Earnings Preview: Amazon.com

Zacks

Amazon.com Inc. (AMZN) is scheduled to report its second quarter fiscal 2012 results on July 26. We witness downward movements in analyst estimates in the build-up to the release.

Prior-Quarter Synopsis

Amazon reported weak first-quarter revenue, but earnings quadrupled the Zacks Consensus Estimate of 7 cents per share on improved margins and a lower share count.

The company reported revenues of $13.19 billion, down 24.4% sequentially and up 33.8% year over year (at the high end of management’s guided range and around 2.2% above consensus expectations). Key strategies for driving revenue growth were competitive pricing, free shipping, user experience on Amazon properties and the Amazon Prime program.

The gross margin expanded 114 bps year over year and 329 bps sequentially to 24.0%. The sequential increase was due to lower hardware costs and a favorable mix.

Second Quarter Guidance

Amazon expects revenue to come in at around $11.9–$13.3 billion (down 4.4% sequentially, or up 27.1% year over year at the mid-point), below consensus expectations of around $12.8 billion. Operating income (including $260 million for stock-based compensation and amortization of intangible assets) is expected to come in at approximately ($260) to $40 million.

Detailed earnings results can be viewed in the blog titled:  Amazon Soars on Solid Q1 Results

Agreement of Analysts

Out of the 30 analysts providing estimates, 2 decreased their estimates for the second quarter as well as for fiscal 2012 in the last 30 days.

The analysts expect second-quarter revenue to be in line with the Street Consensus Estimate of $12.9 billion. They also expect gross margin numbers to improve in the upcoming quarter due to a favorable mix of business, with strong growth of 3P and AWS, offsetting the effect of other incremental costs.

GAAP EPS is expected to be materially ahead of the consensus estimate of 13 cents, primarily driven by gross margin expansion and accelerating eCommerce share gains.

However, a few analysts remain concerned about FX volatility and weak macro conditions in Europe. They believe that strong eCommerce trends in the U.S. will likely be offset by macro weakness in Europe, pushing results below the consensus estimates.

Magnitude of Estimate Revisions

In the past 30 days, the Zacks Consensus Estimate remained unchanged at 1 cent and $1.21 for the second quarter and fiscal 2012, respectively.

Over the last 90 days, the Zacks Consensus Estimate witnessed a significant decline of 19 cents for the second quarter and 15 cents for fiscal 2012.

According to analysts, Amazon remains in an investment cycle across three primary fronts –– global distribution footprint (distribution centers), digital initiatives (Kindle, tablet and video content), and Amazon Web Services (:AWS). They believe that the company’s increased spending on fulfillment centers, along with heavy investments in technology infrastructure to support rapid growth in AWS and the digital business will lead to continued margin pressure, impacting profitability. This could be the primary reason for the expected lowering of estimates.

However, longer term, the analysts believe that effective utilization of the company’s distribution centers and the global expansion of AWS will lead to an improvement in its productivity.

Recommendation

Amazon is one of the leading players in an extremely fast-growing market. We believe that Amazon’s first-quarter momentum will likely continue in the second quarter given the consistent growth in the overall eCommerce market. We also believe the company’s Prime platform and expansion of product categories will continue to boost revenue per user while facilitating customer retention.

The Kindle platform will likely remain a major growth platform for Amazon this year. The company’s next-generation Kindle Fire is expected to be thinner and lighter, and feature a built-in camera. It will also have a display resolution of 1,280 x 800 pixels, about the same as iPad 2. We think that this could be a good strategy to compete against Apple Inc.’s (AAPL) iPad and Google Inc. (GOOG) Nexus 7. According to sources, the device is expected to be shipped before September.

Given that there is significant growth potential in domestic and more so in international ecommerce, Amazon may be expected to benefit. However, the next phase of growth is dependent on its own capacity to serve customers, especially in international markets, where growth rates are likely to be higher and its own facilities fewer.

As a result, both fulfillment and technology investments will likely continue to grow. We expect Amazon to target international growth more aggressively, by starting operations in new regions around the world.

Therefore, despite its longer-term growth potential based on continued share gains, we think that these technology investments are pushing out the investment cycle. Therefore, we do not see any alleviation of margin pressure any time in the near term. .

Additionally, competition from eBay Inc. (EBAY), Apple through its iBooks app, Barnes & Noble, Inc. (BKS) and Google remains as strong as ever.

Amazon shares currently carry a Zacks Rank of #3, which translates to a Hold recommendation for the short term (1–3 months).

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