Amazon Surpasses Walmart; 2Q Exceeds Expectations

Back in mid-June, I wrote about Amazon's 38% stock increase on the heels of a strong 4Q and 1Q. Since then, AMZN reported blowout 2Q results, and the stock has increased another 34%, for a total of a 72% increase since January 29.  Amazon's market cap now stands at $250 billion, surpassing Walmart's $230 billion market cap. What has led Amazon to surpass the largest retailer in the world?

Retail Sales Unexpectedly Accelerated; Outlook Positive

Expectations were for a gradual sales slowdown, as Amazon has been showing for some time. However, sales actually accelerated in the quarter from 15% in 1Q to 20% in 2Q. Specifically, its largest retail component, EGM (Electronics and Other General Merchandise) accelerated from 20% in 1Q15 to 24% in 2Q15, likely driven by increased Prime membership.

This growth was even more impressive as it came in spite of strong FX headwinds. Excluding FX, total sales growth (inclusive of AWS and other components) was 27%.

Furthermore, the outlook is bright, as the growth in Prime users is expected to drive continued sales growth (as Prime users tend to spend significantly more than regular users). Additionally, Amazon held its widely-publicized Prime Day in 3Q. While many users were disappointed, Amazon themselves noted significant growth in prime membership and unit sales. This will likely have a positive impact on sales and on margins in 3Q.

Profitability Continues its Upward Trajectory

Amazon's profitability continues to improve. Recall that after its 4Q results, Amazon signaled an increased focus on efficiency. Since that quarter, profitability has made significant improvements. In 2Q, operating margin expanded 208 basis points, which was much higher than expected and higher than the 38 basis points of margin expansion in 1Q15. Additionally, operating income came in at $464 million, which was much higher than management's guidance of -$500 million to +$50 million.

AMZN 2Q15 Op Margin Change.png

Spending in numerous areas such as fulfillment, marketing, and G&A came in below expectations (which is a good thing for profitability). Meanwhile, gross margin came in higher as the company continues to sell more 3P products (which I explained in a previous blog post). After a significant investment phase in 2014, the company now appears to be returning to a higher level of profitability.

AWS Demonstrates Strong Potential

Amazon's disclosure of AWS financials in 1Q showed a highly profitable and fast-growing business. While some media sites reported on the margin deterioration of 641 basis points in 1Q15, sophisticated investors expected this as the margin contraction was due to price cuts implemented several quarters earlier (in 2Q14). In 2Q15, this view was reaffirmed as AWS lapped its price cuts last year and showed strong operating margin expansion of  1,377 basis points to 21.4%. Additionally, sales accelerated significantly from 49% in 1Q15 to 81.5% in 2Q15. As AWS grows sales, investors expect this segment to gain scale and gradually improve its profitability over time. 

My Amazon model is now updated for 2Q and can be accessed here.