Amazon Plunges After Missing On Revenue, Poor Guidance

After two days of dramatic volatility in its stock, which saw the share price of Amazon first drop then soar by over $100, Jeff Bezos' online retailing titan was expected to report blow out earnings, and while it indeed reported EPS which smashed expectations, it missed on revenue while guiding well below consensus, in a carbon copy of what it did last quarter.

In kneejerk response, the stock tumbled more than 6%.

Here are the details from Amazon's just concluded third quarter:

  • EPS of $5.75, smashing estimates of $3.11
  • Operating income of $3.72 billion, also beating consensus estimates of  $2.13 billion
  • However, revenue of $56.576BN, missed the estimate $57.06 billion. Amazon in July forecast revenue of $54 billion to $57.5 billion

More importantly, Amazon guided Q4 net sales to be between $66.5 billion and $72.5 billion, which however was far below the consensus est. $73.78B. Meanwhile, operating income is expected to come in between $2.1 and $3.6 billion, compared with $2.1 billion in Q4 2017, and also well below the consensus estimate of $3.9 billion.

This will be the key question facing shareholders: why the drop in margins in what is traditionally Amazon's most lucrative quarter?

Here a quick reminder that at the end of last quarter, Amazon did the exact same thing: beat on Earnings and Operating Income, while missing on revenue and guiding lower, yet the stock soared. Why the opposite reaction this time? The answer is likely due to heightened investor concerns about "peak earnings" and with the company once again guiding well below consensus, even if it is due to sandbagging, the market is not happy.

Indeed, as RJ Hottovy, analyst at Morningstar writes, investors are worried about the weak profit outlook for the busy holiday quarter and why Amazon expects spending to increase.  Specifically, analysts will want clarity on whether it's a result of one-time costs like investing in a second headquarters or ongoing expenses like giving warehouse workers raises and opening new Amazon Go stores.

"It all comes down to not knowing why they expect to have heavier spending in their busiest quarter," he said.

Going back to the historical data, and looking at Amazon's most important segment, Amazon Web Services, or AWS, in Q3 it generated net sales of $6.68 billion, up from $6.11 billion last quarter, an increase of 46% Y/Y, if below the 49% growth rate last quarter but better than the 36% growth a year ago. Here is the historical growth rate of AWS:

Despite the modest decline in annual revenue growth, Bloomberg reminds us that a year ago, consensus seemed to be that competition from Microsoft and Google would cut into AWS’s growth, but that has yet to happen. The division remains the leader in the rapidly growing cloud computing space, and a perhaps a leading candidate to secure the Department of Defense’s lucrative $10 billion Jedi contract.

On the bottom line, AWS was responsible for operating income of $2.1 billion, a 31.1% profit margin, up from the 25.6% margin a year ago. In other words, for yet another quarter, AWS was responsible for more than half, or 56% of Amazon's total operating income.

In addition to AWS, another bright spot was Amazon’s ad business. Ad sales, which represents the preponderance of a category that for now Amazon calls “Other,” was up 123% this quarter to $2.5 billion. However, like AWS the pace of growth is slowing and in the second quarter it was up 129%.

Looking at the not so good news, subscription services revenue which is mostly the $119 annual Prime membership fee, increased 52%, however like AWS, this too slowed down modestly from 55% and 56% over the last two quarters - another sign of a slight slowdown in a key revenue category.

Amazon also reported physical-store revenue, which is largely its Whole Foods grocery chain, of $4.248 billion: this was a slowdown from the previous two quarters, when it grew by $4.312BN and $4.263BN, and as Bloomberg notes, "it shows how competitive the grocery market is right now, with discounters like Walmart and Aldi raising their game by offering more natural and organic products to grab upscale shoppers."

As has traditionally been the case, Amazon reported international operating income that was negative on $15.5 billion in sales. Additionally, international sales slowed notably. On the conference call, CFO Olsavksy addressed the weakness in international sales, saying the timing of Diwali holiday in India moved some sales into 4Q from 3Q. He also said the wage hike to $15 per hour minimum will impact around 400,000 workers in the U.S., but he won't specify exactly how they have baked that into the 4Q guidance.

Finally, the following chart may hold the key to investor concerns: it shows that e-commerce revenue growth, in the form of sales at both Google and Amazon, appear to have peaked.

In his remarks in the press release, CEO Jeff Bezos indicated that he is focusing on Amazon Business, noting that the segment has reached a $10 billion annual sales run rate.

“And we’re not slowing down – Amazon Business is adding customers rapidly, including large educational institutions, local governments, and more than half of the Fortune 100. These organizations are choosing Amazon Business because it increases transparency into business spending and streamlines purchasing, with increased control. The team is doing a fantastic job building and innovating for customers.”

For those still concerned about AMZN's cash burn, the company reported LTM Free Cash Flow in Q2 of just over $15.4 billion, a new all time high.

Perhaps even more impressive is that after sliding in early 2017, Amazon's operating margin has soared in the past three quarters, largely as a result of AWS, and just hit the highest number on record.

Clearly, this means that the company's LTM operating margin is soaring, after dropping modestly in early/mid 2017:

What is somewhat surprising is that after constantly growing its global net sales, in Q3 this number dipped sharply, from 44% in Q2 to 35% in Q3 even as total headcount increased from 575K to 613K. As a reference, at the beginning of 2017, Amazon employed around 350,000 full- and part-time workers. Now the headcount is at 613,300, up 13% from the same time last year.

As noted above, the kneejerk reaction was negative, and the stock has plunged much as 6% after hours.