In its recent earnings, Amazon (NASDAQ:AMZN) reported a substantial slowdown in the growth of Others segment, which is primarily made of advertising revenue. At 36%, the growth rate in this segment is only a few percentage points higher than Facebook’s (NASDAQ:FB) growth of 26% in the latest quarter. This has led to concerns that Amazon is close to hitting the saturation in terms of ad load and pricing. Strong growth in advertising segment gave a bullish momentum to Amazon stock in the last few quarters. Hence, a slowdown in this segment can hurt the long term sentiment.
However, there are a number of levers which Amazon can use to deliver better advertising growth in the near term. For starters, Amazon is experimenting with video search features. It is also developing better tools to improve ad conversions. Amazon has a long growth runway to improve its advertising business and increase the market share in digital advertising.
The advertising segment continues to be an important factor for Amazon stock and investors should closely watch the future growth trend in this business.
A Slowdown or a Transition for Amazon?
The quick growth in Amazon’s advertising business had taken the market by surprise. Now, it has increased expectations, which led to a mismatch between revenue growth and current capabilities. Amazon’s advertising growth in the last few quarters was over 100% but that was due to an accounting change. If we remove this factor, the Q4 2018 growth was 38%. The growth rate in the advertising segment was between 51% and 73% in the previous quarters.
Source: Amazon filings
Facebook was also at this revenue rate in 2014. Since then, it has reported an average revenue growth rate of close to 45%. And like Facebook, Amazon has a number of options to improve its revenue from advertising. Long-term investors should see better sentiment in Amazon stock as the company improves its advertising tool.
Amazon is currently trying to make those improvements with video search ads, which is a direct shot at Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google. The less-controversial nature of Amazon’s platform is also attracting more brands. Last year, Piper Jaffray’s Michael Olson had forecasted that Amazon’s advertising income will surpass AWS profits by 2021.
Next Big Growth Driver for Amazon Stock
One of the big opportunities with Amazon is to shift marketing spend from in-store branding. Morgan Stanley has estimated that a whopping $178 billion is spent on in-store brand promotions and coupons. While Google can only offer brand marketing to bigger consumer-packaged-goods (CPG) companies, Amazon can offer performance marketing. This means that Amazon’s platform helps in driving sales for these companies. On the other hand, Google can only put the ads in front of customers — it’s far less of a guarantee of converting them into sales.
This is a gradual process in which more ad dollars will shift to Amazon’s platform. Walmart (NYSE:WMT) is trying to improve its own advertising business. Recently, the company moved its entire ad sales for its stores and website in-house. While Walmart has a larger sales base, Amazon is ahead in terms of its tools and third-party sales. This is a big advertising segment and Amazon is sure to grab more ad dollars from in-store promotions industry.
What About the Competition?
Amazon’s rapid growth has alarmed Google and Facebook. Both these giants are now looking to expand their own retail presence. Facebook has launched new features which allow customers to directly make a purchase from within Instagram. Google has recently launched new shopping features at Google Marketing Live event. Users will be able to make purchases from within YouTube by the end of this year. Google will also have a personalized Google Shopping page where users can compare and filter by price and brands.
According to eMarketer, Amazon is in third position behind the duopoly of Google and Facebook in terms of digital ads. And it’s coming for them.
In the recent quarter, Amazon’s growth was ahead of both Facebook and Google. As new features and advertising tools are launched by Amazon, we should see an upward trajectory for growth in advertising revenue. Amazon’s advertising segment is currently close to $10 billion on a trailing-12-month basis. At the current growth rate, this number should hit $20 billion by the end of 2020. Better margins in advertising will help in driving the overall margins higher. We have already seen this in the past few quarters. Amazon reported an operating margin of 7.4% compared to 3.8% in the year-ago quarter.
The concerns over a slowdown of the advertising segment in Amazon are overblown. Even at the current growth rate, Amazon should be able to show a revenue trajectory similar to that shown by Facebook in the last five years. There is a high probability that we will see an uptick in advertising growth from Amazon as new tools and features are launched.
The long-term growth projections for Amazon’s advertising segment are very bright. This will help in lifting the operating margin of the entire company and help in the improvement of EPS. And we should continue to see bullish momentum in Amazon stock in the near future as the advertising segment increases its revenue share.
As of this writing, Rohit Chhatwal did not hold a position in any of the aforementioned securities.
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