Is the Clock Ticking on Amazon’s Margins?

Last quarter, investors put Amazon’s (NASDAQ:AMZN) operating margins close under their microscope as analysts had expressed fears that the manner in which the company did business — operating with extremely thin margins — had finally begun to hurt its profitability. But Amazon’s results showed the company had begun to transform its business by using its more profitable cloud computing and digital content businesses to offset the small margins used to keep its retail business competitive.

Three months have passed and now analyst can revisit this issue to see whether the evidence of a transformation had strengthened along with the company’s margins.

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Amazon’s Chief Executive Officer Jeff Bezos has told investors time and again that the focus of the company is on creating new opportunities and growing its business, not generating massive profits. Based on its 2013 first-quarter results reported Thursday, Amazon appears to have kept its allegiance to this ethos.

The Internet company reported that revenue rose 22 percent to $16.07 billion, but profits slumped. For the three month period, profit dropped 37 percent to $82 million, from $130 million in the first quarter of 2012. Earnings of 18 cents per share did beat Wall Street’s expectations, although they fell from the 28 cents per share reported in the year-ago quarter. Surprisingly, revenue came short of expectations; analysts polled by FactSet had forecast sales of $16.14 billion…

The disparity between earnings and revenue point to a particular problem with the way Amazon does business. Part of the reason that Amazon’s profits remain so low is because the company invests heavily in new markets as well as in research and development of products — including its recently-announced television set-top box and rumored smartphone. The Internet retailer significantly discounts some of its products, the Kindle in particular, to remain competitive, and this practice also eats away at its margins.

In particular, profits declined in the first quarter because of Amazon’s heavy spending on acquisitions, new distribution centers, global expansion, and digital media growth like original programming for its Prime Instant Video.

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The only question left for analysts is how long this practice can continue. “The bar is low when it comes to profitability at Amazon, but the clock may finally be starting to tick for Amazon to produce profits,” BGC Partners analyst Colin Gillis wrote in  a note to investors seen by The Los Angeles Times. “The bull case that Amazon can become a gusher of profitability once its investments mature is going to be tested later this year in our opinion.” Gillis said he assumed that Amazon only earns three-tenths of a penny on every dollar of revenue.

Shares of the e-commerce behemoth ended the Thursday up $5.92, or 2.20 percent, at $274.70 — a level close to the stock’s 52-week high. But following the release of the earnings shares dropped 3.37 percent to $265.45 in after-hours trading.

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