Amazon: Shaking Off My Bearish Bias Heading Into Q3 Earnings (Rating Upgrade) (AMZN)

Amazon.com, Inc. (NASDAQ:AMZN) is set to release its Q3 2023 earnings on October 26th after the market closes. Analyst consensus estimates suggest total sales and earnings will grow 11% and 111% YoY, respectively — implying a solid boost in growth and profitability. In that context, strong sentiment is supported by a likely strengthening e-commerce business vs. Q2. Moreover, Amazon’s AWS cloud business is stabilizing on late stage cost optimizing. Other topics of optimism could include upside to advertising revenue, operational efficiency through AI and potential workforce adjustments, as well as flattish CAPEX guidance for 2024. On supportive pre-Q3 reporting insights, I am upgrading Amazon stock to a “Hold.”

For context, Amazon stock has demonstrated strong performance since the beginning of 2023, delivering year-to-date gains of approximately 46%, outperforming the S&P 500 (SP500) by a factor of 4x.

However, switching perspective to the trailing twelve months, Amazon underperformed the S&P 500 by about 1 percentage point.

Consensus Points To Growth & Margin Inflection

Based on data from Seeking Alpha as of October 23rd, a total of 32 analysts have shared their predictions for Amazon’s third quarter results. They anticipate Amazon’s total sales for Q3 to fall within the range of $138.34 billion to $143.87 billion, with the average estimate standing at $141.59 billion. This is broadly in line with Amazon’s own guidance range, which was set at $138 billion to $143 billion. If we use this average analyst consensus as a reference point, it suggests that Amazon’s Q3 2023 sales might show an increase of approximately 11.4% compared to the same period in the previous year; this would bring the company’s top line growth back to double-digit rates.

In addition to this, analysts have provided earnings per share estimates spanning from $0.44 to $1.09, with an average of $0.59. As always for Amazon earnings estimates, the dispersion of projections is very wide.

Having provided the number context, I would like to point out that on a collective level of analysts’ expectations, both revenue and earnings revisions have started to gradually pick upwards again. This may suggest to investors that the sentiment has bottomed. However, compared to sales projections made two years ago, projected for the Q3 2023 quarter, expectations are still about 20-30% lower.

Expected Strong E-Commerce Business

Strong analyst sentiment is justified by a relatively bullish environment for consumer spending through the 2023 summer months. To start with, I would like to point reader’s attention to a survey conducted by TD Cowen (TD Cowen, Research note on Amazon dated 13 October), inquiring about online consumption on Amazon. In the third quarter of 2023, approximately 66% of the U.S. respondents from TD Cowen’s monthly survey reported holding Prime membership. According to the bank’s estimate, this corresponds to roughly 82 million U.S. households, an increase of approximately 7 million compared to the same period in 2022.

Furthermore, TD Cowen’s analysis reveals that during 3Q23 about, 94% of Prime subscribers were monthly visitors to Amazon.com. Additionally, 88% of these Prime subscribers, on average, made monthly purchases on the platform during. These statistics suggests a 1-2% increase when compared to the previous quarter on both visitor and purchaser engagement.

As another indicator for e-commerce volume, I like to look at alternative data: An analysis of Bank of America’s credit and debit card data reveals that U.S. e-commerce spending showed slight improvement in the September quarter. According to Bank of America insights, transactions in the third quarter of 2023 increased by 0.8% year-on-year (YoY). This contrasts with a 0.9% YoY decline in Q2 and a 1.3% YoY decline in Q1 (BofA equity research: PYPL note dated 13 October). However, it’s important to note that the U.S. Michigan consumer confidence indicator suggests that consumer bullishness is decreasing again post Q3, potentially setting up for a bearish management outlook in the upcoming conference call.

Cloud/AWS At Inflection Point

Adding to the strengthening e-commerce sentiment, also Amazon’s Cloud business gives reason for optimism. In Q2 2023, Amazon’s AWS business has already started to stabilize, despite ongoing cost optimization efforts of clients (emphasis added):

As the economy has been uncertain over the last year, AWS customers have needed assistance cost optimizing to withstand this challenging time and reallocate spend to newer initiatives that better drive growth. We’ve proactively helped customers do this. And while customers have continued to optimize during the second quarter, we’ve started seeing more customers shift their focus towards driving innovation and bringing new workloads to the cloud. As a result, we’ve seen AWS’ revenue growth rate stabilize during Q2 where we reported 12% year-over-year growth.

Looking into Q3, I see Amazon’s AWS business continuing to show stable growth, likely 100 basis points higher than in the June quarter, suggesting 13% YoY growth in Q3. Investors should also consider that the nature of the AWS business positions Amazon to capture the AI tailwind relatively early, likely before Google (GOOG) and Microsoft (MSFT), as the AWS cloud computing platform is providing the first step in providing the infrastructure to leveraging AI through the cloud. As businesses are looking to run pilot programs for AI, there will likely be an early, increased demand for access to servers, storage and databases.

Our Take On Other Key Topics To Watch

Amazon is increasingly growing to become a true advertising juggernaut, with Amazon’s revenue from advertising in Q2, 2023 having grown 22% YoY to $10.7 billion. Given the growth and scale of the ads business, I am keenly interested in every comment that management makes about the company’s future opportunity in the digital advertising landscape. In my opinion, Amazon is well positioned to capture a significant portion of this growth in retail media advertising, along with opportunities in off-platform advertising and the introduction of video ads on Prime Video. In the second quarter of 2023, advertising revenue accounted for 7.9% of Amazon’s total revenue, up from 7.2% in the same quarter in 2022 and 6.6% in 2021.

Amazon may be set for a boost in operating margin throughout the second half of 2023 and into 2024. In that context, I watch two key topics: Firstly, I am interested in Amazon’s strategic utilization of artificial intelligence and automation to support productivity and overall efficiency of their infrastructure. This entails leveraging technology such as the recently revealed fulfillment robots. Secondly, there’s the pursuit of optimizing employee work arrangements, which could potentially involve workforce reductions or other adjustments. This encompasses a strategic evaluation of staffing levels, job roles, and even geographic locations in order to maximize operational efficiency and reduce expenditures.

Lastly, I am interested in Amazon’s CAPEX investments, which are an important input to estimate cash available for share buybacks. Personally, as an investor, I would hope for CAPEX in FY 2024 of less than $50 billion, in line with 2023.

Investor Takeaway

Amazon is scheduled to present its Q3 2023 earnings report on October 26th. Analysts’ consensus forecasts anticipate an 11% year-on-year increase in total sales and a substantial 111% growth in earnings, indicative of strong progress in both revenue and profitability.

The positive outlook is underpinned by expectations of a reinforced e-commerce sector when compared to Q2. Additionally, Amazon’s AWS cloud business is stabilizing as it approaches the later stages of cost optimization efforts. Furthermore, there’s optimism regarding potential increases in advertising revenue, operational efficiency driven by artificial intelligence, potential workforce adjustments, and a consistent CAPEX outlook for 2024. Given these encouraging pre-Q3 insights, I am shaking off my long-held bearish bias, revising my Amazon stock rating to “Hold.”