Amazon Earnings Preview: Can Amazon Deliver A Beat This Quarter?

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All eyes will be on Amazon (NASDAQ:AMZN) on Thursday, January 29th, when the company reports its fourth quarter results for the year 2014. As some early indicators suggest, the company’s top-line growth could continue to outperform in Q4, due to a solid holiday season. Amazon’s same stores sales rose at over twice the overall e-commerce growth rate during October and November, helped in part by an early start to the holiday season (as per ChannelAdvisor). However, the same figure dropped somewhat in December, but still remained above the broader market’s growth rate. While Amazon’s management had estimated revenue growth to range between 7% and 18% during the fourth quarter, we expect the final figure to fall around the high-end of this guidance range. Heavy demand for electronics and general merchandise, along with growth in the Amazon Web Services business, are likely to be the key driving factors for fourth quarter results.

Amazon’s profitability figures will be keenly tracked during the earnings results, as this is an area that has caused considerable disappointment among investors in the past. Investors have punished Amazon over the last few quarters for its earnings misses, and we expect this quarter to be no-different. We think Amazon will continue to face margin pressure through Q4, due to its heavy investments in diverse areas and increased expenses to accelerate demand during the holiday quarter. Moreover, we think Amazon will find it hard to raise margins over the next couple of years, as its top-line growth could slow down with tougher year-over-year comparisons. On top of this, we expect expenses to stay high, leading to a grim profitability outlook over our forecast horizon.

Our $263 price estimate for Amazon’s stock. implies near 10% downside to the current market price.

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Profitability Will Be A Key Concern In The Earnings Report

Amazon’s low profitability has been a long standing concern as its management has consistently chosen to prioritize growth over improving margins, reinvesting profits through both lower pricing and higher expenditures. However, investors are increasingly becoming tired of the this “invest now, profits later” strategy and have punished the company’s stock over the last few quarters for its earning misses. Amazon posted an operating loss of $544 million in Q3 2014, against a loss of $25 million in the same period a year ago. In addition, the company guided to an operating income (loss) in the range of $(570) million and +$430 million for Q4 2014, compared to $510 million in Q4 2013. These results did not go down well with the company’s investors, which caused the company’s stock price to tumble by around 10% post the earnings announcement.

We expect Amazon to face similar profitability pressure during the fourth quarter as well, due to heavy investments in fulfillment centers, technology infrastructure, original content, hardware development and geographical expansion. We expect a year-over-year increase in technology and content costs, fulfillment costs, marketing expenses and general and administrative expenses during the fourth quarter. Around $170 million loss was incurred on the Fire phone inventory write-down and supplier commitment costs during the third quarter, and we think a significant portion of the remaining $83 million worth of Fire phone inventory could get written off in the fourth quarter as well.

Revenue Growth Will Be Driven By High Demand Across Electronics And General Merchandise And Amazon Web Services Businesses

The electronics and general merchandise category comprises around 69% of Amazon’s overall sales. Strong demand in this segment has bolstered the company’s top-line results in the past. During the nine months ended September 2014, the revenue growth in this business across North America and international region stood at around 29% and 24% respectively. We believe this segment will continue to carry the company’s earnings during the fourth quarter as well, due to Amazon’s immense scale and competitive advantages, along with heightened demand during the important holiday season.

According to ChannelAdvisor, Amazon’s same stores sales increase was recorded at over double the overall e-commerce rate during October and November 2014 at 32.4% and 35.7% respectively. However, the same metric decelerated to 21.8% in December, which could also be due to tougher year-over-year comparison, as well as an early start to the holiday season, as Amazon started its promotional activities early in November. [1] All in all, the holiday season (spanning November and December) was successful for the company, as its sames stores sales came in at around 27% during the period against 16.2% for the broader market.

We also expect the ‘Other’ category to show superior revenue growth, as the ‘Amazon Web Services’ business is rapidly gaining traction among customers. These services witnessed solid usage growth (in volume) at around 90% during the past few quarters, and we expect this trend to continue in the future, as there is a large market opportunity for Amazon to offer its services to smaller, more nimble companies most inclined to outsource infrastructure. Product innovation and lower pricing will also enhance uptake of these services in the near-future.

Media And International Sales Will Be Keenly Tracked

The media segment has showed sub-par growth over the past few quarters — sales increase in this segment slackened from 10% in Q1 to 8% and 4% in Q2 and Q3 respectively. Tougher year-over-year comparisons and the trend towards book rental (as compared to outright purchase) were cited as the reasons for this performance. It will be interesting to see how this segment performed during the holiday season as the company is making heavy investments on this business (over $100 million was spent on original content in the third quarter alone). In case these investments fail to propel results in this segment or Prime subscriptions in general, then it could negatively impact the company’s profitability.

We will also be tracking international sales figures closely during the fourth quarter, as the revenue growth within this segment had subsided from 18% each in the first two quarters to 14% in the third quarter of 2014. Imposition of consumption tax in Japan in April is one of the factors that has impacted sales from this region during the recent past. As Amazon is making large-scale investments to expand its presence in markets such as China, India, Italy and Spain, we think some of these investments could impact the company’s overall margins adversely in the near-term, due to the intense competition being seen in these e-commerce markets. Achieving superior top-line growth within these markets, will become critical for Amazon to grow its margins in the coming years (in our view).

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Notes:
  1. December 2014 SSS ChannelAdvisor Same Store Sales (SSS) for eBay, Amazon, Search, CSE and other e-commerce channels, ChannelAdvisor, January 7, 2015 []