Amazon (AMZN) will report its third quarter results on October 25th. In July, the company forecast Q3 revenue to grow between 19% and 31% year over year, but also projected a quarterly loss due to heavy investments in content, warehouses, and other assets to support future growth. The analyst community currently projects revenue of $13.92 billion, representing 28% year over year growth. This is near the top of the guidance range.
I think that Amazon has a pretty good chance of meeting or beating consensus on revenue for the quarter. Amazon released an updated Kindle Fire last month at a lower price ($159), as well as a higher performance model called the Kindle Fire HD. The Fire HD is clearly meant to be a stronger competitor to Google's (GOOG) highly successful Nexus 7 tablet. I don't think that the new Kindle Fire models will have performed as well out of the gate as the original model last year (due to seasonal factors and the presence of much stronger competition in the sub-$250 tablet market). However, the release of a new Kindle and Kindle Fire lineup should still boost revenue year over year (since the Fire was not available at all in Q3 of 2011).
Another factor that will probably favor Amazon in Q3 is the implementation last month of sales tax for purchases shipped to California. There were many stories in the last few weeks before September 15 about customers making massive purchases on Amazon before the deadline. This probably pulled some incremental revenue forward from Q4. Considering these two factors, I am projecting Q3 sales and profits around the top of Amazon's guidance range.
However, I do not expect this to provide a boost for the stock, because Amazon is likely to provide a disappointing Q4 guidance at the same time. The average analyst estimate for Q4 revenue currently stands at $22.84 billion, representing 31% growth year over year. This revenue figure suggests a flat trend or some slight acceleration relative to Q3. It is necessary to make a few assumptions to arrive at this number: 1) Kindle Fire sales show strong year over year growth despite much heavier competition, 2) the imposition of sales tax in Texas, Pennsylvania, and California over the past several months will have no effect on sales, and 3) Amazon will not be affected by global macro weakness.
Unfortunately for Amazon, while Kindle Fire sales may be buoyed by the addition of higher priced (though lower-volume) models such as the LTE version coming in November, the other assumptions are probably invalid. On the macroeconomic side, Amazon's international business is heavily concentrated in Europe, and the economies there are obviously performing very poorly. In Q2, sales in the International segment fell to 43% of Amazon's total sales from 45.5% in Q2FY11. I expect Europe to continue weighing down Amazon's results going forward. Furthermore, gas prices have remained elevated much later into the fall in the U.S. compared to 2011. As of Friday, the national average for regular gasoline was $3.81 according to AAA, compared to $3.405 a year earlier. Amazon could benefit from high gas prices if consumers move to more online ordering in order to save on gas consumption. On the other hand, delivery costs are likely to be higher and overall discretionary spending will be negatively impacted. On net, Amazon is likely to suffer, though not as much as physical retailers.
Secondly, while the company claims that it performs well in markets with sales tax or value-added tax, that does not rule out a significant slowdown in sales growth. Moreover, the leveling of the playing field provides other retailers significant opportunities to compete on price with Amazon. As I have previously noted, Wal-Mart's (WMT) decision last month to stop selling Kindle products in-store suggested a new focus on Amazon as a primary competitive threat. On Friday, the Wall Street Journal reported that Best Buy (BBY) intends to match prices from Amazon and a number of other online retailers this holiday season (although the offer has some fine print). A price match promotion will be much more effective in jurisdictions where Amazon customers cannot avoid sales tax; otherwise, online purchases would have a lower effective price. Much of Amazon's growth in recent years has been in consumer electronics and other "big-ticket" items. Given that Amazon actually has an equivalent or higher cost structure than other competitors in this segment (e.g. Wal-Mart, Best Buy, and Costco (COST)), the combination of sales tax and price match programs could seriously dent Amazon's growth.
For these reasons, I expect Amazon's revenue growth to slow significantly in Q4. I project revenue of approximately $21 billion for Q4, up a little more than 20% year over year, but below even the most pessimistic estimate reported by Yahoo Finance. As I have argued earlier, Amazon's current valuation is sustained by the belief that revenue growth can remain in the 25-30% range for several more years. As a result, if Amazon guides towards a revenue figure below $22 billion for Q4, I expect the stock to drop significantly after earnings.