Amazon Dipped: Why It May Not Be Time To Buy Yet (AMZN Q3 FY 2021)

28 Oct 2021

Amazon reported a weaker than expected third quarter after the bell Thursday. Net sales increased 15% YoY and 2-year compound annual growth rate (CAGR) of 25% to $110.8 billion and was right in the middle of management’s past guidance, but analyst expectations were higher, and the result fell short of the $111.551 billion consensus estimates.

Operating income declined from $6.2 billion last year to $4.9 billion in the third quarter of 2021, missing estimates of $4.129 billion. Earnings were a miss as well, with Amazon delivering $6.12 per share, down from $12.37 last year, and below estimates of $8.90. Higher costs related to the labor shortage, disruptions to the global supply, and inflation in the cost of materials such as steel and services impacted Amazon’s cost structure. The company estimates these costs had a $2 billion impact in the quarter, particularly in August and September. The company sees these costs approaching $4 billion in the fourth quarter, leading us to management’s guidance.

As a result of these disappointing numbers, shares of AMZN traded down ~4%. 

Rough guidance:

Amazon’s prospects do not look any rosier for the fourth quarter, the holiday shopping season quarter. Net sales are expected to grow between 4% and 12% YoY to between $130.0 billion and $140.0 billion. This midpoint of this outlook was below the estimate of $142.173 billion.  Management's forecast anticipates an unfavorable impact of approximately 60 basis points from foreign exchange rates.

Operating income in the fourth quarter is expected to be between $0 and $3 billion, and this $1.5 billion midpoint is well below estimates of $7.713 billion. CEO Andy Jassy said in the earnings release that they expect to spend several billion on additional costs to support the Consumer business as it navigates through several pressures like labor supply shortages, increased wage costs, global supply chain issues, and increased freight and shipping costs. In total, Amazon incorporated nearly $4 billion of added costs into its guidance. In addition, Amazon plans to support its digital media content efforts by increasing spending by $1 billion YoY. The company also sees a $1 billion YoY negative impact from lower fixed cost leverage in their fulfillment networks.

Obviously, Amazon is never shy about reinvesting in its business and focusing on what’s best for its customers over the long term. Amazon built its culture on this principle. However, the fact that Amazon may not generate a profit next quarter off $130 billion in sales will raise some eyebrows.

Breaking down the results:

• Looking at the quarter by geography, North American net sales increased 10% YoY to $65.557 billion, missing estimates of $67.12 billion. Operating Income shrank 61% YoY to $880 million, or roughly half the $1.658 billion analyst estimate.

• Meanwhile, International sales in the quarter grew 15% excluding FX to $29.145 billion, representing a small miss against estimates of $29.623 billion. The International segment reported an operating loss of $911 million, down from a $407 million profit in the third quarter last year and a miss against estimates of $114 million.

• By segment, net sales at Online Stores, which is Amazon’s e-commerce business, grew 3% to $49.942 billion, missing estimates of $51.343 billion and representing the largest source of the top line miss. Worldwide shipping costs grew much faster than revenues, with costs increasing 20% YoY to $18.108 billion.

  • Amazon made a ton of progress in the third quarter building and new facilities. As a result of these actions, Amazon said it is no longer capacity constrained for physical space in the network for the very first time since the pandemic began.

  • For the full year, Amazon expects its footprint additions to exceed last year’s building, putting them on track to double their fulfillment network over the 2-year period since the start of the pandemic.

  • On 1-day shipping, Amazon plans to increase investments in this fast delivery service next year. The rollout of 1-day shipping should provide a boost to demand in the future.

• Sales from Physical Stores, which is mostly made up of Whole Foods, increased 12% YoY to $4.269 billion. This was a slight beat vs. estimates of $4.095 billion.

  • There was a small discussion about Amazon’s physical store strategy on the call, with management saying they want to give customers the choice between shopping online and in-store.

• Amazon Web Services was a major bright spot, with revenue growth accelerating to 39% YoY to $16.110 billion, exceeding estimates of $15.523 billion.

  • Amazon said the strong growth rate was driven by a broad base of services and customers. Management spent some time on the call highlighting how AWS is the preferred cloud provider for machine learning services.

  • Operating Income was strong too, increasing 40% YoY to $4.883 billion, which beat estimates of $4.129 billion.

  • In addition to higher revenues, margins expanded on a sequential basis from 28.3% to 30.3%, which was about flattish from the third quarter last year. Margins are known to fluctuate quarter to quarter, especially because management is committed to passing through benefits and efficiencies to customers in lower pricing.

• In Subscription Services, which is the money Amazon makes off Prime, audiobook, e-book, digital video, digital music, and other services, revenues increased 23% to $8.148 billion, beating estimates of $8.038 billion.

  • Because the value of a Prime membership continues to grow, with more original programming and services constantly added, we think it was only right for one analyst on the conference call to ask about the possibility of a price increase in the future. CFO Brian Olsavsky said he has “nothing to discuss or announce around Prime price increases, but we always look at that.” 

•  Sales from Third-Party Seller Services, which include commissions, fulfillment and shipping fees, and other third-party seller services, increased 18% YoY to $24.252 billion, in line with estimates for $24.194 billion.

• Lastly, sales from Other increased 49% YoY to $8.091 billion, missing estimates of $8.246 billion.

  • Advertising revenue makes up most of this segment, so the miss here should not come as a complete surprise after seeing some of the soft advertising numbers from Snap, Facebook, Twitter, and Alphabet’s YouTube this earnings season.

  • Management credit the strong advertising growth rate to adoption across Amazon vendors, sellers, and authors. Brands that don’t sell into the Amazon store are advertising too, thanks to the streaming TV offerings the company has built.

  • Importantly, Olsavsky said that supply chain concerns have not had an impact on the growing advertising business. Some have been worried that companies would advertise less this holiday season if they didn’t have enough product to see, but it sounds like this isn’t an issue for Amazon. 

Bottom line —Not time to buy yet:

 Overall, it was a weaker than expected quarter for Amazon as the cost of operating an e-commerce business has gotten very expensive over the past few months due to the labor shortage and supply chain. But what you should know about Amazon is that it will always prioritize its customers and partners over any cost. CEO Jassy said it best in the press release tonight: “We’ve always said that when confronted with the choice between optimizing for short-term profits versus what’s best for customers over the long term, we will choose the latter." By operating the business this way, Amazon's powerful flywheel effect remains intact, leading to bigger gains in the future.

With that in mind, how would we approach tonight's sell-off?  The market may have been braced for some type of disappointment given the fact that Amazon’s stock price has gone nowhere since July 2020. Shares coming into the print for this Q was considerably cooler than when it did last Q, which ended with a 10% sell-off the next day. We actually think that market open will be seen as a buying opportunity for investors, and will likely see the stock reverse losses; it comes down to the fact that almost everyone anticipated this Q to be bad, and they continue to trust Amazon's investment decisions, and it's time to pick up an underperformer of 2020. Given the dynamic, we would not buy or sell anything. We have the right position size here, so we will not buy until the two-thousands, or will not sell until the four-thousands. For subscribers without any position, we would suggest to wait at least 3 days for the sell-off to shake out any weak-hands, before starting a position. To give you some assurance, look at what AMZN did after a massive sell-off after the last quarter.