Amazon Earnings: Take A Seat And Relax
- Contrary to popular perception, Amazon is executing well and results are good.
- Investors can count on Amazon to make the right choices.
- Amazon will continue to benefit for quite some time as consumer shopping behavior aggressively shifts to online.
Last week was the busiest week for S&P 500 earning this quarter. If you are an active investor working at home, perhaps with young children, congratulations, you survived the onslaught.
The first quarter of the year will go down in history as an extra special earnings season because the tide just went down and we get to see who is swimming naked. Judging from Amazon's (NASDAQ:AMZN) 7.6% drop on Friday after it released earnings and the negative headlines in the media, one might conclude that Amazon reported some terrible results. Although results did not live up to the hope and dreams of the buyside, results are fine. I repeat, results are fine. Listen to Jeff Bezos and take a seat (yes, Bezos literally told investors "you may want to take a seat" in their earnings release).
Numbers are boring, but like vegetables, the professionals say they are probably necessary to ingest (in full disclosure, I don't eat vegetables - yuck). Let's go through it real quick.
Before we begin, a word of advice: don't read too much into first quarter consensus estimates for any stock because Wall Street projections are all over the place. Many are stale, many more are wild guesses. It's OK, just roll with it.
Q1 revenue came in at $75.5 billion, +26% y/y, beating the high end of guidance and beating consensus by 2%. Operating income of $4.0 billion also beat guidance, but came in 1% below consensus. Q1 was fine, investors aren't that worried about it.
Now Q2 guidance is where it gets interesting. The revenue guide is fine, bracketing consensus, but operating income was guided to $0 - zero, zilch, nada - at the mid-point. This missed consensus by $4 billion, all driven by $4 billion of spending related to COVID-19 in Q2.
Where's My Money, Amazon?!?!
If your wondering where your $4 billion went in Q2, Jeff Bezos spelled it out for you:
Under normal circumstances, in this coming Q2, we’d expect to make some $4 billion or more in operating profit. But these aren’t normal circumstances. Instead, we expect to spend the entirety of that $4 billion, and perhaps a bit more, on COVID-related expenses getting products to customers and keeping employees safe. This includes investments in personal protective equipment, enhanced cleaning of our facilities, less efficient process paths that better allow for effective social distancing, higher wages for hourly teams, and hundreds of millions to develop our own COVID-19 testing capabilities. There is a lot of uncertainty in the world right now, and the best investment we can make is in the safety and well-being of our hundreds of thousands of employees. I’m confident that our long-term oriented shareowners will understand and embrace our approach, and that in fact they would expect no less.”
In other words, Amazon is thinking long term, which is what Amazon always does and the reason why it is the great company that it is today. I discussed Amazon's disregard for short-term profits for long-term value creation many times in the past and won't repeat the same arguments here. If you are interested, here are a few links (out of many I wrote on Amazon):
- July 31, 2017: Amazon Bears Will Get Crushed
- October 30, 2017: Amazon Bears Are Getting Crushed
- July 30, 2018: Amazon Q2 Earnings Destroyed Bear Thesis
Another important thing to keep in mind is that Amazon would have beaten Q2 consensus operating income estimates if not for the COVID spending.
We Learned A Few Things
In this section, I'm going to go over some of my key takeaways from the Q1 earnings call. I'm using FactSet, but you can access the transcript through Seeking Alpha here.
#1) Violent change in demand beginning in early March caused "major challenges in "our operations network and with our seller community and our suppliers." The change isn't limited to just a surge in demand, but a fast mix shift to household staples and away from discretionary items such as apparel, shoes, and wireless products. While Amazon is no stranger to massive volumes, the company usually spends months ramping for an anticipated surge in demand. Clearly, the virus did not give them a heads-up on its arrival.
#2) Amazon executed extremely well given the circumstances. If anyone doubts the company's ability to execute, we learned that the company hired 175,000 additional employees, most of them in April. Example 2: On a dime, the company expanded grocery delivery capacity by 60% while nearly doubling in-store pick-up at Whole Foods.
#3) Investors can count on Amazon to make the difficult but correct decisions. The company didn't hesitate to make bold decisions like prioritizing shipping essential items, which are usually lower margin. Think about the relative margins of selling and shipping toilet paper vs. a smartphone. During the call, Amazon's CFO said essential items are lower ASP (average selling price) and prioritizing them is coming at a cost. Although this decision will hurt short-term profitability, I strongly believe that the net present value of this decision is much higher than the alternative.
Another example is Amazon's decision to spend $300 million on developing its own COVID-19 testing capabilities to meet the needs of testing its employees. Despite the politically-driven hit jobs on Amazon in the media, how many companies are doing this for their employees? I applaud Amazon's leadership for making these investments.
#4) Amazon Prime's value proposition continues to increase. What Amazon loses upfront with massive COVID-19-related investments, it seems to be gaining in customer goodwill. For example, during the call, management highlighted continued progress and engagement of Prime members:
On the Prime program, what we're seeing is, again, we're seeing a lot of pick-up in Prime shopping benefits. We see our Prime customers are shopping more often, they have larger basket sizes. We're also seeing a lot more use of our video benefits and our digital benefits. So in March, the first-time viewers nearly doubled, which is I think a good time for people to – a lot of them are staying at home to stay entertained and see our video collection.
Relax, Everything Is Good
Amazon's 7.6% drop post-earnings would suggest poor earnings results, but I don't believe this is true for several reasons.
First, I believe Amazon is executing very well, making the right decisions, and would have guided to above Q2 operating income consensus estimates if not for COVID-19 investments. These investments are already paying dividends in terms of satisfied customers and employees (remember, Amazon hired 175,000 new employees while millions were losing their jobs in the broader economy).
Second, the S&P 500 sold off 2.81% on the same day, so Amazon's drop is more like 5% post-earnings.
Third, going into Amazon's earnings, Amazon shares were up over 30% YTD, which bested Microsoft's (MSFT) gain of 13-14% and the S&P 500's negative 10%. This clearly indicates that expectations are sky-high.
If you are an Amazon investor, this isn't the time to panic. Amazon is executing well and I believe will continue to benefit for quite some time as consumer shopping behavior aggressively shifts to online.
Stay safe and healthy.
This article was written by
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