Profitability finally seemed to be turning a corner at Amazon.com (NASDAQ:AMZN) in 2016, following years of low margin. However, Amazon's recent second-quarter earnings report dashed bulls' hopes of steady profit growth. While revenue jumped 25% year over year, operating profit plunged by 51%.
In this episode of Industry Focus: Consumer Goods, the team drills down on the reasons Amazon's profitability came under pressure last quarter. Amazon is investing as aggressively as ever to keep sales growing. For long-term investors who believe in Jeff Bezos' vision, there's no reason to be worried about this decline in Amazon's margin performance.
A full transcript follows the video.
This video was recorded on Aug. 1, 2017.
Vincent Shen: Some other big news we wanted to cover from last week was Amazon earnings. I feel like this usually runs in Dylan's wheelhouse on the Tech show, but we're going to talk about the e-commerce giant's latest results and use them to segue into some related topics. Amazon's stock has been beaten up a little bit since releasing earnings. What did the company report to get a bearish response?
Adam Levine-Weinberg: On the sales front, Amazon is still chugging along. They had good growth last quarter. Revenue was up about 25% year over year. That's really good. Amazon has definitely managed to keep its growth rate steady or even increasing despite being now more than a $100 billion revenue company. That's really rare and extremely impressive. What caused the stock to fall is that their operating income is coming under pressure again. That's definitely an area of some concern for investors, because Amazon, obviously, for many years was barely profitable. It was actually losing money. Investors accepted that because they were growing. It seems, a couple of years ago, that with the growth of Amazon Web Services, which has pretty high margins, that Amazon was finally getting to be steadily profitable, was on a long-term earnings growth trajectory where they would be growing revenue very quickly as well, but also increasing their margins year after year. That story just broke down last quarter.
Just a look at the numbers. While sales reached $38 billion, up 25%, operating income plunged more than 50% year over year last quarter, down to $628 million. And actually, if you look and break that down by segment, more than 100% of that operating profit came from Amazon Web Services. So the retail business as a whole, which is still the vast majority of Amazon's sales, was unprofitable last quarter. And some of that is foreign currency. They've certainly been hit hard, as other retailers have, by the strong dollar in their international operations, which are losing money right now. And even in North America, you're seeing a lot of growth initiatives that are keeping sales growth at such a high rate, they are having an impact on the profitability. Two of the ones I would call out are first their investments in video, on Prime Instant Video.
Shen: On content.
Levine-Weinberg: A great driver, it's a reason why the Prime membership program is growing so quickly, because they offer all of these side benefits aside from the free shipping that Prime became known for. But that's really expensive, and you're basically putting money in there where you're not getting a direct return for that investment, because it's just included as an add-on once you buy the Prime subscription. So I'm sure it drives some incremental revenue for Prime, but the main reason why people sign up for Prime is to get the free shipping. So the real benefit for Amazon is, as you can keep people loyal to the Prime program, they should start spending more and more money Amazon.com.
The other thing I would call out is, you have their Prime Now same-day delivery. That's obviously really expensive compared to even two-day shipping, because when you have warehouses all over the country, you can use regular ground shipping to get an item to somebody within a day or two; whereas if you need to get it there in two hours, then all of the sudden you need to have a special courier network and warehouses that are very centrally located to get the items out to customers. That's obviously very expensive, and Amazon hopes to drive down that per-unit cost of delivery over time primarily just by increasing its scale. The more deliveries you're doing, the lower the cost per drop off. But that's going to take a while to get that to a cost that's really affordable for Amazon. So for now, that's definitely dragging on that profitability in North America.
Shen: The big takeaway that you will often see now in their quarterly reports, the AWS business continues to subsidize the retail segment, especially, you mentioned on the international side, as they try to expand out that business, too, there's going to be rising costs with that. But even, as you mentioned, the gem that AWS generally is, did see lower profitability and costs rising across the company. I think that's ultimately why Wall Street analysts and the market's response in general was a bit more bearish. I still find this reaction to the report interesting. You mentioned that, for years, Jeff Bezos has been growing the company, and he's been doing so at the expense of the bottom line. He really doesn't make a secret of that. The stock has done incredibly well, it's marched higher and higher, and then you have this one somewhat underwhelming report, that enough investors get shaken to push the shares down 6% to 7%. But at this point, I feel like you have to have this faith in Bezos and his long-term vision and strategy to even be a shareholder in the company.
Levine-Weinberg: I think that's absolutely true. Amazon right now, even after getting knocked down, it's still worth almost $500 billion. That's a huge amount of money for a company that, last quarter, earned a little over $600 million in profit. It's a very small operating profit relative to what the company is worth. You have to be betting on this company's growth not for the next few years, but for the next few decades to be a long-term Amazon shareholder.
Adam Levine-Weinberg has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.