AI investment accelarates, users now more thrifty, is Amazon going to "retire" again?

After the U.S. stock market closed on August 1st, Amazon released its financial report for the second quarter of 2024. Overall, the revenue from the retail sector was slightly below expectations, while operating profit exceeded the upper limit of the original guidance by about $700 million (+4.8%), still surpassing expectations but no longer as astonishing. Although this performance does not have any obvious flaws, similar to Microsoft's previous performance announcement, a lack of highlights under full valuation may lead to some downward pressure. Specifically:

1. In terms of overall performance, Amazon achieved a total revenue of approximately $148 billion this quarter, slightly below the upper limit guidance of $149 billion and the market expectation of $148.8 billion. Year-on-year growth rate was 10.1%, slowing down by 2.4 percentage points compared to the previous quarter. Specifically, the slowdown in retail business growth was the main drag, consistent with the guidance from the previous quarter and recent signs of slowing U.S. macro consumption data.

The overall operating profit is close to $14.7 billion, higher than the sell-side expectations of $13.7 billion and the upper limit guidance of $14 billion. However, compared to the profit beat of about $3 billion in the previous quarter, the extent of exceeding expectations this quarter is relatively modest, possibly just meeting the buy-side expectations. Specifically, this is mainly attributed to the fact that the decline in profit from the AWS business was not as pessimistic as the market expected.

2. The main highlight of this quarter's financial report comes from the AWS business. With revenue of $26.3 billion, the year-on-year growth rate has increased to 18.7%, about 1.4-1.5 percentage points higher than expectations and the growth rate of the previous quarter. Compared to the slowing growth of Azure and the relatively stable growth of Google Cloud, AWS is the only one among the three major cloud computing companies this quarter to significantly accelerate on a quarter-on-quarter basis. It can be inferred that Amazon is narrowing the gap with Microsoft and Google in terms of AI capabilities/services.

From a profit perspective, AWS achieved an operating profit of approximately $9.3 billion, nearly $1 billion higher than expected. Although the profit margin decreased by about 2.1 percentage points to 35.5% compared to the previous quarter, it still exceeded market expectations by more than 3 percentage points. In other words, although higher AI-related investments have dragged down AWS's profit margin, the impact is not as significant as the market feared.

3. As expected, the retail business showed weakness, with an overall growth rate of 8.4%, a 3.2 percentage point decrease from the previous quarter, marking a significant slowdown for two consecutive quarters. By region, the growth of the retail business in North America dropped from 12.3% to 9.1%, which was the main drag. After excluding the impact of exchange rates in the international region, the growth rate only decreased by 1 percentage point, showing relative strength. In terms of specific business segments, except for the relatively resilient growth in subscription revenue, all other businesses saw a comprehensive slowdown of 2%-5% quarter-on-quarter. According to the company's explanation, consumers are starting to prefer lower-priced goods, which has dragged down sales growth.

In terms of profit, the operating profit of the North American retail sector was $5.06 billion, completely in line with sell-side expectations, with no surprises. The profit margin decreased by 0.2 percentage points quarter-on-quarter, mainly due to stock incentives increasing by approximately $1.8 billion. The international retail sector achieved an operating profit of $270 million this quarter, a significant decrease from the $900 million in the previous quarter, and lower than the market's $320 million. The profitability of the international sector remains unstable

4. From the perspective of costs and expenses: ① Although revenue growth is slowing down, the gross profit margin for this quarter has increased compared to the previous quarter, with a 0.8 percentage point increase. It can be seen that due to the increase in the proportion of high-margin revenue such as cloud computing and advertising, Amazon's gross profit improvement is a long-term trend that can relatively cross cycles. ② In terms of expenses, marketing and management expenses are still relatively restrained, with little increase in the expense ratio compared to the previous quarter. The research and development (R&D) and content expenditure ratio increased significantly by 0.8 percentage points compared to the previous quarter. Apart from investments in video content for members, it is highly probable that investments in AI-related research personnel and equipment have increased. Similar to its peers, Amazon can be seen to be relatively cautious in its expense investments, with AI-related investments even being somewhat forced.

5. In this AI cycle, compared to other Mag7 companies such as Microsoft, Google, Meta, etc., Amazon has always been relatively conservative in Capex investments (learning a painful lesson from excessive investments in 2021-2022). This quarter, the company finally showed signs of accelerated investments, with fixed capital expenditures increasing by 18% to 17.6 billion. Although this officially marks Amazon's re-entry into a capital expenditure expansion cycle, compared to the nearly doubled investment intensity of its peers, Amazon is still leaning towards being conservative. It is important to monitor whether the subsequent Capex will continue to rise significantly.

6. Regarding the performance guidance for the next quarter, the company expects the upper limit of revenue to be consistent with the market's expectation of 158.5 billion, reflecting that the company's expected revenue growth is to some extent below market expectations. However, based on the upper limit of guidance, the revenue growth rate has not significantly decreased compared to the previous quarter.

On the profit side, the company guides the upper limit of operating profit to be 15 billion, lower than the market's expectation of 15.8 billion. However, since the actual profits delivered by the company generally exceed the upper limit of guidance, it is not considered below expectations. This implies that the market may not expect the company's operating profit margin to continue to rise in the short to medium term.

Dolphin Research Viewpoint:

As mentioned earlier, Amazon's financial report for this quarter, apart from the slightly higher-than-expected slowdown in retail business, did not show very obvious flaws. The post-earnings decline is more due to the lack of clear highlights under fairly full valuations and earnings expectations, which can lead to pressure for profit-taking.

While most of the focus on other Mag7 stocks revolves around AI-related matters (or derivatives such as autonomous driving), Amazon's current narrative and investment logic do not place as much emphasis on AI. Apart from AWS benefiting from the growth demand brought by AI, the improvement in the profit margin of the retail business is at least an equally important focus point (if not more important).

Therefore, compared to Microsoft or hardware companies, even if the revenue or profit growth in recent quarters is not so satisfactory, the long-term AI story that has not been falsified is enough to support the valuation without a significant decline.

However, the slowdown in retail consumption is a more urgent issue that can be promptly confirmed or refuted. Although we cannot currently determine the extent of the subsequent bottoming out of European and American consumption, what can be confirmed is that with the fluctuations in the macro consumption situation in Europe and America, Amazon's valuation may experience significant fluctuations, unlike the more "pure" AI targets that have a stronger ability to transcend economic cycles.

Detailed comments are as follows:

I. The only highlight: AWS growth accelerates, profits better than expected

Although there were no particularly significant highlights in Amazon's overall performance this quarter, the AWS business performed better than expected, achieving a revenue of $26.3 billion, with a year-on-year growth rate rising to 18.7%, approximately 1.4-1.5 percentage points higher than expectations and the previous quarter.

In comparison, this quarter, Microsoft's Azure growth rate slightly decreased, while GCS growth rate remained roughly the same. AWS showed the most significant acceleration among the three major cloud computing operators. Of course, part of the reason is that AWS's growth rate, which is still below 20%, is significantly lower than the approximately 30% growth rates of its two competitors, leaving more room for acceleration due to the lower base.

However, we believe that AWS's relatively stronger acceleration compared to its peers also implies that after nearly a whole year of catching up, Amazon has narrowed the gap to a certain extent in AI-related functions and cloud computing products with Microsoft and Google, the two leaders.

Profit-wise, AWS business (also the only one) continued to perform significantly better than expected, with an operating profit of $9.3 billion, significantly higher than the expected $8.4 billion. Although the operating profit margin decreased from 37.6% in the previous quarter to 35.5% on a quarter-on-quarter basis, it is still 2.1 percentage points higher than the conservative expectations.

Market expectations for a significant quarter-on-quarter decline in AWS's profit margin this quarter (although it still saw a substantial year-on-year increase) may have been mainly due to the belief that the increase in Capex and expense investments would suppress the profit margin. However, the actual impact was not as significant as expected.

II. The expected slowdown in retail business, slightly exceeding market expectations

The guidance given during the previous quarter's performance regarding the deceleration of revenue growth, along with the deceleration in U.S. macro consumption data in recent months, has long hinted at the fate of the slowdown in revenue growth for Amazon's retail segmentIn fact, excluding AWS, the revenue growth of the company's retail-related business this quarter was 8.4%, a decrease of 3.2 percentage points from the previous quarter, showing a significant slowdown for two consecutive quarters.

Looking at it regionally, the nominal growth rate of the international retail business this quarter dropped from 9.7% to 6.6%, which also had a drag on growth from a financial perspective. However, at constant exchange rates, the growth rate only slowed from 11% to 10%, so in actual business terms, the international region was not the main drag on the slowdown in retail business this quarter, but rather the impact of exchange rate headwinds. However, the retail business in North America, which dropped from 12.3% to 9.1% growth, cannot be attributed to exchange rates, in other words, the drag from the weakening U.S. segment is more significant.

Specifically, all sub-business segments showed a slowdown in growth. Among them, online self-operated and offline stores experienced the most significant slowdown, with the lowest absolute growth rate. The slowdown in 3P merchant services and advertising business was relatively weaker, while the slowdown in membership subscription services was the mildest, reflecting the stable cash flow and countercyclical advantages of the membership business.

Combining cloud business and retail business, Amazon achieved total revenue of approximately $148 billion this quarter, a year-on-year growth of 10%, slightly lower than the market's expectation of $148.8 billion, although AWS revenue exceeded expectations, it was dragged down by the retail business.

III. Is the cycle of retail business profit margin improvement temporarily delayed?

On the revenue side, due to the drag from the retail business, the overall performance was slightly below expectations. On the profit side, it was relatively better, slightly exceeding expectations. Specifically, the overall operating profit this quarter was $14.7 billion, better than the sell-side average expectation of $13.7 billion, and higher than the previous upper limit guidance of $14 billion. However, considering Amazon's historical experience of actual delivery generally slightly exceeding the upper limit guidance, we believe that this quarter's profit should only meet the buyer's expectations. The overall operating profit margin is 9.9%, ending the trend of continuous quarter-on-quarter increase in operating profit margin for the past five quarters, which to some extent will suppress the market's expectations for the magnitude of future profit margin improvement for the company

Looking at different segments, as mentioned earlier, AWS cloud business's actual operating profit exceeded expectations by nearly 1 billion, making it the biggest and only contributor to the overall profit exceeding expectations.

The operating profit of the North American retail segment was 5.06 billion, exactly in line with the seller's expectations, not beating them. The international retail segment achieved an operating profit of 270 million this quarter, a significant decrease from the 900 million in the previous quarter. It is also lower than the market's 320 million. This shows that the profitability of the international segment is still not stable.

IV. Other expenses remain conservative, R&D & Capex spending is on the rise

From the perspective of costs and expenses: 1) This quarter's gross profit margin is 50.1%, a further increase of 0.8pct from the previous quarter, higher than market expectations. Despite slightly lower revenue than expected, the gross profit continues to rise, reflecting the company's increase in high-margin revenue from cloud computing, advertising, and other high-margin businesses. The rise in gross profit is a long-term trend that can relatively withstand economic cycles.

2) In terms of expenses, marketing and management expenses remain relatively restrained, with no significant increase in expense ratio compared to the previous quarter. The main increase is in R&D and content expenditure ratio, which increased significantly by 0.8pct compared to the previous quarter. Dolphin Research believes that, on one hand, there has been an increase in production costs for member video content, and it is highly likely that AI-related R&D personnel and equipment have also increased.

In the recent AI wave, Amazon has always been relatively conservative in Capex investment compared to other Mag7 such as Microsoft, Google, Meta ( the painful lesson of excessive investment in 21-22 ). This quarter, the company finally showed signs of accelerating investment, with nearly double growth compared to peers, continuously reaching new highs in investment intensity. Amazon's 18% quarter-on-quarter growth in fixed capital expenditure this quarter is not aggressive, but it also marks the arrival of a turning point in acceleration. As the company continues to catch up in AI, it is necessary to pay attention to whether Amazon's subsequent Capex will increase significantly.

Dolphin Investment Research's Previous Research on Amazon:

Financial Report Reviews

May 1, 2024 Conference Call "Amazon: Profit Soaring, Clash of Strong Performance and High Expectations"

May 1, 2024 Financial Report Review "Amazon: Profits Will Continue to Rise, But Investment Cycle is Restarting"

February 2, 2024 Conference Call "Amazon: Retail Continues to Improve, Huge Space for AI Cloud Computing"

February 2, 2024 Financial Report Review "The 'Rejuvenated' Amazon, How Many More Surprises Are There"

October 27, 2023 Conference Call "Amazon: New Demand for Cloud Computing Will Strengthen Again"

October 27, 2023 Financial Report Review "After Google, Meta, and Others Continuously Falter, Is Amazon Becoming the Backbone of US Stocks?"

August 5, 2023 Conference Call "Amazon: Retail Efficiency Improved, AI Will Be Heavily Invested"

August 5, 2023 Financial Report Review "Retail Stands Strong, Amazon Is Back in the Game"

April 28, 2023 Conference Call "Amazon: Cloud & AI & Efficiency Improvement and Cost Reduction Are Three Major Themes"

April 28, 2023 Financial Report Review "Amazon: Soaring Retail Profits, But Can't Lift the Weak 'AWS'?"February 3, 2023 Conference Call "Amazon: Balancing Prospects and Cost Control" (link)

February 3, 2023 Financial Report Review "Without Bezos, Does Amazon Still Have a Future?" (link)

In-depth Research

February 28, 2023 "Microsoft and Amazon Down, Is it Time for Airbnb & Uber to Shine?" (link)

May 30, 2022 "Macro 'Headwinds' Too Strong, Amazon Web Services Can't Escape Either" (link)

Risk Disclosure and Disclaimer for this Article: Dolphin Research Disclaimer and General Disclosure