Amazon.com, Inc. (NASDAQ:AMZN) stock is still struggling since its huge earnings miss. Amazon profits could come under further pressure.
Amazon.com, Inc. (NASDAQ:AMZN) stock is yet to recover from its post-earnings sell-off and has struggled recently to breach the $1000 mark. Investors did not take the massive drop in earnings of the Jeff-Bezos founded company kindly. Amazon stock's rise had never been so much about to its profitability. However, with the rise of the retail giant's cloud business Amazon Web Services (AWS), the company's profitability had garnered some attention. Now, it's like AWS accounts almost all of the Amazon.com's profitability. And, it now appears that Amazon profits could be under further pressure and this doesn't bode well for AMZN stock.
In the second quarter earnings release, the online retail giant was expected to report an EPS of $1.40 but instead reported only an EPS of 40 cents, courtesy fall in net income of the company. The company managed a net income of just $197 million for the quarter. Further, in Q2, the Selling General & Admin Expense increased 37.45% YoY while the Research & Development Expense jumped 43.04% YoY. The Q3 earnings are expected to be further under pressure as in the earnings call, Brian T. Olsavsky, CFO-Amazon.com, Inc., stated: "Q3 is typically a lower operating income quarter as we're preparing for the Q4 holiday peak." The management guided Q3 Operating income (loss) to be between $(400) million and $300 million, compared with $575 million in third quarter 2016. However, a major cause of worry for the Seattle, Washington based company's profits is the impact of AWS profitability.
AWS profitability under pressure.
An important point to note here is that AWS operating income embodied more than 100% of the eCommerce giant's TTM (Trailing Twelve Months) operating income, as of the second quarter. AWS's success has also contributed much to Amazon stock's rise over the last few years. While there's no doubt Amazon's AWS is still the largest cloud player and is in a league of its own but the rising competition is taking a toll on its growth and its profits. A Synergy Research Group report suggests that AWS's growth is being hampered because of its competitors. And, its competitors slashing their prices also is not helping Amazon's cloud segment.
Price cuts are not something new for AWS and it has helped the company in remaining the dominant force in the cloud computing market. However, price cuts have an immediate impact on the segment's profitability which is certainly not good news for Amazon's overall profits and AMZN stock. AWS, in a latest move, took the cloud pricing wars between AWS and rivals including Microsoft's (NASDAQ:MSFT) Azure and Alphabet's (NASDAQ:GOOGL) Google Cloud platform to a next level. Yesterday, AWS announced a new pricing structure that lets users pay by the second for some of its services such as Linux instances on its Amazon Elastic Compute Cloud (EC2) and Elastic Block Store (EBS) services while its rivals still offer options to pay by the minute.
These price cuts are of late taking a toll on AWS's operating profit. One can observe in the image below, over the last four quarters operating income (profit) growth has stagnated even though the revenues are soaring. In percentage terms, AWS’s operating margin dropped to 22.3% in Q2 2017 from around 26% in Q4 2016. The drop in AWS margins does not bode well for the Amazon's overall margin's as already the retail segment's margins are under pressure. With more heavy spending on the retail front in the festive season in India in Q3 and the US in Q4, the profits are likely to take a hit. Further, as stated in the Q2 earnings call by Amazon CFO, the company is making aggressive investments for geographic expansion of AWS and the marketing expenses are increasing in AWS which are likely to exert larger than normal impacts on the AWS operating margins in the coming quarters.
Amazon stock remains a good long-term buy.
We all know that it would be foolish to bet against the Amazon stock just because profit is taking a hit and history is the witness for that. The Jeff Bezos founded company is facing margin pressure. Given the highly competitive market, the price cuts would play a big role going ahead on AWS profitability which in turn would have a direct impact on Amazon's overall earnings. This is a cause for concern, but AMZN stock has many other growth drivers which could still drive the stock higher. In our recent coverage, we have highlighted why Amazon stock could be a multi-bagger even today. Amazon stock remains a good long-term buy.
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