Amazon CY23 Earnings Outlook & Q4CY22 Review

Revenues:

Amazon Cloud (AWS), Amazon Ads, and Amazon Third-party seller services (3P) are the three pillars of growth for Amazon revenues over the next couple of years; online retail is getting into an easy comp. period in CY23 (YoY) but it’s offset by lower expected consumer spending. Amazon is increasingly relying on 3P services to generate revenues. Third-party seller services (3P) are 35% of CY22 revenues up from 23% in CY17 and a CAGR of 30% during the same period. 3P revenues will continue to increase with the launch of “Checkout with Prime” wherein merchants can provide Prime checkout, payments, and free shipping/return services on their own website using the Amazon Prime checkout button. 3P logistics services introduced in 2H22 allow merchants to use AMZN shipping just like Fedex/UPS. We expect a 10.5% AMZN revenue CAGR for CY22-24.

EBIT:

AMZN continues cost improvements in the North American retail segment in 2023, but on the international retail front, they are not as fast as the street has expected and hence the disappointment on international retail cost control. AMZN doubled its fulfillment center footprint in two years during the pandemic and simultaneously built a last-mile delivery network of the size of UPS during those two years hence costs have increased significantly which they are now optimizing. Better logistics infrastructure has reduced delivery times significantly in major metro areas but the higher fixed costs are hurting margins. Once customers get used to same-day delivery it’s difficult to move them back to 2-3 day delivery times and so the only option for AMZN is to grow sales to reduce the fixed cost overhead. AMZN needs to increase retail sales in high single digits to offset higher fixed logistics infrastructure costs; due to macroeconomic concerns we don’t expect retail sales growth in CY23 but in CY24 there’s a high probability AMZN could get back to retail sales growth. International retail segment losses are a cause of worry. The faster it stops bleeding, the faster it will stop being a drag on AMZN’s stock price. Currently, the major concern is the negative cash flow from the retail segment and primarily the international retail segment. North American retail EBIT was -241 mm dollars in Q4CY22 and International retail EBIT was -2,228 mm dollars. International retail negative EBIT remains stubbornly high and almost unchanged from Q3CY22 in spite of higher sales in Q4CY22 which should have provided some positive operating leverage but it didn’t; it means costs were still rising drastically in the international retail segment in Q4CY22 and cost-cutting initiatives were not helpful on a net basis. With AWS revenue growth as well as margins declining and International retail EBIT remaining stubbornly high in the negative $2B range, it would be difficult for the stock to move significantly higher.

EPS:

AMZN needs to cut costs rapidly in the international retail business segment. So far, AMZN has disappointed in cost cuts. Its Q4CY22 retail losses were roughly similar to Q3CY22; so no improvement over an entire quarter. In CY22, AMZN’s cloud business (AWS) growth was making up for all the retail losses. CY23 is a tough year for AWS as its growth slows and margins shrink and so if retail doesn’t stop losing money, there’s not much to cheer about for AMZN’s stock in CY23 and hence difficult to see any meaningful move in the stock price. Since CY22 was such a bad year (Adj. EPS?down 53% YoY), our CY22-24E est. EPS?CAGR is 78%. On a positive note, that’s still a good long-term 19% CAGR between CY19-24E.?

TAM:

a)?Buy with Prime Service: AMZN Expanded Buy with Prime to all eligible U.S. merchants, letting merchants offer Prime customers fast, free delivery, Prime checkout, and easy returns on their own websites. Data shows that shopper conversion increases an average of 25% when merchants use Buy with Prime. Amazon also introduced a capability for Buy with Prime merchants to display customer reviews from Amazon.com within their own online stores and announced an integration with BigCommerce, an e-commerce platform, that will help merchants easily enable Buy with Prime on their storefronts with no coding required. This feature is aimed at Shopify customers: Shopify CY22 revenues of $5.5B have grown at a CAGR of?52 percent over the last five years. b) Amazon Advertising: We expect Amazon advertising to continue growing at a CAGR of 20% plus for the next two years. According to some industry estimates, about 74% of all product searches in the US start on Amazon; so AMZN is a direct competitor to Google & FB for advertising. Moreover, Amazon advertising is benefitting from Facebook’s loss of accuracy due to Apple id changes. Advertisers prefer Amazon instead of Facebook since they get better and more accurate attribution vs. Facebook. As a reminder, Facebook reduced its attribution from 30 days to 7 seven days which means if the user doesn’t execute within 7 days Facebook loses the attribution revenues which in the past used to be 30 days. c) Amazon introduced 3P Logistics services with storage and warehousing in direct competition with Fedex/UPS. This will keep increasing 3P (Third Party Seller Services) revenue contribution which has been growing at a CAGR of 30% over the last five years (CY17-22). d) AWS Software Services: Amazon Security Lake, a service that automatically centralizes an organization’s security data from the cloud and on-premises sources into a purpose-built data lake. Amazon DataZone is a new data management service that unlocks customer data across organizational boundaries, including the cloud, on-premises infrastructure, and third-party SaaS applications. With AWS DataZone, customers can catalog, discover, and share data with governance and access controls.

Risks:

Continuous decline in AWS (IaaS) margins as the business are commoditized and no margin (market share at any cost) strategy adopted by the other two large competitors, MSFT & GOOGL. Retail continues to see lower margins for a long time due to lower sales growth which could hamper AMZN’s ability to lower logistics costs overhead. Both retail and AWS business generate massive operating leverage, however, in a slower growth environment, negative operating leverage will hurt quarterly results. It’s a race between how soon AMZN can contain costs vs. the speed with which growth declines in CY2023. Trying to reduce costs in a declining revenue year (retail segment, CY23) further increases the risk of not achieving the desired margin improvement.

Valuation:

The stock trades at 70x CY23 PE multiple and 2.7% TTM Adj. CFO Yield which seems expensive compared to its mega-cap peers. The valuation improves as we move closer to the end of the year and comps move to CY24 which is now at 36x PE multiple. Over the next few years, if AMZN is able to control costs and reduce losses in the retail segment, EPS could surprise on the upside and eliminate the high valuation risk especially if macroeconomic conditions improve in CY24 which could significantly boost retail revenue growth as well as positive operating leverage. As we get closer to CY24, there’s a high probability of a positive surprise on either retail revenue growth or international retail cost cuts which could catapult the stock back into growth mode.?

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