The post-pandemic world has created a difficult environment for e-commerce businesses, causing revenue and profit levels to drop. Inflation further worsens the situation and has caused stalling sales growth for most companies. The current market situation has been tough for Amazon.com Inc. (AMZN, Financial), with its share price dropping by more than 35% in the last 12 months.
A plethora of factors is leading to pessimism in the markets. However, the chief concern stems from Amazon Web Service, or AWS, which is seeing a slowdown in growth.
Investors are right to be cautious because valuations are being driven by optimism. But they should also not shy away from taking risks in such an environment as it can bring about great rewards in the long term.
I think Amazon is an attractive option in the current market. Its cloud growth may have slowed down somewhat, but it will not drastically impact the company's profitability. Plus, its multiple business lines provide stability and growth potential. Investors do not need to be concerned about the growth slowdown of AWS as Amazon operates as a conglomerate in every sense.
Putting the numbers in context
Amazon Web Services has become integral to Amazon's success in recent years. The cloud service provides on-demand computing resources for businesses of all sizes. It has enabled the company to reduce costs quickly as well as increase efficiency and scale.
It offers various services, including computing, storage, networking, databases, analytics and application services. With its flexibility and scalability, AWS has become the go-to choice for many businesses regarding cloud computing solutions.
However, in the past few months, the slowing growth of AWS has led to Amazon shares taking a hammering alongside the broader market selloff.
In its fiscal fourth quarter, Amazon's cloud revenue recorded modest 20% growth compared to the year before. Further, during the most recent earnings call, the company disclosed that growth dropped to the mid-teens in January.
Even though Amazon had a great head start, the market has been slowing down and favoring Microsoft Corp.'s (MSFT, Financial) advancement. As a result, it looks like it might be giving the competition a chance to narrow Amazon's lead.
The three most dominant cloud providers continue to have an overwhelming majority of the cloud market share, representing two-thirds of worldwide cloud revenue. However, according to Synergy Research, Microsoft expanded its market share from 21% to 23% in the fourth quarter of 2022. Meanwhile, Amazon dipped from 34% to 33%. Alphabet Inc.'s (GOOGL, Financial) Google held steady at 11%.
There is no doubt that Amazon's success over the years is largely attributable to AWS. In its latest quarterly report, which was released earlier this month, the company revealed that AWS generated 14% of total revenue. However, executives cautioned that AWS growth would experience a further dip in the upcoming quarter since customers are reducing their expenditure on the cloud-based platform to minimize costs due to wider market instability.
In comparison, Microsoft's cloud revenue increased 22% from the previous quarter, down from 24%. Likewise, Google Cloud reported 32% growth, lower than the 38% recorded in the prior quarter.
The recent economic situation, the U.S. dollar's strength and a declining Chinese market have led to a difficult quarter for the cloud infrastructure sector. Organizations are reducing expenses to handle this uncertain climate, which has impacted market growth.
Nevertheless, AWS has seen impressive growth trends in the past, and if that continues, it is likely to become a $100 billion revenue business with high profitability.
Last year's figures demonstrated this potential; net sales increased 29% year on year. AWS will hit $100 billion in net sales in 2023 if it musters the same rate of growth it saw last year.
Undoubtedly, it is a maturing market, but broader headwinds are at play here. If those get better in the coming months, AWS will come out of 2023 in a very healthy position.
Diverse businesses are the key to long-term success
Amazon has been one of the most successful e-commerce companies in recent years. However, its traditional strong base, e-commerce sales, has recently declined. Despite this, the company is still finding ways to remain competitive and profitable through other business areas.
The Seattle-based company reported a healthy 19% increase in fourth-quarter ad sales compared to the previous year, totaling up to $11.56 billion. The ad unit seems to be a small part of Amazon's $149.2 billion in fourth-quarter revenue; however, it has been growing quickly, and analysts expect it to be a key force in the digital advertising landscape.
As for subscription service Amazon Prime, which provides customers with a range of benefits, including exclusive deals, free two-day shipping, streaming of movies and TV shows and more, the company saw a drop in its membership base in 2022, amounting to 2 million members, according to data from Consumer Intelligence Research Partners. This starkly contrasted with its steady growth in 2020 and 2021. According to Amazon, the estimate is inaccurate, however, and Prime membership continues to rise.
Nevertheless, with an impressive 50% surge in U.S. membership from 2019 to 2021, the recent decrease in growth is not all that unexpected as it was bound to stagnate at some point.
In addition, a major cause for the growth slowdown could be a price hike that was initiated last year. Additionally, Amazon recently modified the free delivery requirements for Prime members, making the minimum order value $150 instead of $35. Furthermore, it will charge a fee between $3.95 and $9.95 based on delivery specifications.
Apart from that, there are other macroeconomic factors in play as well.
There was a notable dip in the popularity of online shopping over the last 18 months following the widespread distribution of Covid-19 vaccines. People felt more comfortable with brick-and-mortar stores, leading to a shift in consumer behavior.
With financial instability and rising inflation, consumer spending moved away from luxuries and shifted toward necessities. As Amazon specialized in non-essential items, people felt their Prime membership was no longer essential.
Hence, a slowdown in subscriber numbers should not come as a surprise. But that does not mean the segment does not have value.
Amazon has invested large amounts of money in supporting the popularity of Prime – this includes providing big-name content on its video service. Additionally, its quick-delivery services are another major attraction, encouraging customers to return and spend more.
Although Amazon's Prime membership has taken an unavoidable step backward, it still has millions of households as loyal customers. The large network of businesses it has created provides an advantage, which draws in additional merchants and supports its logistics and delivery systems. This creates a beneficial cycle that constantly expands and strengthens.
Taking it altogether, it should come as no surprise that Amazon is forecasting a successful first quarter of 2023 as it predicts revenue will fall somewhere between $121 billion and $126 billion, marking an increase of 4% to 8% from the previous year.
Painful but necessary cost-cutting initiatives
Amazon has reduced costs by cutting some of its workforce to 18,000 employees. These cuts mostly affect store and People Experience and Technology Solutions (PXT Solutions) teams, as is normal with technology-oriented companies.
With rising inflation, people are trying to cut back their expenses, affecting businesses. As a result, the company has had to close some of its physical stores.
Earlier this year, Amazon reported that it had incurred a financial loss of $640 million due to severance payments and another $720 million from closing stores in the fourth quarter.
However, as the global economy continues to suffer from the impacts of a possible recession, Amazon is taking decisive action to protect its operating margin. One-time costs will not hamper much in the long run, and investors will value management for acting quickly under the circumstances.
Takeaway
Amazon continues to diversify and grow its business. Though recent quarters have seen a dip in profits, the company is still financially stable and should return to growth soon.
The economic slowdown is hitting businesses like AWS, yet the recent results from advertising services are encouraging. Amazon's unique service offerings give it an edge and should it them afloat even in tough times.
Although Amazon announced the closure of some of its operations in order tests, the stock still has value potential. The shares have dropped around 35% over the last year, which makes it an excellent value play, considering its wide moat and future growth prospects.
