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Sunday, April 29, 2018

Amazon: Uncovering The Hidden Profit Model Driver: Buy Rating

amzn
Amazon (NASDAQ:AMZN) reported earnings Thursday after the close. AWS revenues accelerated. Company profits jumped. But there was one sleeper line-item that is the big change in this story that could make earnings even more powerful. And we'll show you.

Advertising

AWS (Amazon's cloud division, Amazon Web Services) has been the profit story for Amazon. As long as AWS isn't dropping prices in a quarter it's driving most of the profit growth.

This quarter however you had both AWS and Amazon's "North America" divisions both drive growth. 

North American Retail profits jumped 93% in Q1 which was the fastest growth in about two years.  If you think it was Whole Foods, it could have been but the profit growth was much higher than Q4 when they had the first full quarter of Whole Foods. We'd also guess they are giving away the store at Whole Foods hurting profits.

We think the profit driver was advertising. 

If you go to page 13 of their release they have an "other" line-item. That line-item "primarily includes sales of advertising services." That tiny line-item way down on page 13 reported over $2B in sales up over 100% year-over-year. 

Here's what they said about advertising on Thursday's earnings call, 

"It's now a multibillion-dollar program and growing very quickly."

Not bad right?

What are the margins of online advertising?  Facebook's operating margins approach 50%. Google's operating margins are about 25%. That would mean that advertising profits drove about $500 million to $1 billion of Amazon's profits in Q1. That's out of total company operating profit $1.9B in operating profit in Q1. That would be meaningful.

Other than AWS, advertising is becoming super important.

Let's look.

North America Margins Accelerating

What's exciting is when you look at the underlying 2-year margin trend. That reveals the potential power in this Amazon business model.

The two-year check takes this year's growth rate plus last year's growth rate. It's a simple analyst tool that smooths out one-timers to spot an underlying trend.

Look at what we discovered. Q2'17 was down 2%, Q3  down .8%, Q4 down .1% and Q1 up .3%.

Do you notice a trend there? 

That two-year trend is getting better. We'd guess it's going to continue to rise.  You've now discovered what we believe is the hidden power in the Amazon earnings model.

Conclusion

Traditional retail is now even more dead. Think about it. They have to sell things at a profit. Amazon doesn't. They can sell advertising and subscriptions and give the product away. That advertising model is starting to show up and was a big driver to their profits. If it continues there is big upside potential for Amazon's profits and stock price.





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