Some investors express worry over the perceived stagnation and profitability of Amazon’s (NASDAQ:AMZN) retail business. However, the company’s subscription, cloud, and advertising segments are expected to be the main drivers of its value in the future. While the retail division contributes a significant portion of Amazon’s revenue, it doesn’t need to outperform expectations for the company and Amazon stock to continue growing.
A closer look reveals that Amazon’s operating income is divided into three segments: “North America,” “International,” and “AWS.” Although the international segment still operates at a loss, North America has returned to profitability compared to the previous year. While AWS’s growth rates have slowed, it is the decline in operating margins that raises concern, potentially due to increased competition from Microsoft and Google.
It is worth noting that the profitability of Amazon’s North America and International segments would likely be worse if retail alone were considered. Subscription and advertising revenues contribute higher margins than retail. In the future, the company may choose to present the operating profitability of Advertising and Subscriptions as separate units, similar to how AWS is reported. This could enhance investor perception of the segments’ profitability and potentially serve as a catalyst for the stock.
Amazon’s revenue is categorized into seven segments, with online stores and physical stores showing minimal growth. The real growth potential lies in the remaining five segments. The combined subscription and advertising segments are approaching the size of AWS and have the potential for similar profitability.
Subscription revenue provides a consistent profit engine for Amazon, akin to AWS. As the company continues to add value, especially in international markets, there is room for subscriber growth. If Amazon raises subscription prices further, it could significantly impact the bottom line.
The demand for cloud computing is booming, and Amazon’s AWS stands to benefit. The company may further improve the efficiency of its cloud services through advances in semiconductor technology. Any enhancement in server compute cost-effectiveness would directly impact AWS’s profitability, potentially accelerating its growth.
The strength of Amazon’s advertising lies in its ability to target users with high purchase intent. This first-party approach makes advertising more likely to convert than generic search-based or brand advertising. Amazon’s advertising segment is growing rapidly, contrasting with the slowdown faced by companies like Google and Meta. While the profitability of this segment is influenced by the lower-margin retail segment, it has the potential to become Amazon’s “next AWS.”
Amazon’s retail division has the potential for efficiency gains through further integration of robotics and autonomy. As the company continues to invest in robotics technology, the number of retail employees may decrease. Incremental improvements in automation, such as those seen in Ocado’s facilities, could boost margins. Additionally, advancements in autonomous driving and delivery would enhance efficiency in retail and fulfillment operations, leading to increased profitability.
Amazon Stock Performance and Valuation
Although Amazon has experienced a significant rally, the returns over the past five years appear less impressive in comparison to the S&P 500 and even Walmart. To sustain its rally, Amazon needs to justify its valuation by improving profitability and demonstrating the benefits of its substantial retail and fulfillment investments.
While Amazon’s stock valuation may seem high, its growth investments and opportunities justify it in the eyes of the market. Regulatory scrutiny, international expansion challenges, and the risk of failing to improve profitability and top-line growth are concerns. However, the overall risk/reward balance is viewed as attractive, with confidence in Amazon’s ability to capitalize on growth opportunities in areas such as AWS, advertising, subscriptions, and third-party seller services. These segments are expected to be the company’s future growth drivers, with the potential for margin expansion.
In summary, despite the slowdown in retail, Amazon possesses numerous growth opportunities. The company is well-positioned to monetize its investments, and the risk/reward profile is viewed favorably.
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