Could Amazon AWS Margins Get Worse This Year?

Deutsche Bank expects Amazon.com, Inc. AMZN to report its first quarter print "in-line and guide conservative", with retail financials stabilizing. But, the brokerage has a "careful watch on the magnitude of the first sequential AWS margin downtick in nearly two years."

"AWS remains a top factor for AMZN's stock performance, evidenced by the recent relief rally following the GCP conference, and we expect the AWS Summit Series kicking off in Chicago to provide further confidence," analyst Ross Sandler wrote in a note.

Sandler noted, "The one concern we have in 1Q is that the 2-3 point margin tailwind from FX enjoyed in each quarter in 2015 reverses out, and hence reported CSOI (Consolidated Segment Operating Income) is likely to drop to 24%-26% down from 29% in 4Q (while ex-fx CSOI margins remain stable)."

He continued, "This FX phenomenon may cause investors to take a closer look at AWS profitability, and drive downward revision to the expected 35% CSOI margin in the out year (2018)."

Related Link: How Amazon Gets AWS To $100+ Billion

The analyst also added "retail GP growth ex-fx faces tougher comps each of the next two quarters (1Q and 2Q) hence we expect it to decelerate to the mid 20%'s, but we think AMZN's retail metrics have been derisked after last quarter's issues and the consensus reset."

On a positive note, the analyst's checks on AWS show that AWS:

• 1) "Isn't losing share to GCP, Azure (case in point the ~$1B in revenue added in 1Q is likely several times the amount added by the rest of the public cloud space)
• 2) pricing appears to be benign, as AWS hasn't responded to GCP's recent cuts
• 3) continues to move up the stack, with evidence pointing to build-out in data management and security
• 4) the cadence of feature updates (2x per day) is faster than the competition."

Sandler noted one area that will garner much more attention from the investment community is the Echo business, and overall strategy to "win the connected home", where he thinks Amazon has moved meaningfully ahead of the peers.

Sandler has a Buy rating and $800 price target on the stock saying, "AMZN shares have been range-bound since the 4Q implosion and we think remain so until we get past the 2Q "tough comps", hence we still advocate adding selectively in the mid-$500's as our long-term bull case remains intact."