What We Liked: Gross Margins, AWS Acceleration, Investment Offense
Despite the revenue weakness, gross margins were stellar, accelerating to +261bps on a tougher comparison. High margin businesses of AWS (+39%), Subscription Services (+24%) and Advertising (+50%) outgrew lower margin retail (+4%). AWS accelerated 190bps to +39%, its 3rd straight quarter of acceleration. The management team is clearly investing heavily for growth, a bullish sign for the Tail. In typical Amazon fashion as revenue is slowing instead of cutting spend, the company is accelerating investment to drive the next leg of growth. The street generally doesn’t expect/like the margin degradation, but historically Amazon has always delivered much greater growth as a result.
What We Disliked: Retail Revenue Trends, New Costs, Prime Day Shift Pressure, 4Q Effect Back
Revenue trends, and particularly those in Retail, were weak. 3Q revenue in total missed by about 1%, the 2nd miss in a row after a guide down, and after a streak of 10 beats. Revenue slowed 740bps on the 2yr avg. AWS and Physical Stores were the only areas of acceleration, the others saw big slowdowns. Online Stores were up just 3.3% slowing from 15.8% last Q and 44.3% in 1Q. The slowdown was global too, as International revenue slowed 1100bps. The company talked about supply chain constraints, though its bottleneck was fulfillment labor shortages. The company had to step up wages, now offering an average starting wage of $18/hr and at times offers of sign on bonuses of $3000. Wages, materials inflation and supply chain costs cost AMZN $2bn in 3Q, and are expected to create another $4bn in cost pressure in 4Q, just about eliminating the tailwind from lapping other Covid costs. The guide was also ugly, implying revenue growth slows roughly another 700bps at the midpoint. The Prime Day shift out of 4Q last year to 2Q is hurting Retail, though as a top Ad spend day, the Prime Day shift is also hurting Advertising revenue growth (expect a 4Q slowdown there). It seems the 4Q effect is back, as growth comes under pressure again in 4Q21 after a 1 year hiatus in 2020.
Ecosystem Callouts
Investment: Amazon is stepping on the investment pedal hard, attempting to leave competitors in the dust. It’s taking up wage rates to win labor capacity, it’s ramping digital content investment by $1bn YY for video, music and gaming content, and it’s continuing to invest in infrastructure globally as it works towards its 1 Day delivery target it set back in 2019, which was delayed by Covid. Capex this Q was $15.75bn, over 14% of sales. That looks like a new record for Amazon. Clearly management sees much more growth ahead, and it’s spending to get share. The company will have doubled its fulfillment network over two years since the start of the pandemic and it's still not done growing it. When other major platforms like W are talking about structurally higher margins, Amazon is taking margins down 200bps to keep its foot on the throat of competitors. We’d flag similar reinvestment needed for ETSY to sustain growth. Watch out for AMZN 6-12 months down the road.
Gaming and Sports: A fair deal of call time was spent talking about gaming and sports. On the sports side, we think this is the influence of Andy Jassy, who is an avid sports fan and part owner of the Seattle Kraken. It's also a good platform to leverage to connect with consumers. On the gaming side, further investment makes sense given the company’s Twitch asset and customer base. Though talking this much publicly about gaming hasn’t been common in recent years. Maybe it has something to do with the number of former Amazon execs now sitting in the C-suite of GameStop. Amazon launched an online game called New World that has been popular on Steam, we’ll see where else it plans to go in the gaming realm as the retail gaming competition heats up.
SOTP
We’re adjusting our sum of the parts framework slightly. We’ve take down NTM retail growth, taken up the AWS multiple given the business performance, taken up the Advertising multiple, and added a conglomerate discount of 25% to the segments total. Here is the updated table.
