Growth From AWS, Advertising, and 3P Sellers Will Deliver Huge Cash Flows

Rapid operating cash flow growth continues as expected.

Amazon’s Q3 performance was very solid.

Not only did it have solid revenue growth, but its net margins expanded, AND it was still investing heavily in AI capex. Investors loved to see it. As for my estimates, year on year revenue growth in a few segments are in line with my expectations, like Online stores, Physical stores, AWS and Subscription services. However, the likes of Advertising, and Third party sellers, are slightly below my annual revenue growth estimates, but that’s not a huge concern because they’re still growing well.

As mentioned last quarter, one of the main metrics I’m watching, operating cash flow, is still growing incredibly well at 57% higher than Q3 last year, reaching $112bn for the last 12 months.

Below is how my narrative assumptions are tracking individually:

1. Online store growth beat my expectations, again
   1. Online store sales grew 7% YoY to reach $61.4bn for the quarter. This is still faster than the 5% I expected. This is the third quarter where it has outperformed my estimates (7% p.a. last quarter). The company reportedly had strong black Friday in Q4 this year, so we’ll see the results of that soon. It seems Amazon’s longer term investments in fulfillments are paying dividends. While I’ve been estimating 5% for the last few quarters, and results have come in slightly higher than that, I don’t believe now is the time to raise these estimates, because I would prefer to remain conservative.
2. 3P sellers growth slowed and is below my estimate
   1. 3P sellers revenue grew 10% YoY to reach $37.8bn for the quarter. This is below with my 16% p.a. growth that I expected in my original narrative. I hope to receive more information on this at the Q4 results in a few weeks, so will re-asses when I see the annual report.
3. AWS growth is picking up again
   1. AWS revenues grew 19% again YoY to reach $27.45bn for the quarter. This is again close to my 20% p.a. growth expectation, which is great. For now, I’ll leave my original AWS growth expectations of 20% p.a. in my narrative as they are.
4. Advertising growth still going well and benefitting from 3P adoption and Prime Video
   1. Advertising revenue grew 19% YoY to reach $14.33 for Q3. Like prior quarters, this solid growth on an increasing revenue base which is great to see. The company expects to still be able to expand its offering in this area with sponsored products and Prime ads.  
   2. This revenue growth fell short of my 25% p.a. growth expected from advertising revenues. Prime Day and Prime Big Deals day was in Q3, where customers apparently saved over $5bn across 50m deals. I’m surprised to have not seen higher growth than we did. More importantly though, Black Friday is in Q4 (as always) and so it’ll be interesting to see how the ad business performs in this coming quarter compared to a year ago given the huge expansion in the ads business.
5. Subscription services growth to slow and generate no profits still
   1. Subscription revenue grew 11% YoY to reach $11.2bn for the quarter. This was slightly better than the 10% I expected p.a., but not meaningfully, so I will continue to watch this space. 
   2. The company continues to add new benefits to its subscription offerings (primarily Prime), and given it’s a loss leader (get customers subscribed, and you can make money in other areas), I don’t expect it to generate a profit, as mentioned in my narrative. The company noted in the earnings call that growth in memberships picked up in Q3, and given all the additional benefits provided for Prime members, this makes sense.
6. Physical store growth was good, but still expect it to not be meaningful
   1. Physical store revenues grew 5% YoY to reach $5.2bn for the quarter. This was in line with my 5% expected, but as mentioned in my original narrative, I don’t expect it to grow meaningfully, nor contribute to OCF meaningfully either. The company didn’t provide much commentary on it in the earnings call transcript from what I could tell.
7. FCF and OCF continue climbing rapidly.
   1. Turns out you can have your cake and eat it too.
   2. The company has continued to improve its operating expenses and capital expenses by focusing on the core business (after a heavy investment period from 2020 to 2022), which has driven the large increase in OCF and FCF. 
   3. For the year to September 30 2024, OCF grew 57% to $112bn, which is incredible, and FCF went from $17bn to $43bn ($21bn to $48.7bn on their 10Q). This TTM FCF is slightly lower than last quarters figure of $53bn, but TTM net margins have improved from 7.4% last quarter, to 8% this quarter, which the market liked a lot.

Overall, the business is performing well and mostly in line with my expectations, which is great to see.  

The company is currently valued at $2.4trn, which means it’s trading at 21.4x OCF, and 51x FCF. For a business expected to grow its OCF and FCF by 17% and 29% annually respectively (from analysts over the next 2 years), that seems like a pretty good deal to me. At today’s share price of around $231 though, I see it as fairly valued by the market, since it’s close to my $222 FV estimate.

For my commentary on all the operating margins of these respective businesses, check out my original narrative. 

For now, I’m going to keep my narrative assumptions and valuation estimate as they are.  

Amazon Q3 release: https://ir.aboutamazon.com/news-release/news-release-details/2024/Amazon.com-Announces-Third-Quarter-Results/