Amazon is one of the FANG stocks in the well known acronym coined by Jim Cramer. It stands for Facebook, Amazon, Netflix, Alphabet (ticker GOOG).

These stocks have had phenomenal moves year to date as investors have bid up FANG stocks because of their dominant competitive position in their respective industries.

Today we look at Amazon and see how it performed in Q1 2017 and what management sees as future opportunities.

Key Highlights From Q1 2017

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Amazon beat on revenue consensus as well as EPS. But as you can see, the operating income declined.

We will dig into why that’s the case later on. Let’s see what drove revenues for each of Amazon’s operating segments.

Revenue By Segment

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Year over year (YoY) revenue for each of the 3 segments grew by double digits in Q1 2017. However, the rate of growth declined from Q1 2016.

AWS is still the fastest growing segment and, as the pie chart shows, comprises only 10% of Q1 2017 revenues. There is opportunity for future growth in this segment.

North America segment revenue, which comprises a whopping 59% of revenue, saw YoY growth of 24%, which is impressive.

Let’s dig deeper and analyze revenue by service to get additional color on where Amazon is generating these revenues.

Revenue Breakdown By Service

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Retail Subscription Services

Retail Subscription Services grew 49% YoY and analysts wanted to know what drove this revenue growth.

This segment includes different categories of revenues, the largest being Amazon Prime.

These different segments include:

• Amazon Prime (the largest)
• Audio Books
• Ebooks
• Digital Videos
• Digital Music
• Other subscription services

The key reason for the revenue jump was not Amazon Prime where the growth has remained strong and consistent.

It was the increased adoption of the remaining categories that was the driver of the revenue jump for this category.

AWS

Even though AWS comprises 10% of overall revenue, this is a high margin high growth category for Amazon. According to management, revenue run rate for AWS is expected to be $14Bn.

As an existing or potential investor, you might want to keep an eye on this category that has Wall Street excited.

Analysts were interested in management’s take on future AWS growth and customer adoption.

In a nutshell management has seen strong adoption for their AWS services. Customers migrated more than 23,000 databases using AWS database migration service which was launched just last year.

Management is expanding AWS services internationally as well as inked key relationships with big customers like Liberty Mutual, Snap and Live Nation.

In fact, AWS was the reason why Amazon’s unearned revenue (meaning customers pay first and then use services later which is great for any business as they get cash upfront) is because of a couple of AWS services like reserved instances and prepaid credits.

(Full Disclosure, YourCapital uses Amazon’s AWS services and we also prepay because of the discounts Amazon provides us for paying upfront to reserve servers).

Other

You would be surprised to see this category but hidden in this category is a revenue source that has analysts excited: Advertising Revenue.

Advertising revenue, you ask?

Well, interestingly Amazon offers a service called ‘Sponsored Products’ from which they generate advertising revenues.

The idea behind ‘Sponsored Products’ is that products already on Amazon’s platform advertise to customers when a customer searches for a similar product on Amazon. Currently this feature is largely U.S. based.

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Analysts were wondering if Amazon was interested in expanding this service to other advertisers not on the platform and can this category become a meaningful part of the business.

Management considers advertising to be in early days but mentioned that ‘Sponsored products’ was off to a great start.

Management’s current focus is not on revenue generation but on being helpful to consumers, enhancing their viewing experience and offering targeted recommendations.

Again this is an area to keep an eye on.

Now let’s now look at the operating margins and why they declined.

[Note: Want to know how famous a hedge fund manager picks stocks? Check out how this fund manager reveals his thought process for doing so.]

Operating Margins

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There are two key things to highlight in the margin story:

North American Margin Decline of 0.7%

Operating margins for Amazon’s North American segment fell by 70 bps or 0.7% YoY.

That’s because management ramped up investments in order to support the range of great opportunities front of them.

Amazon has been investing heavily in Echo and Alexa devices as well as video content and marketing of that content.

Furthermore, Amazon has experienced 40% growth in fulfillment by Amazon (FBA) and had to invest to expand fulfillment capacity to support this growth.

Fulfillment centers grew 51% YoY and since Amazon uses robots in its warehouses and fulfillment centers, capex has been higher, thus pressuring operating margins.

Negative Operating Margins For The International Segment

Management gave similar reasons for decline in operating margins for the international segment.

Expansion of Prime services internationally was a key factor that impacted international operating margins.

For example, since launching Prime services in India 9 months ago, Amazon increased prime selection by 75% and fulfillment capacity by 26%. That took investment.

Amazon also launched Prime Video in Q4 2016 & is now available in more than 200 countries.

…And since fulfillment by Amazon(FBA) has seen faster growth than growth in paid units, amazon is heavily investing to increase the number of warehouses.

All this capex has pressured international operating margins.

Amazon’s International Expansion Strategy

Since international expansion is a significant driver of future revenue, management addressed their approach to international expansion.

Basically, it varies country by country. Each country is a case by case situation.

In China, Amazon bought a business and built expanded off of that investment.

In India, on the other hand, Amazon started from scratch and built all services from the grounds up.

In Middle East, Amazon bought Souq because Souq pioneered e-commerce and the management felt they could learn from Souq as well as provide support to expand.

So what are the factors that matter to Amazon in deciding on an entry strategy? Here are a few management mentioned:

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There you have it guys! Let me know what you think of Amazon.

[Note: Want to know how Facebook,one of the FANG stocks, performed? Check out our insights from Facebook Q1 2017 quarter and wonder no more.]