Investors can’t get enough of Amazon

Stellar Q4 results show it can invest, keep margins healthy, exceed forecasts

While the valuation is looking more stretched over the past few months, the fundamental momentum remains about as strong as it could be.

Everything is clicking for Amazon. com Inc.

Not only did the internet behemoth post very strong results on a 26-per-cent revenue gain to US$60.5 billion, but Q4 revenue beat expectations in every segment (North America, international, Web Services, advertising etc.) for the first time in eight years.

Perhaps more important, Amazon is demonstrating that it can continue to invest, at the same time as margins remain healthy and even exceed forecasts.

The final quarter of the year is always the most challenging in terms of operations, and Amazon has had warehouse efficiency and shipping problems during the period in the past. Yet the fourth quarter of 2017 appears to have been very strong operationally, as the company’s decision to boost square footage by 30 per cent in each of the past two years is paying off.

That’s evident in the healthy growth coming from the Amazon Prime paid subscription service and the Fulfilled Network for online merchants.

“Amazon is executing extremely well,” said Doug Anmuth, an internet analyst at J.P. Morgan. “We believe Amazon continues to show strong ability to take share of overall eCommerce, and its flexibility in pushing first-party versus third-party inventory and its Prime offering both serve as major advantages.”

He raised his price target on Amazon shares to US$1,650 from US$1,385, representing upside of more than 10 per cent.

The firm is taking a page out of its U.S. strategy, and implementing it in international markets. That includes expanding its inventory selection, speeding up shipping times, and pushing adoption of Prime.

Amazon is also putting a lot of effort into emerging markets such as India and China, and boosting investment in these regions. But as it spends more in areas like digital content for Prime Video’s global rollout (now available in more than 200 countries), margins continue to come under pressure.

Prime attracted more member additions in 2017 than any year prior, with India having the best first year of any country before it. Amazon also shipped more than five billion items via Prime.

“Revenue trends remain strong and the Prime flywheel is in full effect,” said Daniel Salmon, an analyst at BMO Capital Markets, maintaining his target price of US$1,600.

That leaves investors wondering whether Amazon’s belief that video content efficiently converts customers into paid Prime subscribers, thereby generating higher per subscriber spending levels, is really working.

“Amazon’s financial results — and the assumption that Amazon executives are rational economic actors — would seem to support this belief,” said RBC Capital Markets analyst Mark Mahaney.

He raised his price target on Amazon shares to US$1,700 from US$1,200.

Mahaney noted that video continues to drive better conversion of free trials, higher membership renewal rates for existing customers and higher engagement, while Prime users who watch Amazon video also tend to spend more on the platform.

Amazon Web Services happens to be growing significantly faster than the retail business, and boasts operating margins that are 10 times higher.

As a result, Mahaney believes Amazon offers the best mix-shift story in technology today, and along with just a few other companies, can accurately be labelled an internet staple.

Whereas consumer staples typically produce low to single-digit revenue growth, and trade at premiums to the broader market due to their reliable earnings growth prospects, internet staples share those characteristics but have growth rates that are as much as 10 times higher.

The market may have been looking for an excuse to push Amazon lower in the lead up to Thursday afternoon’s results, but the company’s performance continues to silence the critics. Its shares are up 45 per cent in the past four months, and continued their ascent on Friday. They ended the day up 2.87 per cent to US$1429.95 in New York.

“While the valuation is looking more stretched over the past few months, the fundamental momentum remains about as strong as it could be,” said Michael Graham, an analyst at Canaccord Genuity. He raised his price target on Amazon shares to US$1,650 from US$1,500.

Threats like government intervention, both in the U.S. and Europe, do pose a risk, but the likes of Facebook Inc., Netflix Inc. and Google Inc. are arguably more vulnerable.

RBC’s Mahaney also noted that Amazon’s growth outlook appears stronger than the other major internet platforms, since it is facing the largest and least-penetrated total addressable markets.

That includes the US$20 trillion retail space, US$1 trillion cloud market, US$1 trillion advertising industry, US$5 trillion business supplies market, and potentially others.