Amazon (AMZN) Before Earnings (What to Watch)
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Amazon is now trading lower than when we originally published our analysis, creating a more attractive setup ahead of its earnings report this week.
The sell off does not appear to be entirely Amazon specific. Large cap technology earnings have produced a cautious market reaction so far. Alphabet delivered strong revenue and cloud growth, but the stock still sold off as investors focused on its enormous AI spending and negative free cash flow. Tesla also dropped sharply after its report, showing that the market is no longer rewarding companies simply for talking about AI, it wants to see clear returns on that spending. That raises the bar for Amazon this week, but the lower entry price also improves the potential risk to reward if AWS growth, backlog and profit margins remain strong.
We’ve been highlighting the race between Amazon and Walmart to become the first company to reach $1 trillion in annual revenue, and it’s looking like Amazon is pulling ahead as it grows from primarily an e-commerce company into a massive retail operation, the world’s largest cloud provider through AWS, and a rapidly growing advertising business that is already generating more than $60 billion annually. Amazon also has several longer-term bets in motion, including custom AI chips, satellite internet through Amazon Leo, Alexa, connected devices and Prime Video.
Reaccelerating Revenue
In a rarity for such an established company, Amazon’s business is reaccelerating. Revenue increased 17% year over year to $181.5 billion, while operating income climbed to $23.9 billion from $18.4 billion. The real highlight was AWS.
AWS revenue grew 28% to $37.6 billion, marking its fastest growth rate in 15 quarters. AWS also posted an operating margin of nearly 38%, showing that Amazon’s cloud business is growing rapidly. Advertising revenue increased 24% to $17.2 billion, giving Amazon another fast growing, high margin business outside of AWS.
Amazon's AI Buildout
Still, as with other MAG7 companies spending billions on the data center buildout, Amazon’s stock has underperformed the S&P 500 this year. Investors are still unsure whether all this AI spending will ultimately be worth it. Amazon’s capital expenditures are expected to reach approximately $200 billion this year, but the strongest argument in favor of that spending is the company’s massive backlog.
AWS ended the quarter with approximately $364 billion in contracted revenue that has not yet been recognized. This gives Amazon tremendous revenue visibility. Customers are already committing to use Amazon’s cloud and AI infrastructure for years into the future. The question is no longer whether there is demand, it is whether Amazon can build enough infrastructure to meet that demand. That will be one of the most important parts of this week’s earnings report. Investors will want to see AWS maintain strong growth while receiving evidence that Amazon’s enormous infrastructure investments are translating into revenue, operating income and future capacity.
Digital Realty Trust (DLR). Opportunity in REITs.
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After spending much of the past year trading like a traditional interest rate sensitive REIT, Digital Realty is beginning to remind investors that it is also one of the most important infrastructure companies behind the AI and cloud-computing buildout.
What does Digital Realty do?
Digital Realty owns and operates data centers around the world. These facilities provide the physical space, power, cooling systems and connectivity needed to operate servers and other computing equipment. Its customers include cloud providers, technology companies, financial institutions, telecommunications companies and enterprises moving more of their workloads online. Companies such as Nvidia may provide the chips powering artificial intelligence, but those chips still need somewhere to operate. Digital Realty provides part of that physical foundation.
AI Demand Is Becoming Real Revenue
The AI infrastructure trade has mostly focused on semiconductor companies, networking suppliers and power generation businesses. However, data center landlords could benefit from the next stage of the buildout as companies begin deploying AI systems at a larger scale. Digital Realty’s latest earnings provided strong evidence that this demand is translating into actual financial growth.
Q2 revenue increased 29% YoY to approximately $1.92 billion, while core funds from operations reached $2.13 per share, up from $1.87 during the same quarter last year. Both figures exceeded Wall Street expectations, and management raised its full year core FFO outlook to between $8.15 and $8.20 per share. (For a REIT, funds from operations, or FFO, is generally more useful than traditional net income because real estate depreciation can make reported earnings look weaker than the underlying business…that’s how we found our $PLD trade in Hyper Wealth.)
Interest Rates Could Become Another Catalyst
Digital Realty offers exposure to two major investment themes at the same time…artificial intelligence and potentially lower interest rates.
REITs generally finance acquisitions and development projects using a combination of debt and equity. When interest rates rise, borrowing becomes more expensive and investors can receive competitive yields from lower risk assets such as Treasury bonds. That can pressure REIT valuations.
The reverse can happen when rates decline. Lower interest rates could reduce Digital Realty’s future financing costs, improve the economics of new developments and make its dividend more attractive relative to government bonds. They could also lead investors to assign a higher valuation to the company’s future cash flows.
Overall, DLR gives investors exposure to continued AI and cloud expansion, while a future decline in interest rates could provide an additional valuation and financing tailwind. As long as bookings remain strong, its backlog continues converting into revenue and management executes on its development pipeline, the long term theory remains intact.
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Disclaimer: This article is for informational and educational purposes only and does not constitute financial advice. Investing involves risk, including the possible loss of capital. Always conduct your own research or consult with a licensed financial advisor before making investment decisions.
Hyper Stocks and its contributors may hold positions in some of the securities or assets mentioned above. These positions are subject to change without notice. Any opinions expressed reflect current views at the time of writing and are not guarantees of future performance. Past performance does not guarantee future results.