How Amazon's Investments Will Deliver

Amazon's focus remains on investing in its core business and expanding into new territories. The company continues to grow revenue and is reinvesting its earnings for long-term growth.

May 13, 2014 at 5:03PM

Amazon (NASDAQ:AMZN) continues to reinvest a major portion of its operating profits into growing its business lines. Amazon is investing large sums in fulfillment centers, cloud computing, and streaming services. These growth areas will drive big upside for the company and widen its durable competitive advantage.

Robust growth
In the last quarter, Amazon's revenue grew 23% year over year to $19.7 billion, and operating income decreased 19% year over year to $146 million. The company has more than 244 million active customers worldwide, and a larger customer base will fuel Amazon's future revenue growth very well. 

Amazon continues to grow faster in North America relative to international markets. In the last quarter, Amazon's North American revenue increased 26% year over year to $11.9 billion, and the company's international revenue increased 18% year over year to $7.9 billion. However, the company is investing heavily overseas and has a big untapped market opportunity, which should result in continued growth going forward. 

Amazon's gross margins stood at 28.8% in the last quarter, which is a notable increase from prior periods. This transition was expected from the company, as it earns more revenue from higher-margin segments consisting of third-party business and Amazon Web Services. In the future, the company should see expanding margins as those higher-margin businesses are growing faster than Amazon's retail business. 

Investing in Prime
Amazon significantly ramped up investments in Prime Video and is playing catch-up to Netflix (NASDAQ:NFLX). The company signed exclusive and expensive content deals to add some of Time Warner's HBO content to its service, as well as other, smaller content deals from Twenty-First Century Fox and BBC America. Netflix will have almost 50 million subscribers at the end of the quarter including June, and Amazon is trying ramp up its subscriber base from 20 million. 

Amazon's CFO stated that the company's prime subscriber base continues to grow very nicely week over week in terms of new trials. In addition, the company expanded its Prime Instant Video to the U.K. and Germany. Amazon is also adding six new original shows after their pilots received good reviews from customers, and is also adding the second season of political series Alpha House

The company's Fire TV product has seen good customer adoption, and Amazon is employing "the razor blade model" by selling the hardware at cost and earning revenue through content sales. Amazon continues the strategy employed by Netflix and will be adding more exclusive and original content to differentiate its service. 

Also, Amazon Prime recently added another service, Prime Pantry, which gives Prime customers essential household items like cereal, soft-drinks, and personal-care products, with a flat delivery fee of $5.99 per Pantry box, thus providing more convenience and more reasons for busy consumers to subscribe to Prime. These incremental services in Prime will appeal to more customers and give consumers a good reason to pick up a Prime subscription.

Investing overseas
In the last quarter, 40% of Amazon's total sales came from overseas. But, international operations suffered an operating loss in the last quarter, as Amazon is investing heavily in expanding in Italy, Spain, and China. Amazon stated that the company is likely to stay in investment mode in these countries, as they represent big addressable markets for future growth.  

In addition, another headwind for Amazon remains the company's net shipping costs as a percentage of revenue. In the holiday quarter, shipping costs made up 4.7% of sales, and in the last quarter, this notched up to 5%. However, the company raised prices of its Prime service, and this number should come down as Prime subscriptions are renewed by consumers. 

Going forward
Amazon Web Services reduced prices on its popular cloud-computing products, including Elastic Compute Cloud and Simple Storage Service. This could lead to more customers and drive higher volume workload for the high-margin AWS business in the future.

The company's revenue guidance for 2Q14 suggests that the company will continue to make additional investments for future growth in its various business units. Amazon continues to drive a better customer experience through more selection, convenience, and price. Amazon's big investments will fortify the company's moat significantly and position it for robust top and bottom-line growth in the future. 

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