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Amazon Just Put 3 Big Doubts to Rest

By Jeremy Bowman – Updated Feb 7, 2018 at 1:55PM

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After a nearly flawless earnings report, the company left bears with little to stand on.

Amazon (AMZN -1.57%) has always been something of a mystery to the market. It has consistently put up strong revenue growth but minimal profits, causing observers to question its long-term viability. Investors have generally given the company the benefit of the doubt, even though its triple-digit earnings valuation has caused a chorus of naysayers to cry foul, insisting that Amazon would never generate enough profits to justify a market cap now near $700 billion.

Well, Amazon just hit all the high notes with its fourth-quarter report, putting to rest many of the biggest questions about the stock. The company blew past its own guidance and analyst estimates, posting a revenue increase of 38% from a year ago to $60.5 billion, above expectations at $59.8 billion, while turning in its first-ever billion-dollar profit in a single quarter as net income hit $1.11 billion, or $2.16 per share (not including a $789 million tax benefit). That topped the analyst consensus at $1.85. 

However, more importantly, Amazon executed in three of the areas where it had appeared most vulnerable.

An Amazon Echo Dot sits on a counter next to a set of keys.

Alexa is one of the company's key growth drivers. Image Source: Amazon.

1. North American retail operating margin is surging

Investors have long questioned Amazon's ability to generate a meaningful profit from its retail division as the segment operated at breakeven for much of its history. After expanding its network of warehouses and convincing most American households to join its Prime loyalty service, the company now seems to be reaping the benefits of those investments. Operating profits in its home market more than doubled in the period to $1.69 billion, with the help of the Whole Foods acquisition, while operating margin reached 4.5%, its highest mark in at least several years. Management explained that the company tends to see better efficiencies in the fourth quarter when its warehouses are operating at full capacity, and CFO Brian Olsavsky called it a "very clean operational quarter".

Notably, Amazon's retail business is still losing money overseas as it reported a $919 million operating loss in the period, but the success in North America should assure investors that the company can eventually be profitable abroad if it can reach the same level of penetration and maturity that it has in North America. At this point, prior projections that Amazon's retail business won't be profitable are simply false. In the last quarter, North American retail operating profits even exceeded that of the vaunted cloud-computing segment, Amazon Web Services.

2. AWS is accelerating

Amazon Web Service, or AWS, has been a juggernaut for the company, putting up dramatic sales growth and huge profits. It's a major reason why the stock has exploded over the last three years since the company broke out the division as its own reporting segment, and the business is arguably more valuable than the retail side. However, some analysts have insisted that Microsoft and Alphabet would eventually catch up to Amazon in cloud computing and slow down AWS' blistering growth.

Coming into this quarter, AWS' growth had slowed for ten quarters in a row, but the company just put an end to that streak with revenue growth at the cloud-computing division improving from 41.9% to 44.6%, and strong operating profit growth as well at 46.2%. 

On the earnings call, Olsavsky explained that lapping a price decrease last year may have had some impact on the growth but that it was mostly due to an increase in usage, noting that usage was outpacing the top line.  AWS added several enterprise customers in the quarter, including Expedia, Ellucian, and DigitalGlobe, and said Walt Disney and Turner named AWS as their preferred public cloud provider.

3. Shipping costs are falling

At times, shipping has appeared to be the Achilles' heel of Amazon's retail model. By offering free two-day shipping for Prime members, the company essentially agreed to absorb shipping costs in order to build sales and customer loyalty.

For years, the company's shipping costs outpaced its revenue growth, but that line item saw its slowest expansion in at least six quarters in the recent period, increasing 31%. That actually lagged the 38% total revenue growth, though it was still faster than currency-neutral revenue growth excluding the Whole Foods acquisition, which was 25%.

Shipping costs are still significant, at over $21 billion over the last year, and Olsavsky acknowledged that they would continue to fluctuate, but he credited faster shipping methods and efficient operations for the moderation in shipping costs. It's clear that Amazon sees Prime as well as free, fast shipping as a source of competitive advantage so the company will continue to invest in fulfillment. But at this point, the model looks much more sustainable than it has in the past.

With blockbuster revenue growth, meaningful profits, and growing competitive advantages, Amazon is fulfilling many of the hopes of its investors, and the company is now stronger than it's ever been before. The stock nearly reached $1,500 a share following the earnings report, but the company is still busy putting more irons in the fire. Alexa, advertising, and even healthcare could all be valuable business segments in the future. If anyone wants to cast doubt on the company's prospects in those categories, Amazon is likely to make them look foolish one way or another.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Walt Disney. The Motley Fool recommends Expedia. The Motley Fool has a disclosure policy.

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