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Prioritizing Profits Is Helping Uber and Amazon -- and Could Help Netflix, Too

Uber said it's forgoing some growth in rides, and Amazon said it's stretching its cloud computing equipment budget over more years. They both represent efforts to trade growth for improved profitability.
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Low expectations are a great thing, as when profit projections for tech companies bottom out in a roaring stock market and the slightest prospect of profit increase gives bulls what they need to drive stocks higher.

Case in point -- Amazon  (AMZN) - Get Free Report is up 14% since reporting better-than-expected results on Jan. 30, hitting a new all-time high of $2,135.60 along the way, a point near which it now hovers not far below. This has pushed the company into the “Trillion Dollar Club” of market cap along with Apple  (AAPL) - Get Free Report, Microsoft  (MSFT) - Get Free Report and Alphabet  (GOOGL) - Get Free Report.

The proximate cause was an increase of 10% in Wall Street’s expected profit per share for Amazon this year of $28.97. Never mind that the estimate is down from an estimate of $39 last spring. Wall Street wanted a good reason to buy Amazon, and despite the nose-bleed valuation multiple on the stock -- 75 times this year’s projected profit -- this suddenly brighter profit outlook is the excuse the Street was looking for.

The Amazon example highlights the increasingly curious situation of investors getting excited by companies that don’t make a lot of money suddenly making just a bit more money, or getting closer to it.

Take the case of ride-sharing giant Uber Technologies  (UBER) - Get Free Report, which had mostly been in the dumps since its IPO in May of last year. The stock is up 10% in the days since it reported better-than-expected results, and said it sees a path to profitability sooner than it had initially projected. Though the company is still projected to lose $1.41 per share this year, that’s easily better than the $2 per share loss that analysts had modeled only as recently as October. (It’s worth noting that Uber still trades a few percent below its first-day closing price of $41.57, and, at a recent price of $40.82, is 10% below its IPO offer price of $45.)

What did they say that made such a difference? In Amazon’s case, it was the biggest beat on EPS since the March quarter of last year, 53% higher than expected. The revenue beat was more modest, only 1.6%, and most of that was foreign exchange.

What shone in Amazon's quarter were savings at the company’s AWS cloud computing service. Amazon’s chief financial officer, Brian Olsavsky, said Amazon is able to make its server computers last longer, which stretches out the depreciation cycle for equipment from three years to four years, which in turn spreads depreciation expense out over a longer period and reduces the expense in any one quarter. The company saved $800 million in the quarter in depreciation expense, and expects to save $2.3 billion this year.

There are other efficiencies, too, that Amazon may find in other areas of its business, such as same-day delivery, where it is spending $1 billion per quarter to build out the service. In coming quarters, Olsavsky implied, Amazon may see that cost burden lighten as it becomes more efficient. These are the kind of levers the company has that can surprise to the upside on profit in a given quarter.

Uber’s story was more dramatic. Though the company is now losing money hand over fist, chief executive officer Dara Khosrowshahi told analysts on Feb. 6 that the company is pushing to report positive adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) by the final quarter of this year, a stepped-up time frame from what it had previously said wouldn't happen until full-year 2021.

Part of the Uber profit view here is simply being less aggressive on growth. CFO Nelson Chai told analysts that the company will moderate the rate of growth in its "gross bookings," the total dollar value of car rides and food delivery fees in “Uber Eats,” that it produces, this year, while hiking its “take rate,” the amount of money it gets to keep after paying drivers. That will boost its EBITDA profit margin.

It will also cut the growth outlook. Uber is now projected to have bookings this year of $79 billion, down from a prior $81.95 billion estimate before the announcement, according to FactSet. And revenue will be lower than previously expected as well.

Both Amazon and Uber are cases of surprising to the upside, with the trade-off of somewhat slower growth. Amazon’s growth is decelerating as its scale makes it harder to expand, and Uber says it’s making a choice to forgo some business in order to be profitable sooner.

And investors seem to love it. Uber got a raft of upgrades on Feb. 7 into the $58 neighborhood (the highest target is $60 according to FactSet.). Amazon has been getting price-target increases for the past two weeks since its report, the highest now being $2,700, which would be 26% upside from a recent $2,145.

This game of low profit expectations is a game others can play as well, and one prime candidate is Netflix  (NFLX) - Get Free Report. With increased competition from Apple, Walt Disney  (DIS) - Get Free Report, Amazon and others, the growth picture is now trimmed a bit for Netflix’s revenue, meaning it's a good time now to get serious about the profit outlook. Netflix's Ebitda margin outlook is already expected to get better next year, but there’s likely room for improvement when the company next reports results in April. 

There were already signs of this in last month’s quarterly report, where management said their spending on licensed content is less as they invest in more originals, which leads to more efficient spending and an improving cash flow outlook going forward. Combined with smart partnerships for distributing the service, Netflix can slow the growth of selling and marketing expense to bring in new subscribers.

Call it an era of diminished ambition. For the moment, growth is less urgent, and wringing more dollars from a more modest outlook is the way investors like their tech giants.

Amazon, Apple, Microsoft, Alphabet, Facebook and Disney are holdings in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells these stocks? Learn more now.