How many surprises does the "reborn" Amazon have in store?

After the US stock market closed on February 1st, Amazon released its fourth-quarter earnings report for 2023. The revenue growth further accelerated as expected, while the pace of profit improvement continued to exceed expectations. The detailed points are as follows:

Steady growth and profits exceeding expectations: In terms of overall performance, Amazon achieved a total revenue of $170 billion this quarter, nearly $4 billion higher than market expectations. The revenue growth rate continued to increase by 1.3 percentage points to 13.9% MoM, mainly driven by the improvement in the growth rate of international business revenue after the decline in the value of the US dollar and the strong performance during the North American fourth-quarter promotion period.

The overall operating profit reached $13.2 billion, approximately $2.8 billion higher than market expectations, or 26%. This is the highlight of this earnings report. The significant improvement in the profit margin of the North American retail business is the main reason for the better-than-expected performance.

Stable AWS revenue and significant profit increase: AWS revenue this quarter was $24.2 billion, with a MoM growth rate slightly increased to about 13%, which is basically in line with market expectations. As the optimization cycle of IT spending by European and American enterprises recedes and the incremental demand brought by AI investment, the market consensus is that AWS's growth rate will marginally rebound.

However, compared with the obvious acceleration of Azure and GCS in the past two quarters, AWS is currently only stabilizing at the bottom. This still reflects AWS's relative competitive disadvantage in AI capabilities, which is also the main concern of the market.

In terms of profit, AWS achieved an operating profit of $7.2 billion this quarter, with an operating profit margin slightly decreasing from over 30% to 29.6% MoM, far exceeding the market expectation of $6.6 billion. Although the growth is only a bottoming rebound in line with expectations, the extent of profit improvement is significantly stronger. The decrease in R&D expense ratio is a visible reason, and it remains to be seen if the management has any other explanations.

Exchange rate reversal and strong promotion boost retail sector growth: The company's retail sector achieved revenue of $145.8 billion this quarter, with a YoY growth rate of 14%, which further accelerated by 1.4 percentage points compared to the previous quarter.

On the one hand, it is mainly due to the positive impact of the decline in the value of the US dollar, with the growth rate of US dollar revenue in international regions reaching 17% (13% excluding the impact of exchange rates). The growth rate in the North American region, which is not affected by exchange rates, also increased by 2 percentage points to 13%, showing a clear recovery. Combined with recent reports, this is mainly attributed to the strong consumer momentum during the Thanksgiving and Christmas holiday promotions.

In terms of business segments, advertising revenue growth remains strong, with a growth rate of 26.8%. Dolphin Research believes that on the one hand, this is a continuation of the trend of advertising investment shifting towards performance advertising. On the other hand, the company recently announced its business of providing TV advertising on Prime Video streaming media, which is expected to continue driving the growth of advertising revenue.

Retail sector's profit margin reaches a historic high: The most surprising aspect of this performance is the significant improvement in the profit margin of the North American retail business. In this quarter, the operating profit of the North American retail sector reached nearly 6.5 billion, which is 52% higher than the expected 4.2 billion. The operating profit margin also increased to 6.1% MoM, the second-highest in the history of the North American business. Dolphin Research believes that this is due to the continuous increase in high-profit advertising revenue and the reduction in investment in content service providers. Additionally, the optimization of unit costs resulting from the decentralization of the North American fulfillment area has also contributed to this improvement.

Looking at the expense ratio, the fulfillment expense ratio has decreased by 0.1-0.2 percentage points YoY and MoM. Although the decrease is not significant, it reflects the improvement in fulfillment efficiency. We believe that the benefits of decentralization will be fully realized in the subsequent quarters. On the other hand, the R&D and content expense ratios have decreased by 1 percentage point YoY and 1.8 percentage points MoM, which is a significant decrease and one of the major contributors to the improvement in profit. Dolphin Research believes that this reflects the company's downsizing in R&D and online video business, as well as a reduction in investment. It is also one of the main reasons for the significant improvement in the profit margin of the retail sector.

Positive outlook for guidance: For the first quarter, the company expects a midpoint revenue of 140.8 billion, which may seem lower than the market's expectation of 142 billion. However, considering the company's actual delivery, which tends to be close to the upper limit of the guidance range, the upper limit of 143.5 billion is still higher than the market's expectation. The operating profit guidance range is 8-12 billion, with the midpoint of 9.1 billion lower than the expected value. However, if we consider the upper limit of the guidance, it is still nearly one-third higher than the expectation. It can be seen that the company's guidance is relatively optimistic.

Dolphin Research's viewpoint:

In the market's narrative logic before the performance, there is generally short-term surprise but also long-term concerns about Amazon. On the one hand, in the retail sector, the market has reached a consensus that the performance in the fourth quarter will be strong (high-frequency data during the peak promotion period has already been verified). However, due to the possibility of economic weakness in 2024, the market's confidence in the growth of the retail business in the second half of 2024 is not so strong.

Regarding the profit margin of the retail business, with the previous downsizing and reduction in investment, the decline in oil prices, the decentralization of fulfillment, and the increase in prices for 3P services, as well as the long-term trend of the increasing proportion of high-profit advertising revenue, the market's expectation for the profit margin of the North American retail business is no longer satisfied with high single digits. Some investment banks have even started to anticipate low double digits. In other words, there is still considerable potential for improvement in the profit margin of the North American retail business. Combining growth and profit, the overall outlook for the retail business is promising.

However, there is more intense debate about the AWS business. On the one hand, it is widely believed that the current cycle of IT spending optimization is gradually coming to an end, and the overall demand for cloud computing will begin to rebound. On the other hand, there is also a view that the increase in investment in AI will squeeze the budget for traditional cloud services. (Azure's continued slowing growth, even after excluding AI-related factors, seems to validate this). Therefore, with Microsoft and Google currently having a clear advantage in AI large models, AWS, which is still lagging behind, may actually become a victim of market share loss.

And this earnings report basically confirms: strong retail growth in the fourth quarter; North American retail business profit margins breaking historical records and heading towards high single digits or even double digits; AWS growth stabilizing at the bottom, but without significant acceleration, although profit margins remain high. In other words, this quarter's performance is in line with recent optimistic expectations, and the guidance for the first quarter still points to a positive outlook.

Therefore, we believe that Amazon is currently in a good cycle of continuous improvement in performance, especially in terms of profitability. The strong employment situation in the United States still implies a strong driving force for short-term consumption. Before the overall U.S. economy shows signs of weakening, we believe there is not much risk at this point.

In terms of cloud business, due to the relatively slow progress in AI advancement compared to its peers, the reduction cycle of enterprise IT spending, and its weak competitive position, Amazon's cloud business has always been relatively weak. However, this year is expected to benefit from the overall recovery in demand, and there is room for a return to higher growth rates compared to its own past low growth rates, although it may still be relatively lower compared to Azure and GCS.

As for the growth prospects of the retail business for the full year of 2024, as well as the magnitude and pace of AWS's mid-term growth, these two markets will determine the company's mid-term performance. We can pay attention to whether the management will provide answers during the conference call.

Detailed comments are as follows:

I. AWS growth stabilizes and rebounds, with profits exceeding expectations

This quarter, AWS revenue reached $24.2 billion, with a growth rate of about 13%, slightly higher than the previous quarter, which is in line with market expectations. As the optimization cycle of IT spending by European and American enterprises recedes and the incremental demand brought by AI investment, the market generally expects AWS's growth rate to start picking up.

However, when comparing the three major cloud service providers in the United States, it can be seen that compared to Azure and GCS, AWS has only stabilized instead of significantly accelerating its cloud computing business in the past two quarters. Although there is an expectation of a rebound in overall demand for cloud computing, AWS's relative lag in AI capabilities is one of the key concerns in the market, leading to continuous loss of market share.

However, in terms of profitability, this quarter AWS achieved an operating profit of $7.2 billion, with an operating profit margin slightly decreasing from over 30% to 29.6% compared to the previous quarter, far exceeding the market's expected $6.6 billion. Therefore, although the growth is only a rebound in line with expectations, the improvement in profitability is significantly stronger, and the reason for the profit margin not declining as expected can be explained during the conference call.

2. Strong promotion season, retail growth continues to rebound

Compared to the mixed feelings of cloud business, the revenue and profit performance of the retail sector is overall stronger than expected. This quarter, Amazon's retail sector achieved revenue of $145.8 billion, a year-on-year growth rate of 14%, an increase of 1.4 percentage points compared to the previous quarter.

In terms of regions, under the favorable impact of the depreciation of the US dollar, international revenue growth has been rapidly recovering, with a growth rate of 17% this quarter (of which exchange rate factors contributed 4 percentage points of growth). In addition, the growth rate in North America has also increased by 2 percentage points to 13%, showing signs of recovery. Recent reports indicate that this is mainly due to the strong online retail sales during holidays such as Thanksgiving and Christmas.

The retail sector remains resilient in North America, while the international region benefits from favorable exchange rates, leading to growth in various sub-sectors of the retail sector. In terms of growth rate, the advertising business has the highest growth rate, reaching 26.8%. The company has also announced advertising business on Prime Video, which will continue to drive growth in the future.

In terms of improvement, the online self-operated retail sector has seen the largest increase in growth rate, from 7.1% to 9.3%, with the largest improvement.

Subscription and 3P merchant services maintain a steady growth rate, while offline retail continues to decline.

Combining cloud business and retail business, Amazon achieved a total revenue of approximately $170 billion this quarter. With the rebound in both retail and AWS business growth, the total revenue growth rate also increased to 14%, exceeding the market's expected $166.2 billion.

3. Retail sector profit margin is reaching new highs

In terms of revenue, the performance of the retail business is already steady and impressive. In terms of profit, after the recovery in the previous quarter, the retail sector's profit continues to increase significantly this quarter. Specifically, the company achieved an operating profit of $13.2 billion this quarter, far exceeding market expectations and $10.5 billion, with an operating profit margin of 7.8%, maintaining a high level.

Looking at the different segments, AWS cloud business exceeded expectations with an operating profit of 7.2 billion, which is 8% higher than expected. The operating profit margin of the North American retail segment also increased from 4.9% to 6.1% MoM, reaching the second-highest level in history.

Although the international retail segment had a higher loss rate of -1% MoM during the peak season, it was still lower than the expected -1.8%.

Therefore, the operating profit margins of the three major segments, AWS, North American retail, and international retail, were all better than expected this quarter.

So, what contributed to the better-than-expected profit margins from the perspective of costs and expenses?

Breaking it down, 1) the gross profit margin for this quarter fell by 2.1 percentage points to 45.5% due to the impact of the Q4 promotion, but it was still slightly higher than expected by 0.5 percentage points.

In terms of expenses, the cost rate for fulfillment decreased by 0.1-0.2 percentage points YoY and MoM, possibly due to the implementation of regional distribution in North America and the decrease in oil prices. However, the positive impact has not been fully reflected.

On the other hand, the decrease in research and content expenses was significant and one of the main contributors to the improvement in profit. The expense rate decreased by 1 percentage point YoY and 1.8 percentage points MoM, showing a substantial decline. Dolphin Research believes that the reduction in expenses is mainly due to the company's downsizing of engineers and sales personnel in AWS and online video business, as well as reduced investments.

As for the sales expense rate, it remained relatively stable, possibly due to increased marketing investment during the peak season.

However, despite the AI boom, the fixed asset investment for this quarter reached 13.4 billion, an increase of approximately 2 billion MoM, mainly invested in servers, GPUs, and other hardware facilities.

Dolphin Research's previous Amazon research:

Earnings Report Analysis:

• October 27, 2023: Conference Call - "Amazon: New Cloud Computing Demand Will Rebound"
• October 27, 2023: Earnings Report Review - "After Google, Meta, and Others Stumble, Is Amazon the Backbone of the US Stock Market?"
• August 5, 2023: Conference Call - "Amazon: Retail Focuses on Efficiency, AI Will Be Heavily Invested"
• August 5, 2023: Earnings Report Review - "Retail Strengthens, Amazon Regains Momentum"
• April 28, 2023: Conference Call - "Amazon: Cloud, AI, and Efficiency and Cost Reduction are the Three Main Themes"
• April 28, 2023: Earnings Report Review - "Amazon: Retail Profits Soar, But Can't Support the Weak 'AWS'?"
• February 3, 2023: Conference Call - "Amazon: Balancing Future Prospects and Cost Control"
• February 3, 2023: Earnings Report Review - "Without Bezos, Does Amazon Still Have a Future?"
• October 26, 2022: Conference Call - "Can Microsoft Safely Navigate the Economic Downturn? (1Q23 Conference Call Summary)"
• October 26, 2022: Earnings Report Review - "No One is Immune to Cycles, Microsoft Can't Hold On Either"

In-depth Research:

• February 28, 2023: "Microsoft, Amazon Fall, Is it Airbnb & Uber's Turn to Reign?" On May 30, 2022, "Macro 'Headwind' is too strong, Amazon can't hide even with its cloud" was published.

On December 3, 2021, "Both are not profitable, why is Amazon more favored than Alibaba?" was published.

Risk disclosure and statement of this article: Dolphin Research Disclaimer and General Disclosure