Amazon.com AMZN will report third quarter earnings on Oct 27 after the bell. Let's take a look at the company's prospects heading into the announcement.
According to our model, stocks with a Zacks Rank #1 (Strong Buy), #2 (Buy) and #3 (Hold) have a higher chances of beating estimates when they also have a positive ESP. Therefore, in Amazon's case, its Zacks Rank #1 and Earnings ESP of +10.47% seems to indicate a positive surprise this quarter.
Amazon's earnings surprise history has been decent with the company beating estimates in three of the last four quarters with an average beat of 90.92%.
AMAZON.COM INC Price and EPS Surprise
What We Are Watching
International/North America/AWS Mix: Last quarter, the segment's contribution to revenues was positive in the highest-margin Amazon Web Services (AWS) business, up 68 basis points (bps), while North America and International segments declined 22 and 46 bps, respectively. This resulted in a positive mix of business and contributed to Amazon's increased profitability in the last quarter.
As far as the retail business is concerned, the North America business being mature generates higher margins, while the international business, accompanied by expansion costs including infrastructure, headcount and inventory, currently generates operating losses. The AWS business contributed 9% of revenues and 56% of profits in the last quarter. Combined segment operating income grew 19.5% from last year.
Prime: Prime membership has been rolled out to some international markets like the UK and Japan where product selection is limited. In the last quarter, the company added India (100 cities in India can now avail the service, with Amazon is planning to add Prime video soon). It remains in various stages of implementation in other geographies.
Fulfillment by Amazon (FBA) is increasing third-party sales and also increasing selection for Prime members. But it tends to put pressure on fulfillment centers during heavy selling seasons, which is why Amazon was supposed to add 18 new centers in the third quarter. Prime Now (one-hour and two-hour delivery of a curated list of key products that people need in a short period of time) has been extended to more than 40 metro areas worldwide, with Germany, Spain and France added in the last quarter.
FX: The positive FX impact on revenues was small in the last quarter at around $166 million. Foreign exchange impact was positive on operating income across all segments. This also had an impact on AWS because revenues were dollar-denominated while a lot of the assets were located in low-cost regions.
Cash Flow: Trailing Twelve Months (TTM) cash flow and free cash flow (FCF) as reduced by lease principal repayments jumped 42% and 65%, respectively on a year-over-year basis.
Guidance: Third quarter revenues are expected to include a 30 bps positive FX impact and come in around $31-33.5 billion (up 6.1% sequentially and 27.2% year over year at the mid-point). Operating income is expected to be in a range of $50 to $650 million.
Management said that there is typically a spike in operating expenses in the third quarter due to increased buildout of fulfillment centers in preparation for the holiday season. In the third quarter, the company was expected to add 18 fulfillment centers to deal with increased demand and also to cater to FBA. Higher costs in the second half of this year can also be due to the doubling of its spending on original TV shows and movies. It targets a threefold increase in the total number of shows to be launched in the second half of this year. AWS and India expansion-related expenses are also expected to remain.
Summing Up
Amazon's retail business remains very hard to beat on price, choice, convenience, you name it. The company has a solid loyalty system in Prime and its FBA strategy, and content addition continues to add selection to Prime memberships. If Amazon is able to replicate its domestic success internationally, investors could see far more growth. At the moment, international contributes a third of the revenues but generates just a fraction of profits.
Amazon Web Services on the other hand is the cash cow for Amazon. The business generates much higher margins than retail, so it has a very positive impact on Amazon's profitability. We remain optimistic about the functionality, partner ecosystem and the experience AWS offers and believe this will lead to continued customer wins.
Other Stocks to Consider
You may also consider the following stocks, with a positive Earnings ESP and a favorable Zacks Rank:
Veeco Instruments Inc. VECO with an Earnings ESP of +17.86% and Zacks Rank #1.
Boyd Gaming Corporation BYD , with an Earnings ESP of +16.67% and a Zacks Rank #2. Please check our Earnings ESP Filter that enables you to find stocks that are expected to come out with earnings surprises.
NVIDIA Corporation NVDA , with an Earnings ESP of +8.93% and a Zacks Rank #3.
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