Amazon's 'magic number' is AWS growth, says Roth MKM's Rohit Kulkarni

Key Concepts

• Amazon Web Services (AWS): Amazon's cloud computing division.
• Revenue Beat: Exceeding expected financial performance in terms of sales.
• Operating Income: Profitability from a company's core business operations.
• Year-on-Year (YoY) Growth: Comparing a metric to the same period in the previous year.
• Cloud and AI Trends: The increasing adoption and development of cloud computing and artificial intelligence technologies.
• Capex (Capital Expenditures): Funds used by a company to acquire, upgrade, and maintain physical assets.
• Performance Obligations (RPO): A measure of future revenue that a company has committed to deliver under contract.
• Retail: Amazon's e-commerce business.
• Discounting and Shipping Costs: Reductions in price and expenses related to delivery, often incurred during promotional periods.
• Profitable Growth: Increasing revenue while also improving profit margins.
• Advertising: Amazon's advertising business segment.
• Ad Stack: The technology and processes used to deliver and manage advertisements.
• Bottom of Funnel: The stage in the sales process where a customer is close to making a purchase.
• Prime Video: Amazon's video streaming service.
• Amazon DSP (Demand-Side Platform): A technology platform that allows advertisers to buy ad inventory across various channels.
• Cohort: A group of people sharing a particular characteristic.

Amazon's Q3 Performance and AWS Acceleration

Amazon's shares surged by nearly 9% following a strong performance in both top-line (revenue) and bottom-line (profit) metrics. A key driver of this excitement is Amazon Web Services (AWS), which reported a 20% year-on-year revenue jump in Q3. This growth rate is the fastest AWS has seen in several quarters, exceeding expectations and surpassing the "bogey" (target) set by the market. This acceleration in AWS growth is seen as a positive sign, especially in light of broader cloud and AI trends observed from competitors like Google and Microsoft. The strong AWS performance is expected to support the stock's upward momentum.

Investor Focus: Beyond the One-Day Pop

To sustain the stock's climb beyond a single day, investors will be looking for more than just a temporary surge, particularly from those who may have underestimated AWS. A significant narrative shift is required. Key indicators that investors will scrutinize include:

• Capex and Performance Obligations (RPO):
  • RPO: AWS has been reporting accelerating RPO growth over the last few quarters, which serves as a leading indicator for cloud growth. The wider the gap between revenue growth and RPO growth in the current quarter, the more bullish investors will be.
  • Capex: Amazon currently has approximately $120 billion in trailing 12-month capex. The street's expectation for next year is around $127-128 billion. However, this figure might be considered conservative. The extent to which Amazon is willing to increase capex will be a crucial point. While a higher capex number might put short-term pressure on the stock, it also signals continued investment and leadership in the cloud market, potentially quieting bearish narratives.

Retail's Role and Holiday Guidance

While the focus has been heavily on AWS, the retail segment's performance and guidance for the crucial holiday quarter (Q4) are also important. Amazon typically provides a wider guidance range for operating income in Q4 due to the inherent variability in retail outcomes.

• Long-Term Shift in Retail: Amazon is undergoing a long-term shift towards "profitable growth" in its retail operations, a trend that began in 2024. This involves controlled investment and continuous improvement in profitability, significantly driven by its advertising business within retail. The combination of accelerating AWS growth and profitable retail growth is viewed positively.

Advertising Growth and Competitive Positioning

Amazon's advertising business is showing strong growth, particularly in an environment where targeted advertising and data-driven organizations are performing well, as evidenced by recent results from Meta and Alphabet.

• Evolution of Amazon's Ad Stack: Amazon is fundamentally redeveloping its advertising technology. Previously, the focus was primarily on the "bottom of the funnel," aiming to convert users actively looking to buy on Amazon by showing them relevant products at the right time.
• Comprehensive Ad Solutions: Now, with services like Prime Video and Amazon DSP, coupled with partnerships (e.g., with Pinterest), Amazon advertising has evolved into a more complete solution.
• Attracting Non-Amazon Sellers: Brands that do not sell directly on Amazon, such as car manufacturers and insurance companies, are now considering Amazon as an advertising partner. This is due to the reach of Prime Video and access to a rich cohort of internet consumers.
• Competitive Advantage: Amazon is seen as addressing advertising challenges in a way that may even surpass Google and Facebook, leveraging its data and AI capabilities.

Synthesis/Conclusion

Amazon's Q3 results highlight a significant acceleration in AWS growth, which is the primary driver of current market excitement. Investors are looking for sustained momentum, which will depend on continued strong RPO growth and strategic capex investments. While retail is undergoing a long-term shift towards profitable growth, the advertising segment is rapidly evolving into a comprehensive solution, attracting a wider range of advertisers and leveraging Amazon's vast data and AI capabilities to gain a competitive edge. The combination of these factors suggests a positive outlook for Amazon, moving beyond short-term market reactions.