Amazon: A Strong Growth Trajectory in Cloud, Retail, and AI

Amazon’s third-quarter results for fiscal 2023 showed us again that the company has a long runway for sales and profit growth across its various segments in retail, advertising, and cloud. We see a notable trend in global IT spending toward digital transformation programs. About 90% of today’s global IT spending is still on-premises. However, that is rapidly changing as firms are modernizing their IT infrastructures and migrating legacy applications to cloud-based solutions. Cloud computing is having a profound impact on how businesses operate, innovate, and compete in the marketplace.

Many firms recognize that to fully benefit from generative AI, and to do so at scale, they need to adopt cloud technologies, otherwise they risk falling behind the competition. Firms that adopt cloud and AI technology across any layer of their technology stack, in our view, will have a competitive advantage and higher ROI in the form of productivitygains, innovation, and cost efficiency, than those that stick to legacy systems. We’re still in the early stages of adopting machine learning and generative AI technologies in both personal and professional environments.

Amazon’s FY23 Q3 revenues increased 11% year-over-year to $158.9 billion, driven by strong demand for AI and cloud computing, growth in advertising, Prime Day success, and resilient retail results. Operating income rose 56% to $17.4 billion. This resulted in a record-high operating margin of 11% (exceeding the prior high of 10.7% in Q1). Profitability was primarily fueled by improved margins in Amazon’s cloud and retail business segments. 

Amazon forecasts FY23 Q4 revenue of $181.5 billion to $188.5 billion for growth of 7% to 11%. Amazon guides operating income of $16 billion to $20 billion, which implies a margin range of 8.8% to 10.6%. The outlook suggests another solid quarter of revenue and profit growth supported by AI and cloud deployments, ad revenue contributions, and ongoing retail sales and margin growth. 

AWS

Launched in 2006, Amazon Web Services (AWS) is Amazon’s cloud computing platform that provides a comprehensive suite of cloud and AI services to individuals, businesses, and governments on a global scale. AWS is growing at double-digits on an annualized revenue run rate of $110 billion. In FY23 Q3, AWS sales increased by 19.1% to $27.5 billion while operating profit margins surged to a record 38.1%, compared to 30.3% in the same period last year. AWS’s impressive growth trajectory aligns with the broader secular trends in cloud adoption (e.g., transitioning from on-premisesarchitectures) and AI integration (e.g., automating processes and enabling data-driven insights). Amazon’s AI division has evolved into a multibillion-dollar revenue run rate business that is growing at triple-digit rates. Amazon CEO Andy Jassy said that in the past 18 months, AWS has released nearly twice as many machine learning and generative AI features as the other leading cloud providers combined.

Amazon is seeing strong adoption for its products and services such as SageMaker (for building, training, and deployingmachine learning models), Bedrock (for building and scaling generative AI applications), and Amazon Q (a generative AI-powered assistant for developers). A variety of foundation models from leading AI companies—including Anthropic’s Claude, Meta’s Llama, and Mistral’s Large 2—are hosted inside AWS through the Bedrock platform. These models can be utilized and customized by developers and businesses to meet their specific AI application needs. We think it will take many years for global IT spending to flip from on-premises to the cloud. This is why we believe there is a long growth runway ahead for Amazon and other hyperscalers. Most generative AI models, particularly large language models (LLMs) are built and deployed in the cloud because of ease of management, scalability, and cost efficiency. Thus, the ability to use generative AI effectively will be a driver to bring workloads to the cloud.

Retail

“If you look at the retail space, it’s a very, very large market segment. I mean, we have a pretty big retail business, and yet we’re only about 1% of the market segment share of the worldwide global retail market segment. And still about 80% to 85% of that market segment share lives in physical stores. And so, if you believe that equation is going to flip in the next 10 to 20 years, which we do, there’s just a lot of opportunity not just for us but several players” — Andy Jassy, Amazon CEO

Amazon’s FY23 Q3 results highlighted the resiliency and continuous progress of its retail business. Every quarter, we learn that Amazon has enhanced the efficiency of its fulfillment network by improving unit economics and productivity, resulting in lower costs to serve and quicker processing and shipping times. In North America, retail sales grew 9% year-over-year to $95.5 billion, while operating margins moved higher to 5.9% from 4.9% a year ago. International retail sales grew at a faster rate, up 12% year-over-year to $35.9 billion, whereas operating margins came in at 3.6%, representing a significant inflection from being in negative territory (-0.3%) only a year ago. Both North America and International retail segments achieved their seventh consecutive quarter of year-over-year operating margin improvement.

Amazon is positioned to further enhance its retail operating margins in the coming years by capitalizing on cost savings from outbound shipping and optimizing its fulfillment and logistics network through regionalization. We also expect Amazon’s advertising business, through sponsored products and Prime Video ads, to serve as another lever for generating higher retail margins.

Final Remarks

Amazon reported a solid quarter that exceeded expectations. We expect there to be commentary and debate regarding the magnitude of capital investment required to meet the growing demand for both generative AI and cloud workloads. The key question is whether the spending intentions for these emerging technologies will translate into a compelling return on capital. In other words, will it all be worth it? 

Our view is that the projected increase in capital spending provides a clear signal and opportunity for monetization in cloud and AI services. We think it sets the stage for growth in AWS’s market share and revenue base in the coming years.While increased investment may potentially dilute near-term AWS margins, we expect that the long-term growth implications in terms of revenue and profits will far outweigh any short-term challenges.

Short-term pain for long-term gain, as they would say.