Amazon (AMZN) reported a weaker-than-expected first-quarter Thursday night.

• Net sales increased 7% year over year to $116.4 billion, in line with estimates.

• But operating income declined significantly year over year to $3.7 billion from $8.9 billion and missed estimates of $5.3 billion.

• Amazon, a Club holding, reported a net loss of $3.8 billion, or $7.56 per share, in the quarter, though this figure includes a pre-tax valuation loss of $7.6 billion in non-operating expense from its investment in Rivian Automotive, which has declined significantly in stock price since its late 2021 initial public offering.

• Based Refinitiv calculations, the company earned an adjusted $7.38 per share compared to the $8.36 consensus estimate.

Fortunately, we don't own Amazon in the portfolio. However, we would like to still break down the quarter, since many of our clients own this name. However, despite this pullback, we're still not looking at this name because the valuation multiple is still very rich. 

Inflation

Inflationary costs ate into the company’s profits. Line haul air and ocean shipping rates are at or above levels from the second half of last year, and the fuel costs are 1.5x higher than a year ago. Combined with wage inflation, Amazon estimates that this has added approximately $2 billion of incremental costs compared to last year. Management explained on the call that these inflationary costs will persist.

Amazon also saw approximately $2 billion of additional year-over-year costs related to lower productivity. What happened here was that after Amazon hired new employees to cover absences related to the Covid omicron variant, Amazon quickly went from being understaffed to overstaffed after the wave subsided, leading to lower productivity. Management expects these cost headwinds to reduce in the second quarter.

Third, Amazon had $2 billion of additional costs related to fixed cost leverage. Basically, Amazon invested heavily to expand capacity in its fulfillment and transportation network to keep up with demand. Now that trends have normalized from unprecedented levels, Amazon has been left with some excess capacity. Management plans to lower operations and capital expenditures for this year.

• In total, these three buckets of costs added $6 billion of costs in the quarter. Management’s guidance below includes that it will incur approximately $4 billion of these incremental costs in the second quarter.

Guidance

For the second quarter, management’s guidance was weaker than what analysts expected.

Amazon expects sales to be between $116 billion to $121 billion, representing year-over-year growth of 3% to 7%. At the $118.5 billion midpoint, this guide is short versus the more than $125 billion the Street was looking for.

• Guidance anticipates an unfavorable impact of approximately 200 basis points for foreign exchange rates.

• The year-over-year growth rates are impacted by Prime Day occurring in in the second quarter of 2021. This year, Prime Day is expected to be held in the third quarter.

Operating income is expected to be between a loss of $1 billion and profit of $3 billion. At a midpoint of a $1 billion profit, this was much lower than estimates of a $6.7 billion profit.

Geographic Q1 sales

The results from North America were mixed. Sales increased 7.5% year-over-year to $69.24 billion, beating estimates of $68.04 billion. Operating income was a $1.57 loss versus estimates for $1.19 billion profit.

International was weak. Sales fell 6% year-over-year, excluding foreign exchange (FX) at $28.76 billion, missing estimates of $30.1 billion. The operating loss was slightly larger-than-expected at $1.28 billion versus an estimate loss of $1.15 billion.

Segment Q1 sales

• Online Stores: $51.13 billion, down 1% year over year ex-FX, versus $51.76 billion expected. The results fit a common theme we heard throughout this earning season in that e-commerce growth  has significantly slowed.

• Physical Stores, mostly Whole Foods: $4.59 billion, up 16% year over year ex-FX, versus $4.29 billion expected.

• Third-Party Seller Services, commissions and any related fulfillment and shipping fees, and other third-party seller services: $25.34 billion, up 9% year over year ex-FX, versus $24.64 billion expected.

• Subscription Services, mostly annual and monthly fees associated with Amazon Prime membership: $8.41 billion, up 13% year over year ex-FX, versus $8.61 billion expected. CFO Brian Olsavsky said on the earnings call that Prime added “millions more” new members during the quarter.

• AWS: $18.44 billion, up 37% year over year ex-FX, versus $18.34 billion expected. The segment reported operating margins of 35.3%, a solid improvement from 30.8% last year and 29.8% in the fourth quarter. The AWS backlog ended the quarter at $88.9 billion, up 68% year over year.

• Advertising Services: $7.88 billion, up +25% year over year ex-FX, versus $8.18 billion expected. We would have liked to have seen stronger results from this high margin business. The Q1 miss here is consistent with all the other major players in online advertising.

• Other, sales related to various other service offerings: $661 million, up 28% year over year ex-FX, vs. $1.08 billion expected.

Bottom line

It was a weaker than expected quarter — and an ugly, but probably conservative, guide as Amazon struggled with the burden of billions of dollars in incremental costs that will likely persist for at least the next couple of quarters.

On the bright side, management said they have seen no indication of weakness in consumer demand, despite the uncertain macro, and Amazon Website Services (AWS) cloud unit remains extraordinary. Amazon’s quarter goes to show you that the winners this earnings season are companies tied to the cloud and data center, while consumer-good oriented areas had a tough time.

Even with the stock flatlining for almost two years and expectations into earnings low, we expect shares will continue to be down. We're not touching this stock until the forward P/E comes down to the twenties.