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Analysis: Amazon in very good shape, but there are some chinks in its armor

Amazon has produced another stellar set of sales figures, with total revenue up by almost 34%. Admittedly this includes around $1.3 billion of sales from the Whole Foods Market acquisition, but even excluding this, sales were still up by an above average 29.8%

Impressively, Amazon has managed to increase the pace of growth from its online stores, where sales increased by 22% over the prior year. This is the highest rate of growth since the second quarter of 2016. A very successful Prime Day, the addition of more customers to the Prime ecosystem, and continued uplifts in spending from both Prime and non-Prime customers alike, all drove the outperformance.

All that said, it is clear that Amazon's own online stores are no longer the star of the show. Both the subscription services arm and Amazon's web services division (AWS) are outpacing product sales in growth terms. The former, which includes Prime fees, grew by 59% and the latter by 42%. In particular, we believe that the growth of Prime will continue to boost subscription revenue in the quarters ahead, all the more so because of the slew of new devices that Amazon is releasing.

We remain extremely positive about this growth of Prime, which we see as a critical tool to extend Amazon's customer reach, gather customer data, and to lock in loyalty in an increasingly fickle marketplace. It is clear that Amazon is investing heavily in the content that underpins Prime's success and this, combined with the new devices and services such as free outbound calling, should help to increase renewal rates and boost subscriber numbers.

For all Amazon's undoubted success, there are a few chinks in the behemoth's armor.

The main one of these is profit. For the quarter, operating income was down by 40% to $347 million. The dramatic growth of marketing costs, which were partly a function of the Whole Foods acquisition as well as the substantial promotion of new devices, took its toll on the bottom line. Fulfilment and shipping costs also increased faster than sales, although the pace of increase is not quite as bad as feared.

International also weighed down on the profit line with a $936 million operating loss during the quarter. This was a sharp increase on the $541 million loss the division posted last year. The launch of new services like Amazon's unlimited music service in several European countries, and the rollout of Alexa services to India and Japan, have all taken their toll on the cost line. Amazon is still very much in the building stage in many of its overseas operations, and we think profitability is likely to get worse before it gets better. However, this near-term pressure should not be seen in negative terms; indeed, we view it as an investment rather than as an unrecoverable cost.

Turning away to Amazon's latest venture, Whole Foods, we believe it is too early to conclusively say whether this is a success story. However, initial signs are encouraging, and our data show some very slight movements on price perception - these are not dramatic, but they are a step in the right direction and show that Amazon's approach is being noticed by consumers. Looking ahead, we excited about the possibilities for the Whole Foods business and believe that over the medium to longer term Amazon will make some more radical changes that will deliver stronger results.

Overall, Amazon is in very good shape. In some ways, the deterioration in profit doesn't matter, if only because the business has an enormous amount to show for its expenditure. These investments -- in services, devices, new ventures, pricing, international markets, and business services -- will all power growth in the years ahead.
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