investing

Amazon (AMZN) Earnings Preview: No Margin for Error?

The recent acquisition of Whole Foods is a wild card for Amazon’s third-quarter sales and profits.

Amazon.com (AMZN; $975.90) is slated to report third-quarter earnings after Thursday’s closing bell. The company has mostly been on Easy Street since 2015, when Amazon Web Services, its cloud computing division, helped spark a still-intact streak of profitable quarters. Before that, Amazon’s bottom line struggled for years because of the low-margin nature of its core e-commerce business.

While sales growth shouldn’t be an issue for the third quarter, and Amazon should remain profitable, if barely, margin issues have crept back into the limelight. Amazon shares have stalled of late as investors fret over how little the company is retaining of its sales as profits after spending aggressively to expand the business. (Prices and returns as of Oct. 24.)

Amazon Earnings Forecast

While analysts on average are expecting the e-tailer’s brisk sales growth to continue at a 28.6% year-over-year clip for the quarter, to $42.1 billion, earnings are expected to plunge from 52 cents per share a year ago to just 3 cents – the company’s worst quarterly bottom-line performance since a 12-cent loss in the first quarter of 2015.

The third quarter typically is weak, with Amazon CFO Brian Olsavsky pointing out after the second quarter’s earnings report that the company must spend to ready itself for the holiday season. Still, investors – who are enjoying 30% gains so far in 2017, but have watched Amazon recede 10% from all-time highs set on July 27 – may be nervous following a wide profit miss for the second quarter, thanks to a re-investment cycle that has seen the e-commerce giant plow profits back into its business.

That includes spending on things such as building out its AWS infrastructure and investing in video content. It also includes Amazon’s June buyout of Whole Foods for $13.4 billion – a move that provides the company with more physical distribution locations to build out its AmazonFresh grocery delivery service, sending companies such as Walmart (WMT) and Kroger (KR) reeling.

But Amazon bulls can take heart: While analysts don’t expect the headline earnings number to be appealing, that largely hasn’t dulled their optimism.

“We believe that Amazon is well-positioned to beat third-quarter margins, excluding Whole Foods, but fourth-quarter margins remain a wild card as Amazon has now added another massive project (Whole Foods) that could prevent meaningful margin expansion in the fourth quarter and first half of 2018,” Piper Jaffray analysts wrote in a recent analyst note. But they continued, “We believe investors are broadly in favor of Amazon’s P&L [profit and loss] investments and are coming to understand Amazon’s reported margin is likely a fraction of its ‘core’ margin.” (Margins, generally speaking, are measurements of how much a business retains of its sales as profits.)

RBC Capital’s Mark Mahaney is a little more hesitant, saying Thursday’s report could be “noisy” and that “one challenge going forward will likely be limited disclosure by AMZN of WFM’s financial impact” – not an unreasonable prediction, given that Amazon still shields certain information, such as how many members its Amazon Prime service has. And Whole Foods is a complete wild card for this coming quarter, as the company did not issue any guidance for the three-month period.

Credit Suisse analyst Stephen Ju took the long view in an Oct. 11 note, raising his price target from $1,100 to $1,350 – implying 37% upside from Oct. 10’s close – on the belief that Whole Foods will bolster Amazon’s delivery service.

“The product development perspective is that while most of the headlines around the Whole Foods acquisition have been about price cuts, we believe the real path for Amazon to create lasting shareholder value is through fulfillment and delivery via Prime Now,” Ju said.

Other figures investors will want to watch out for is growth in Amazon Web Services – which improved revenues by 42% year-over-year in the second quarter, but that was its slowest pace of growth in three years – and the impact of Prime Day, its July 11 single-day deal bonanza that steered shoppers toward Prime memberships and its Echo smart speakers.

Lastly, North America broadly may want to pay attention to the report to see if Amazon provides any early insight into the competition to land the company’s second headquarters. Bidding recently closed, and Amazon says it received 238 proposals across the U.S., Canada and Mexico.

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