☁️ Amazon: Wild Margin Expansion
AI requires billions in Capex but it looks like money well spent
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Amazon (AMZN) is at an all-time high, fueled by record operating profit and free cash flow.
If you were expecting a surprise dividend from Amazon this quarter, you’re not following the company closely. It’s still Day 1. CEO Andy Jassy described the company’s approach as investing upfront to "make that up in operating margin and free cash flow down the road."
Management expects capital investments to “meaningfully increase” in FY24 to support growth in AWS, including generative AI. At the same time, AWS is seeing exceptional margin expansion, making it look like money well spent.
☁️ AWS hit a $100 billion run rate with a 38% operating margin.
However, Amazon’s margin expansion is more than an AWS story. Advertising is surging, and the company has been able to reduce dramatically its costs to serve through internal efficiencies. These investments expand the company’s moat and set the stage for future growth.
Today at a glance:
Amazon Q1 FY24.
AWS and the AI tech stack.
Key quotes from the earnings call.
What to watch: Grocery and Advertising.
1. Amazon Q1 FY24
Income statement:
Revenue breakdown:
💻 Online store (38% of overall revenue): Amazon.com +7% Y/Y.
🏪 Physical store (4%): Primarily Whole Foods Market +6% Y/Y.
🧾 3rd party (24%): Commissions, fulfillment, shipping +16% Y/Y.
📢 Advertising (8%): Ad services to sellers, Twitch +24% Y/Y.
📱 Subscription (6%): Amazon Prime, Audible +11% Y/Y.
☁️ AWS (17%): Compute, storage, database, & other +17% Y/Y.
Other (1%): Various offerings, small individually +23% Y/Y.
Revenue grew +13% Y/Y to $143 billion ($0.7 billion beat).
Excluding AWS:
North America grew +12% Y/Y to $86 billion.
International grew +11% Y/Y fx neutral to $32 billion.
Gross margin was 49% (+3pp Y/Y).
Operating margin was 11% (+7pp Y/Y).
AWS had a 38% margin (+14pp Y/Y).
North America had a 6% margin (+5pp Y/Y).
International had a 3% margin (+7pp Y/Y).
Cash flow (trailing 12 months or TTM):
Operating cash flow TTM was $99 billion (+82% Y/Y).
Free cash flow TTM was $50 billion (vs. a $3 billion deficit a year ago), primarily driven by the improvement in operating cash flow and, to a lesser extent, a decline in purchases of property and equipment by 15% to $49 billion.
Balance sheet:
Cash, cash equivalent, and marketable securities: $85 billion.
Long-term debt: $58 billion.
Q2 FY24 Guidance:
Revenue growth between +7% and +11% Y/Y (vs. +12% Y/Y expected).
Operating margin between 7% and 10%.
So what to make of all this?
Amazon had a stronger-than-expected quarter. The revenue beat was relatively small (less than half a percent). But the earnings per share were 18% above expectations.
AWS continued to rebound for a second quarter after seven consecutive quarters of decline caused by customers trying to cut costs in a tougher environment. The growth acceleration was four percentage points sequentially, more than Microsoft Azure (three) and Google Cloud (two).
Advertising delivered +24% Y/Y growth, barely a slowdown from +27% Y/Y in Q4 FY23, primarily driven by sponsored ads and Prime Video. It remained the fastest-growing segment and a boon for margins.
Operating margin improved by seven percentage points, leading to the highest quarterly income ever. AWS alone was responsible for three percentage points of overall margin improvement. In addition, regionalization remains an essential factor, with shorter distances and fewer touches leading to reduced delivery costs.
Free cash flow TTM improved for the seventh consecutive quarter. Capex was $48 billion in FY23, and management expects a meaningful increase in FY24 to support the growth of AWS and Generative AI efforts.
Q2 Guidance was a mixed bag. Revenue was just shy of Wall Street’s expectations, but the expected operating income implies further margin improvement sequentially.
2. Recent business highlights
☁️ AWS market share and margins
Synergy Research Group estimates that cloud infrastructure spending grew +21% Y/Y to $76 billion in Q1 2024 (accelerating from +20% Y/Y in Q4 2023). AWS revenue growth lagged slightly behind the overall cloud infrastructure market expansion.
Amazon maintained a 31%-34% market share in the past five years. Microsoft Azure (25%) and Google Cloud (11%) have gained market share at the expense of others, but the overall pie is growing for all participants.
Azure was the fastest-growing of the big three in the latest quarter, with a +31% Y/Y growth in constant currency, compared to +28% Y/Y for Google Cloud and +17% Y/Y for AWS.
Critically, AWS expanded its operating margin by 14 percentage points, a staggering achievement. The sudden rise in operating income should jump at you (see visual below).
🤖 An update on the three layers of the AI stack
CEO Andy Jassy always provides an update on Amazon’s position within the three layers of the AI tech stack: 1) Infrastructure, 2) Models, and 3) Apps.
So, let’s revisit them.
1) Infrastructure Layer (Trainium and Inferentia)
Jassy explained:
“We have the broadest selection of NVIDIA compute instances around, but demand for our custom silicon, training, and inference is quite high, given its favorable price performance benefits relative to available alternatives.”
Amazon has been developing customized machine learning chips like:
🎓 Trainium for training.
🧠 Inferentia for inference.
It also offers Graviton for generalized CPU chips at a competitive price.
Trainium2 delivers four times faster training performance and three times more memory capacity versus the first generation.
2) Models Layer (Bedrock)
We previously discussed how this layer is the LLM (Large Language Model) as a Service. Amazon wants to let AWS customers access LLMs and customize them with their data with all the security and privacy features managed for them.
Jassy highlighted SageMaker, a fully managed machine learning (ML) service. More companies standardize their models on this service, like Perplexity AI and NatWest.
More companies will build Gen AI apps and would rather leverage and customize an existing LLM. Amazon Bedrock lets customers run models, fine-tune them with their own data, and create AI-powered agents.
Jassy explained:
“Bedrock already has tens of thousands of customers, including Adidas, New York Stock Exchange, Pfizer, Ryanair, and Toyota. In the last few months, Bedrock's added Anthropic's Claude 3 models, the best-performing models in the planet right now; Meta's Llama 3 models; Mistral's Various models, Cohere's newest models, and new first-party Amazon Titan models.”
Jassy has been positioning AWS against Microsoft and OpenAI by letting customers choose the models that fit their needs. Microsoft pivoted in the past few months, embracing an approach with multiple partners to reduce their reliance on OpenAI. Amazon still boasts the “broadest selection of LLM available to customers” and offers the ability to import a custom model from SageMaker or elsewhere.
3) Apps Layer (Amazon Q)
The top layer has everyone’s attention because these are the apps we always hear about, like Chat-GPT or Gemini.
Amazon Q is now available. It’s a workplace-focused AI-powered assistant.
Here’s what you should know:
🏢 Target Audience: Q is designed for businesses to assist with tasks like coding, summarizing documents, and answering internal questions.
🔒 Security Focus: Built with heightened security and privacy to address corporate data concerns, ensuring safe integration within enterprises.
🌐 Versatile Integration: It connects with cloud data and external platforms like Salesforce, Slack, and Gmail, enhancing workplace productivity.
💵 Competitive Price: Positioned against Google’s Duet AI, Microsoft's Copilot, and ChatGPT Enterprise, Q has a starting price of $20 per user per month.
Jassy sounded very optimistic about the recent beta period:
“Q is not only the most functionally capable AI-powered assistant for software development and data, but also setting the standard for performance. Q has the highest-known score and acceptance rate for code suggestions, outperforms all other publicly benchmarkable competitors and catching security vulnerabilities, and leads all software development assistants on connecting multiple steps together and applying automatic actions.”
To be sure, new products tend to outperform the previous benchmark, only to be overshadowed a few months later. All hyperscalers are rising to the occasion with AI features that directly compete with one another. It’s too early to tell if these productivity tools will be entirely commoditized, but it seems the most likely scenario.
3. Key quotes from the earnings call
CEO Andy Jassy on the benefit of the regional organization:
“We've seen an increase in the number of units delivered per box, an important driver for reducing our cost.”
Fewer boxes and deliveries lead to a better customer experience, a lower cost to serve, and a lower carbon impact. A win-win-win.
On Prime:
“In March, across our top 60 largest US metro areas, nearly 60% of Prime members orders arrived the same or next day. And globally, in cities like Toronto, London, and Tokyo, about three out of four items were delivered the same or next day.”
This focus on speed fuels more frequent purchases, a point Jassy highlighted when discussing the growth of Amazon's Everyday Essentials business.
On advertising:
“The strength in advertising was primarily driven by sponsored products, supported by continued improvements in relevancy and measurement capabilities for advertisers. We still see significant opportunity ahead in our sponsored products as well as areas where we're just getting started like Prime Video ads.“
It’s not hard to understand how sponsored ads on Amazon can deliver exceptional ROAs (return on ad spend). They appear when the user is ready to buy (no one scrolls aimlessly on Amazon). Prime Video ads could drive specific business outcomes like product sales and subscriptions in a way that is hard to replicate for other platforms like Netflix or Hulu.
On AWS:
“Companies have largely completed the lion's share of their cost optimization and turned their attention to newer initiatives. […]
We see considerable momentum on the AI front where we've accumulated a multibillion-dollar revenue run rate already.”
Jassy came short of precisely measuring the contribution from AI the way Microsoft does. It must be at least a 2% impact if it's already a multibillion-dollar run rate.
“We remain very bullish on AWS. We're at $100 billion-plus annualized revenue run rate, yet 85% or more of the global IT spend remains on-premises. And this is before you even calculate gen AI, most of which will be created over the next 10 to 20 years from scratch and on the cloud. There is a very large opportunity in front of us.”
AWS is the clear leader in a market expected to grow at an 18% CAGR through 2028. So Amazon is well positioned to continue to ride that big wave.
A recurring theme of this newsletter is how AI could benefit the incumbents in cloud infrastructure. This thesis is playing out. Big tech was a huge beneficiary of the transition to mobile and cloud. AI is another massive tailwind for existing market leaders.
CFO Brian Olsavsky on capital investments:
“In 2023, overall capital investments were $48.4 billion. As I mentioned, we're seeing strong AWS demand in both generative AI and our non-generative AI workloads, with customers signing up for longer deals, making bigger commitments. Still relatively early days in generative AI and more broadly, the cloud space, and we see sizable opportunity for growth. Right now, in Q1, we had $14 billion of CapEx. We expect that to be the low quarter for the year.”
In short: Let us spend. Thank us later.
4. What to watch looking forward
🍏 Grocery Delivery
Amazon launched new grocery delivery subscription offers in the US, going directly after Instacart:
🌆 3,500 cities.
🏷️ $9.99/month for Prime members.
📦 Unlimited delivery on orders > $35.
🛒 Amazon Fresh, Whole Foods, and more.
⏰ Priority access to Recurring Reservations.
Amazon's new $9.99/month grocery delivery subscription targets Instacart directly. While Jassy mentions it's "off to a great start," it remains to be seen if this will meaningfully shift consumer behavior in a market where Walmart+ and other players are well-established.
▶️ Amazon ads continue to gain market share
Amazon's advertising revenue reached $11.8 billion in Q1, representing:
26% of Google Search advertising revenue (+2pp Y/Y).
33% of Meta's advertising revenue (-1pp Y/Y).
While Amazon remains a distant third, it’s catching up.
Prime Video ads started in Q1 2024 and could accelerate this momentum in the coming quarters. According to Nielsen, Prime Video captured 2.8% of US TV Time in March (a decline of 0.1pp Y/Y).
Prime Video captures roughly a third of Netflix’s market share in US TV time (and more than Disney+ and Paramount+ combined). For context, Netflix had 83 million paid memberships in North America at the end of March.
Amazon is likely seeing very high margins from its advertising business. For example, Meta’s operating margin from advertising is close to 50%. Amazon ads likely represent most of the non-AWS profit.
Amazon is winning with direct response and brand marketing because of its massive reach and is always one click away from a purchase. This walled garden is a defensible moat but will attract more regulatory scrutiny over time.
In summary:
AWS is gearing up for growth as it leverages generative AI features that could bring meaningful scale—even for a company the size of Amazon.
Advertising maintains its robust growth trajectory, reinforcing Amazon's market position and boosting profitability.
It’s still Day 1 at Amazon. Returning cash to shareholders is not on the agenda, focusing first on reinvesting in growth initiatives and infrastructure to improve margins over the long term. These moats aren’t going to widen themselves!
That’s it for today.
Stay healthy and invest on!
Disclosure: I am long AMZN, GOOG, and META in the App Economy Portfolio. I share my ratings (BUY, SELL, or HOLD) with App Economy Portfolio members.
Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.