Amazon Stock May Tumble Following Q3 Earnings Results
Summary
- IBM's cloud growth was very weak and is historically tied to trends in AWS.
- The options market does not see the price on Amazon rising above $3,500 post results.
- The technical pattern sees the shares slipping below $3,000.
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Investors don't often think about IBM (IBM) and Amazon (NASDAQ:AMZN) in the same breath. Still, IBM's latest results could be telling us that Amazon's most profitable business unit, AWS, could disappoint investors when the company report results later this week.
According to data from Refinitiv, analysts' consensus see the AWS business unit growth decelerating to 32.7% or $15.4 billion in the third quarter from a growth rate of 37.1% in the second quarter. The consensus was also looking for solid cloud growth from IBM, with revenue expected to grow by 3.9%. Instead, the IBM business unit increased by just 2.5%, with revenue for that business unit missing analysts' estimates for the first time this year.
Could AWS See A Weak Quarter?
Most surprising is that IBM's cloud growth and AWS have tracked each other since the pandemic began. When the growth of IBM's business unit has accelerated, the same has occurred for AWS, and when growth in IBM's business unit has decelerated, the AWS growth rate has slowed too.
The degrees to which they have climbed and fallen have varied, but the trend has been the same.
(Data from Refinitiv)
This trend is also present in the relationship with Microsoft's (MSFT) cloud unit and IBM, but it is not as strongly linked to the relationship seen with AWS. The first and fourth quarters of 2020 did not see the IBM and Microsoft business units trend in the exact directions.
(Data from Refinitiv)
AWS has historically done an outstanding job beating analysts' estimates, so a miss would be a big disappointment. That's because AWS is the primary driver of the company's total net income, which helps drive those earnings.
(Data from Refinitiv)
However, retail sales have slipped from their Covid peak, and a disappointing quarter from AWS would likely be devastating for the stock. The latest retail sales data indicate a plateau in growth for the overall US economy. This may make it difficult for Amazon to report revenue that comes in ahead of expectations, primarily if AWS cannot deliver a strong quarter.
Analysts Are Cutting Amazon's Sales Estimates
Analysts have already been resetting their expectations. The plateauing retail sales and the weak guidance provided by the company during the second quarter announcement have driven analysts to drop their sales estimates for Amazon over the past three months by 6% to $111.5 billion.
The downgrade of the third quarter estimates has spilled over to the analysts' reducing sales estimates for this year to $475.5 billion in 2021 from a peak of $490.3 billion. The lower revenue estimates have pushed the stock's price-to-sales multiple up to 3.6 times this year's estimate. It is much higher than the 10-yr average of 2.7.
A Big Options Bet See Amazon Stock Staying Below $3,500
The options market doesn't seem to be too concerned on the surface. Currently, the long-straddle options strategy indicates that the shares rise or fall by around 4.4% from the October 29 $3,340 strike price. It would place the stock in a trading range of $3,265 and $3,488 following its results.
What's most interesting is that options activity has been muted heading into these results, and perhaps that is because traders don't have a firm conviction around these results or a good read into how they may turn out.
However, there was one huge bet recently placed the stock would not advance past $3,500. On October 20, the open interest levels for the November 19 $3,500 calls rose by roughly 1,200 contracts. While this may seem like a bullish bet on the surface, the options data shows these calls were sold and traded on the bid, with the trader taking in a premium of between $71.50 to $78.35 per contract. It is most likely the case this was a covered call transaction, indicating the trader likely owns the stock and looking to generate extra income. But the fact they are willing to sell these calls would suggest they do not think the stock will rally. Otherwise, they stand a chance to have their shares called away upon expiration or may need to pay a higher price to repurchase the calls, taking a loss.
Now, this doesn't sound like a big trade, but it is massive. The trader took in a premium of more than $8.5 million, betting that the stock would stay below that strike price over the next month.
AMZN Stock May Slip Below $3,000
Given the technical setup, there is a good chance the stock does stay below $3,500 and potentially goes lower. Since mid-July, the shares have been trading lower and have yet to recover from their weaker than expected second quarter earnings announcement. When combined with a strong level of technical support around $3,200, the downtrend creates a bearish technical pattern known as a descending triangle.
Additionally, the relative strength index has been trending lower in the same direction as the stock since the middle of July. It would suggest that momentum in the stock has turned bearish.
When measuring the triangle's height to the base, it amounts to nearly 560 points or roughly 15%. A similar decline would target a drop to approximately $2,630. Now, that doesn't mean the stock will fall that far, but it is more guidance on how much it could fall. There are some key levels of support before that at $3,020 and $2,880, which could serve as a place to stop on a decline.
Overall, this could be a pivotal quarter for Amazon. With plateauing in retail sales and potential weakness in the cloud business, investors may not be very pleasant.
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This article was written by
I am Michael Kramer, the founder of Mott Capital Management and creator of Reading The Markets, an SA Marketplace service. I focus on long-only macro themes and trends, look for long-term thematic growth investments, and use options data to find unusual activity.
I use my over 25 years of experience as a buy-side trader, analyst, and portfolio manager, to explain the twists and turns of the stock market and where it may be heading next. Additionally, I use data from top vendors to formulate my analysis, including sell-side analyst estimates and research, newsfeeds, in-depth options data, and gamma levels.
Disclosure: I/we have a beneficial long position in the shares of MSFT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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