Amazon's risky bet is paying offApril 27, 2012: 11:04 AM ET
Investors panicked in the third quarter when net income dropped as the company spent lavishly on investments in fulfillment and the Kindle. History is not repeating itself.
FORTUNE -- Can Amazon, which has long relied on low profit margins, prove its long-term strategy will pay off? If its latest quarterly earnings are any indication, there's certainly a good deal of reason to think so.
In the first quarter, revenues were $13.2 billion with operating income of $192 million. Both figures easily trumped Wall Street's predictions of less than $13 billion in revenues and operating income of just $186 million. The surprise sent shares up 14% after-hours. "Revenues came in higher than expectations -- not at the higher end of guidance -- but even better than what people thought," says ThinkEquity analyst Ronald Josey. "More importantly, their operating income blew away most people's expectations."
Amazon's (AMZN) latest earnings reflect a positive turn. In the fourth quarter 2011, the company missed estimates, which was initially met by a 9% drop in shares. Concerns also arose when Amazon's annual net income fell sharply from $1.4 billion in 2010 to $631 million in 2011. Much of that was due to Amazon's investment in new fulfillment centers, as well as hardware like the Kindle Fire tablet. In particular, the Fire is widely believed by analysts to be a device the company is losing money on.
This isn't Amazon's first trip to the dance, though. "They are very similar to what we saw back in the 2004 to 2006 timeframe when the company was making a lot of investments and margins got squeezed," Caris & Company analyst Scott Tilghman told Reuters. "Then in the years following, margins expanded and revenue accelerated. ... We might not see quite as much of an acceleration on the revenue, given the size of the company, but it does look like they have the ability to generate the margins."
In light of yesterday's earnings announcement, many analysts believe Amazon's risky digital strategy is working, and that the latest numbers indicating growth in the company's media business mean users -- including new Fire owners -- are buying more e-books, movies, and television shows. To wit, research firm comScore recently reported that the Fire now accounts for nearly 54% of all Android tablets in the U.S. "Customers are buying a lot of content," Amazon chief financial officer Tom Szkutak said during an earnings call with analysts. "You're seeing that accelerate."
No one expects the firm's tight margins to fatten up in the coming months, however. Analysts from Goldman Sachs expect Amazon to continue robust investments in fulfillment, technology, content and expanding its Kindle line through the rest of 2012. At the very least, it remains on track to open 13 more fulfillment centers this year. According to Josey, it generally takes two or three years for those fulfillment centers to operate at expected efficiency levels and thus two or three years for them to boost Amazon's margins, rather than constrict them. In other words, the warehouses built this year likely won't have a positive, material impact on the company's bottom line until 2014.
"Amazon's very clear their goal is maximize absolute dollars to the extent that they're benefiting from e-commerce," says Josey. "Margins are important, absolutely right, but if overall dollars are growing that's the key thing."
As for Kiva Systems, a robotics manufacturer Amazon is buying for $775 million once the deal wraps this quarter, it's too early to tell when the benefits of the acquisition will kick in. Szkutak admitted during the call that Amazon must still figure out how to implement the technology in all their warehouses.