This past week's big tech earnings reports saw most names sell off hard, with Amazon (AMZN +0.55%) logging a 6.8% decline on Friday after its Thursday night earnings, even as the broader market was up 2.5% on the day.
Sellers were probably worried about two things: relatively tepid fourth-quarter guidance, along with lower-than-expected revenue growth and margins in the Amazon Web Services (AWS) segment.
Those were not unfounded concerns, although quarter-to-quarter fluctuations are expected, especially as interest rates and natural gas prices spiked over the summer.
Yet lost underneath the headlines, there were actually several segments of Amazon showing positive strength and profitability -- each of which could be bullish indicators for the stock's long-term future.
NASDAQ: AMZN
Key Data Points
Advertising revenues are large and accelerating
The reason AWS looms large for many investors is because it's a high-margin business, whereas Amazon's retail operations have generally operated at razor-thin, or negative, margins in pursuit of growth and market share.
However, Amazon's burgeoning advertising business, which it just started breaking out this year, has the potential to be another high-margin business within Amazon's corporate empire. And that segment, for all intents and purposes, is booming.
Last quarter, Amazon's ad segment actually showed an acceleration, growing 30% year over year to more than $9.5 billion. That's really impressive, especially when so many digital advertising companies showed tepid growth last quarter.
By comparison, Alphabet (GOOG +0.44%) (GOOGL +0.66%) saw Search ads rise only 4% in the third quarter, and YouTube and third-party ad networks each fell 2%. Meta Platforms (META 1.18%) saw its advertising revenue fall roughly 3.3%. And lest you think that is because Amazon's ad business is much smaller than these two behemoths, Amazon's ad revenues are now greater than both YouTube and Alphabet's third-party networks, and are more than one-third the size of Meta's ad revenue.
Amazon Chief Financial Officer Brian Olsavsky said on the conference call with analysts: "[O]ur advertising is at the point where consumers are ready to spend. So we have a lot of advantages that we feel that will help both consumers and also our partners like sellers and advertisers."
Amazon doesn't break out the operating margin for its ad business, but even in a bad quarter in which margins compressed, Google's services segment -- which also includes some lower-margin hardware -- sported a 32.2% operating margin, down from 40% a year ago. Meta's "family of apps" operating margin was 34%, down from 45.9% in the year-ago quarter.
So it stands to reason Amazon's ad business is probably high-margin as well -- especially given its robust top-line growth.
Shipping costs go below paid units growth
Another positive lurking in the fine print of Amazon's report was shipping costs. Over recent quarters, Amazon's shipping cost growth outpaced units shipped, putting pressure on margins. However, in the third quarter, units shipped grew 11%, while shipping costs only grew 10%. That's the first time unit growth outpaced shipping costs in a long while.
Getting shipping costs under control was one of the things investors wanted to see, given that Amazon had way overbuilt its infrastructure during the pandemic, and demand slowed in the first half of the year. It's likely that lower oil prices during the third quarter played a role. Also, this could be the beginning of seeing the fruits of its own in-house expansion of its shipping infrastructure, as opposed to using third-party delivery companies.
Of course, overall margins were squeezed by currency headwinds in Europe, which swung third-quarter revenue growth by a whopping 17 percentage points, from a 12% gain in constant currency to a 5% revenue decline. But in the North American segment, operating losses narrowed quarter over quarter, lending credence to the hope that the e-commerce segment will eventually return to profitability in short order.
Other revenues were up 168%
Finally, with e-commerce, AWS, and advertising taking up so much attention, investors may not have noticed 168% year-over-year growth and 18% quarter-over-quarter growth in Amazon's "other" revenues.
Other revenues were only $1.26 billion, or about 1% of total revenue, but remember, the advertising segment used to be included in this segment, and it's probably where some of Amazon's exciting experimental ventures reside.
In its filings, Amazon describes the "other segment" as "sales related to various other offerings, such as certain licensing and distribution of video content and shipping services, and our co-branded credit card agreements."
The step up in Amazon's other revenues really showed up in the second quarter, which could be related to its closing of MGM Studios late in the first quarter. However, that doesn't explain the big surge of growth from the second quarter to the third quarter.
I'm very bullish on Amazon's new "Just Walk Out" technology that enables customers to shop without having to wait in line to check out; however, it's unclear if that is even monetized yet, or if it's included in the physical stores segment or other revenues.
In any case, while other revenue is a small footnote to the other all earnings picture, something within the segment has been growing at an exponential rate over the past two quarters. Amazon is known to experiment a lot to develop new products and services, so it's something to watch going forward.
Short-term pain, long-term gain
The headwinds Amazon faced last quarter primarily related to AWS. However, AWS saw 200 points of margin compression as natural gas prices spiked, causing higher electricity costs, according to management. Those prices have since come down in a big way since September. In fact, natural gas prices are down some 40% over the past two months. Meanwhile, Amazon was helping customers looking to save money move to some lower-cost services. which caused a revenue "disappointment" of only 27% growth.
Unlike the pandemic, when some customers saw an acceleration of demand, the interest rate spike of 2022 is causing a pullback across the board. However, AWS was able to reaccelerate growth after a brief lull at the start of the pandemic, and I'd expect the same once inflation is under control and interest rates come down. Meanwhile, Amazon's AWS backlog was actually up 57% year over year to over $104 billion. So, the long-term trajectory of cloud computing seems very much intact.
Meanwhile, the three silver linings outlined above bode well for other parts of Amazon's future as well. This sell-off seems like a short-term overreaction, and a gift to long-term investors.
