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The Biggest Surprise in Amazon's Earnings Report

By Jeremy Bowman – Apr 30, 2019 at 8:30AM

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The e-commerce giant posted another round of blowout profits. This overlooked segment was a key reason.

Amazon (AMZN -8.43%) passed its latest test with flying colors.

Earnings more than doubled in its first quarter to $3.6 billion, or $7.09 per share, a new quarterly record for the company; the top line climbed 17% to $59.7 billion. Investors greeted the report by sending the stock up 2.5%, putting it just a few percentage points away from its all-time high.

The usual suspects, Amazon Web Services (AWS) and high-margin e-commerce-related businesses, helped drive the surge in Amazon's profit.

  • AWS, its cloud computing division, saw revenue jump 41% to $7.7 billion, while operating income rose 59% to $2.2 billion.
  • Third-party seller services revenue rose 23% to $11.1 billion.
  • Revenue from subscription services, including Prime, increased 42% to $4.3 billion; this was helped by last year's increase in Prime fees from $99 per year to $119 per year.
  • "Other revenue," which is primarily advertising, rose 36% to $2.7 billion.
  • As a result, operating income in the North America division doubled to $2.3 billion, even though revenue grew just 17% to $35.8 billion.

The AWS and North America segments drove the majority of the operating-income gains, adding nearly $2 billion in operating profit. But the biggest surprise in the company's bottom-line surge was the gains it made in its international segment, where its operating loss narrowed from $622 million in the quarter a year ago to just $90 million, despite only a 9% increase in revenue as a stronger dollar weighed on results there.

An Amazon Prime Air jet in a hangar

Image source: Amazon.

A problem area

From 2016 to 2018, Amazon lost a total of $6.5 billion in its international segment. That figure peaked in 2017 with an operating loss of $3.1 billion, and came in at $2.1 billion last year.

It's not clear what, specifically, drove those losses. The only impactful expense in the international segment that Amazon refers to in its 10-K report is the expansion of its fulfillment network. One culprit appears to be aggressive spending in India, to build out a fulfillment infrastructure in that fast-growing economy of over 1 billion people. India has become the biggest focus of Amazon's international efforts in recent years; the company pledged to spend $5 billion on the subcontinent three years ago, and has now nearly reached that target. In other words, the heaviest-spending phase of its Indian expansion seems to be over, which may explain the sudden narrowing in international losses.

By comparison, in 2014 and 2015, Amazon's international segment had operated closer to breakeven; prior to 2014, the international segment was reliably profitable, even more so than the North America segment in some years. International operating profit reached as high as $981 million in 2010, topping North American profit of $955 million.

That shows that Amazon's recent losses are an anomaly, rather than an extended pattern. Investors should expect the segment to swing back to profitability sooner rather than later.

Turning the corner

On the recent earnings call, CFO Brian Olsavsky said that the company was seeing "good advertising growth both in North America and internationally," showing that the emergence of its advertising business is driving profitability around the globe. Olsavsky said advertising growth across the board was a bit higher than the 36% it reported in "other revenue" growth, so advertising should be a key factor in returning the international segment to profitability. Earlier in April, Amazon said that it will be shutting down its Chinese e-commerce marketplace on July 18, a move that should also boost international profitability as the tech giant has struggled in that market for years.

The $7.09 in earnings per share posted by Amazon trounced expectations of $4.72, and the improvement in the international segment appears to be a major reason, as the growth in North America and in AWS was relatively predictable.

Looking ahead, improving profitability in the international business would be a significant driver for the company's overall bottom line. If Amazon's international operating margin last year had mirrored the 5.1% it had in its North American market, its international operating profit would have reached $3.4 billion instead of the $2.1 billion operating loss it reported -- adding $5.5 billion to its total operating income, for a 44% lift. That would have made a big difference to the bottom line.

As Amazon's sales growth slows, ramping up profit is key in order for the stock to continue moving higher; bringing the international market up to speed represents a huge opportunity. With the growth of advertising, spending in India starting to slow, and the decision to pull out of China, look for Amazon's international segment to move into the black later this year. Doing so would be a significant step for the company, as profitability begins to take priority over top-line growth.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.

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