Should Investors Pick Amazon Into Earnings?
Amazon.com, Inc. (AMZN) has redefined the way consumers shop for goods. Anyone that didn’t bet on Jeff Bezos and AMZN can’t help but feel that they might have missed an opportunity.
The stock is up 448% over the last five years, with share prices rising past $2,000 last week. With many analysts saying AMZN has the momentum to continue this upward trajectory, investors are wondering if they should also buy the stock before its July 25 earnings release.
Q2 Earnings Guidance
In management’s Q2 2019 guidance, they are expecting to see revenue within the range of $59.5 billion and $63.5 billion, up 12.5% to 20% year-over-year. According to consensus estimates, EPS should be $5.58, up from $5.07 from the year- ago quarter. Operating income could be between $2.6 billion to $3.6 billion, which represents a decrease in growth by 13% from the year-ago period. This means operating margin should be between 4.1% and 6.1%, falling from 7.4% in Q1.
CFO, Brian Olsavsky, points to the $800 million spent in Q2 to upgrade Prime’s free two-day shipping benefit to free one-day shipping as the reason for lower margins. “We're currently working on evolving our Prime free two-day shipping program to be a free one-day shipping program. We're able to do this because we've spent 20-plus years expanding our fulfillment and logistics network, but this is still a big investment and a lot of work to do ahead of us,” he said.
Renewed Focus on Profitability
Despite a rocky year for AMZN share prices, the company has been shifting focus towards achieving sustained and consistent profitability.
Amazon’s Prime Day is an event in and of itself rivaling that of Black Friday and Cyber Monday. Last year’s Prime Day was the company’s largest shopping event in its history. Consumers bought over 100 million products, bringing in $6 billion. This almost matched the entire retail industry’s combined $6.22 billion in online sales on Black Friday.
Even on low-margin business categories, AMZN has figured out a way to make a profit. The company charges grocery brands if sales from their promotional products result in a loss. It also blocks ads for unprofitable products, giving it the ability to force merchants to order from less expensive suppliers and change to more affordable packaging.
Amazon Business Model is Growing
The company is working to expand Amazon Web Services (AWS), its cloud computing platforms for individuals as well as enterprises of all sizes. On June 24, it announced that the AWS Control Tower and AWS Security Hub are now available to customers. These products simplify the process of setting up, securing and monitoring cloud environments for its corporate clients.
Last year, the company announced that these new product offerings are a part of a larger effort to lower the barrier of entry for large enterprises that want to begin using the cloud. The company hopes the products will also reduce friction for existing customers that want to expand their cloud footprint.
Its cloud service has been essential in AMZN’s overall profit growth. In the previous quarter, AWS made up 13% of the total revenue at approximately $7.7 billion, a 41% year-over-year jump. Half of the total operating income was attributed to AWS, increasing 59% to $2.22 billion year-over-year.
The company is also growing the advertising segment of its business. On May 31, AMZN announced that it is set to acquire Sizmek’s ad server and Dynamic Creative Optimization unit. The technology will help personalize ads using data.
A Fair Valuation Based on Cash Flow and Growth
We can also look at operating cash flow to measure how well AMZN is performing, as the company is known for making heavy investments in growth opportunities. Operating cash flow reached $34.4 billion for the trailing twelve months, an 89% increase year-over-year. Free cash flow more than tripled, up to $23 billion year-over-year.
While some investors may be wary of AMZN’s hefty price tag, five-star financial blogger, Bret Kenwell, argues that the valuation is justified. He writes, “Its strong earnings growth (estimates call for 35% growth this year and 40% growth in 2020) makes the valuation more palpable. Even better? AMZN has been crushing earnings estimates over the last seven quarters, while its immense cash flow buoys any financial worries from investors.”
Top analyst, Scott Devitt, agrees that there’s more upside for AMZN. He maintained his Buy rating on the stock and $2,300 price target on July 19, suggesting 17% upside potential. “We expect continued strength in Amazon’s high-margin businesses, AWS and Advertising, which should continue to be a tailwind for operating margin and allow the company to invest more heavily in its retail capabilities, including one-day delivery. Amazon is well- positioned as the leader in retail/cloud, and should continue to gain share in the advertising market as it adds new tools/services, makes strategic acquisitions (Sizmek), and leverages its valuable consumer data,” he said. Devitt has a 71% success rate and 23% average return per rating.
On July 18, another analyst, Tom Forte, reiterated his Buy rating and $2,550 price target. He believes share prices could soar by 30% over the next twelve months. “We see two potential catalysts for shares over the next 12-month period: 1) stronger than expected operating results from the company’s cloud computing efforts, which we believe remains the primary driver of its share price and 2) due to its increasing mix of highly-profitable third-party sales," he said.
The Bottom Line on AMZN
The sentiment surrounding AMZN is resoundingly positive. The stock boasts a ‘Strong Buy’ analyst consensus and a $2,260 average price target, suggesting upside potential of 15%.
