation of close to $1 trillion by 2025 with a PE multiple of 20 to 30 times.
The consensus forecast for Amazon’s future revenue is fairly favorable. The majority of the increase would come from more lucrative categories such as advertising, subscription, and third-party services, which should enhance the company’s profitability. These three divisions’ revenue base is already close to $50 billion, which equates to 40% revenue share in the most recent quarter. AWS accounts for an additional 18% of Amazon’s income. In the medium to long term, an increase in revenue share from high-growth, high-margin industries should strengthen attitudes toward Amazon.
Takeaway for Investors
The AWS slowdown has been overstated, and it was already factored in due to the company’s adverse macroeconomic condition and tough comps. Even with a modest growth rate and margin, AWS should report an operating margin of more than $25 billion in 2025, giving this segment a standalone valuation of close to $1 trillion. Amazon’s other lucrative areas are expanding its revenue share, which should help improve the company’s total sales growth rate and profits. Despite recent AWS results, Amazon stock is a buy owing to long-term growth potential in key industries.
Featured Image: Unsplash @ Daniel Eledut
