Amazon Beats Estimates as Digital Content Pays Off

By Danielle Kucera
Amazon.com Inc. (AMZN), the world’s largest online retailer, reported operating profit that beat analysts’ estimates as investments in digital content and warehouses attracted more shoppers.

First-quarter operating income was $181 million, the Seattle-based company said in a statement yesterday. Analysts on average had projected $96.8 million, according to datacompiled by Bloomberg. Sales rose 22 percent to $16.1 billion, in line with analysts’ predictions.

Margins are holding up even as Chief Executive Officer Jeff Bezos continues to pour money into expansion. While new warehouses and digital content are costly, they’re also drawing in new customers and outside sellers who in turn generate extra income. That’s helping Amazon’s profitability, according to Daniel Kurnos, an analyst at New York-based Benchmark Co.

“The improving margin story appears uninterrupted from what we saw in the fourth quarter,” Kurnos, who rates the stock a buy, said in an interview.

Net income fell 37 percent to $82 million, or 18 cents a share, from $130 million, or 28 cents, a year earlier.

The shares slipped in late trading. Amazon had advanced 2.2 percent to $274.70 at the close in New York yesterday. The stock is up 9.5 percent so far this year, while the Standard & Poor’s 500 Index is up 11 percent.

Margins Steady

Gross margin was 26.6 percent in the first quarter, compared with 24 percent in the same period a year earlier, data compiled by Bloomberg show.

Bezos added 20 shipment hubs last year to attract customers by offering faster delivery times with a massive selection of products that eclipses what retail stores can offer. The initiative is also attracting new merchants willing to sell their wares through Amazon’s storefront and use the e-commerce company to complete orders.

Products sold by third parties made up 40 percent of total sales, Chief Financial Officer Thomas Szkutak said on a conference call. Digital-content sales are increasing at a “much faster” pace than physical products, Szkutak said. The 10 best-selling items on the website in the first quarter were digital products or sales related to Kindle tablets and electronic-book readers, he said.

Shipping costs as a percentage of net sales decreased, indicating warehouses that are closer to delivery destinations may be tempering expenses. Those expenses were 4.7 percent of revenue in the first quarter, compared with 5.1 percent last year.

For the second quarter, Amazon is forecasting an operating loss of $340 million to a profit of $10 million, compared with analysts’ projections for a profit of $165.1 million, a sign Bezos’s spending spree will continue through at least June.

Revenue Growth

Second-quarter revenue will be $14.5 billion to $16.2 billion, Amazon said. Analysts are projecting sales to rise 24 percent $15.9 billion.

“It looks like revenue growth is continuing into the second quarter without any major investment issues,” Kurnos said.

Investors have rewarded Bezos’s investment strategy with one of the highest valuations among the company’s peers. Amazon is trading at 81 times projected 2013 earnings, compared with a price-to-earnings ratio of 19 for EBay Inc. (EBAY) and 25 for Japanese online-retailer Rakuten Inc. (4755), according to data compiled by Bloomberg.

Operating margin in North America widened to 4.9 percent from 4.7 percent the year prior. Investors use that number to predict the trajectory of Amazon’s overall profit, because it excludes a negative impact from lower-margin emerging markets.

Gross-Margin Expansion

Amazon announced digital-content agreements with A&E Television Networks LLC, CBS Corp. (CBS) and Public Broadcasting Service in the first quarter, bringing shows such as “Downton Abbey” and “Justified” to its video customers. The online retailer is also planning to release a television set-top box that would stream video over the Internet into consumers’ homes, people familiar with the matter have said.

Third-party sales and online services will continue to boost profit, since “once those things become drivers of gross margin expansion, they hold,” said Mark Mahaney, an analyst at RBC Capital Markets in San Francisco who rates the stock outperform.

Szkutak also highlighted potential for growth in Amazon’s advertising business, which made up less than 4 percent of revenue in 2012.

“We think it’s a very sizable, very good long-term opportunity for us,” he said. “It’s something we’ve been working on for some time. We’re really trying to help customers find and discover what they want to buy online.”

To contact the reporter on this story: Danielle Kucera in San Francisco atdkucera6@bloomberg.net

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