Amazon.com AMZN will report second quarter earnings on Jul 28 after the bell, so it makes sense to take stock of the company’s prospects heading into the announcement.
According to Zacks, stocks with Buy (Zacks Ranks #1 and #2) and Hold (Zacks Rank #3) ratings have higher chances of beating estimates when they also have a positive ESP. Therefore, in Amazon’s case, the Zacks Rank #3 (Hold) and Earnings ESP of 37.72% makes seems to indicate a positive surprise this quarter.
To be honest, Amazon’s earnings surprise history has been spotty with the company beating estimates in three of the last four quarters. But the average beat is very high at 133.55%, so it still looks very good.
The shares also look tremendously overvalued meaning that investors have huge growth expectations. That is of course not surprising given Amazon’s pioneering advantages in online commerce and infrastructure-as-a-service (IaaS) markets.
What We Are Watching This Quarter
Amazon is focused on building platforms that can generate recurring sales. So on the ecommerce side, it has Prime subscriptions and devices and on the cloud side, it has customer relationships and infrastructure.
The Prime membership program, which Amazon sells for $99 a year (or $10.99 a month for Sprint customers), remains a huge success. Prime memberships have been growing at over 50% in the last two years, but domestic growth rates could understandably slow down as more people start using it. That is why Amazon has started celebrating Prime Day in July, so people buy a subscription to avail of the massive discounts that are exclusive for Prime members on that day. And once you buy a Prime membership, it tends to grow on you. The main lure seems to be free shipping and the convenience of a one-stop shop for your every need.
And Amazon is piling on the benefits with fresh digital entertainment whether it is music, video, gaming or books. As customers get access to so much more for the same price, they tend to spend much more on Amazon.It has also thrown in some services so you pretty much don’t need to go anywhere else for any of your needs.
Amazon has also started extending Prime to faster-growing international locations like the UK and Japan, where it is in various stages of implementation and more recently, to India, where growth rates have exceeded all expectations.
The second platform is devices, particularly the kind that can interact with you, buy stuff and connect your home. So here we see its popular Kindle readers, tablets, not-so-popular phones, dash buttons, Echo devices, etc. Amazon intends to become a major player in the connected home. All its devices facilitate consumption or ordering of products and services. The personal assistant that operates through Echo devices takes this to another level because through it, Amazon helps you do things like play your favorite song or turn off the lights. Amazon is working with companies making household items to integrate its personal assistant within them.
Amazon, through AWS, is the leading provider of infrastructure services for the cloud. This business involves the renting out of computing resources to companies, small businesses, individuals and anyone else that prefers to pay infrastructure costs on the basis of the amount used. Amazon has around 13 infrastructure regions across the world and is on track to build out another four by next year, adding to the scale.
This business is much higher-margin compared to retail and is also faster growing. So it’s not surprising that at just 9% of revenue in the last quarter, it was able to generate 43% of profits. In 2015, we saw the increased utilization of its cloud assets, which positively impacted both revenue and profits. But expansion in this business necessarily means increased investment to build out infrastructure, which should increase costs.
Exactly when these costs will start kicking in isn’t clear, but they should be coming. The business is however positive from an FX perspective, because revenues are dollar-denominated while a lot of the assets are located in low-cost regions. While Microsoft MSFT remains in hot pursuit, Amazon has a head start and ultimately, there is plenty of growth opportunity for both, as well as other emerging players like IBM IBM, Alphabet’s GOOGL Google, Salesforce (CRM), etc.
Summing Up
Amazon has a solid growth strategy and executes well. At the same time, estimates appear less reliable with both earnings beats and misses coming in at huge margins. This happens because the company plays things rather close to the vest (possibly because of cutthroat competition) and management doesn’t appear too concerned with price changes. So analysts have less information to go on.
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