- Amazon reported a mixed FQ1 card but issued hugely disappointing guidance. The pandemic tailwinds have turned into significant headwinds.
- AMZN stock continues to trade at a growth premium, despite its post-earnings sell-off. Moreover, it also lost a critical support level.
- We urge investors to remain cautious and wait for momentum to return before adding exposure in Amazon stock.
- As such, we revise our rating on AMZN stock from Buy to Hold.
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Amazon (NASDAQ:AMZN) reported an underwhelming Q1 card that hugely disappointed investors. But, although we were disappointed, we were not surprised by the weak Q2 guidance. We had highlighted in a pre-earnings article that Amazon stock was well-balanced heading into earnings. But there were headwinds that Amazon was executing against. Therefore, we noted the importance of a good guide against those headwinds for investors' confidence to return.
But, management didn't execute well enough, at least in the near term. In addition, the pandemic tailwinds had shrouded its pull-forward effect for many leading tech companies, including Meta (FB) and Netflix (NFLX). Therefore, these tailwinds reversed course as headwinds and returned in full force to impact Amazon's execution capability.
As a result, the company turned from chasing fulfillment capacity and logistics and labor shortages to dealing with excess capacity and labor supply. While the supply chain disruptions continue to disrupt its logistics infrastructure, Amazon's hugely expanded fulfillment footprint has caused operating deleverage and near-term inefficiencies.
But the company remains confident that it can pull through these headwinds, even though we think the sell-off was justified. Despite that, AMZN stock continues to trade at a premium against the market. Therefore, management needs to execute its H2'22 plan well to justify its premium.
While we remain holders of AMZN stock, we observed that a period of consolidation and premium digestion could continue in the near term. In addition, we also observed that the market makers had taken out its critical support level. Therefore, we encourage investors to bide their time and wait for momentum to rebuild in the stock, before returning, given its growth premium.
Consequently, we revise our rating on AMZN stock from Buy to Hold.
Amazon Needs To Justify Its Growth Premium
As seen above, Amazon reported FQ1 revenue YoY growth of 7.3%, which was in line with the consensus estimates. However, its EBIT margin performance was significantly impacted by a multitude of macro and internal factors. Amazon turned from chasing capacity and labor to ending with too much capacity and workers. As a result, its EBIT margin fell to 3.2%, markedly below the 4.5% consensus estimates.
Notably, the company's revenue and profitability growth cadence has also been impacted as Amazon continues to digest these headwinds. Consequently, the consensus estimates over these key metrics have also been downgraded in response.
Nevertheless, the estimates suggest that Amazon could fend off its headwinds from H2'22, despite the revisions. Therefore, the expectation of an inflection post-FQ2 remains intact. Amazon CFO Brian Olsavsky was also cautiously optimistic about its ability to surprise investors on the upside moving forward. He articulated (edited):
This year's Prime Day sales event will occur in the third quarter, in July to be specific. In 2021, Prime Day occurred in the second quarter and added 400 basis points to our FQ2'21 YoY revenue growth. What we see is that the fixed cost deleverage will narrow as we go through the year. We'll be really glad we have this capacity in Q3 when Prime Day hits because that's always a big surge of both inventory and orders and then definitely in the holiday season. The way we see it is we've come out of a very tumultuous 2 years. We are glad we made the decisions we made over the past 2 years. And now we have a chance to better rightsize our capacity to a more normalized demand pattern. (Amazon's FQ1'22 earnings call)
Notably, AMZN stock NTM normalized P/E went up despite the post-earning sell-off! The company's guidance on its Q2 profitability saw substantial revisions in the earnings estimates, as we discussed earlier.
As a result, AMZN stock last traded at a P/E of 71x NTM earnings. Pre-earnings, it was about slightly above 60x. Therefore, we highlighted that the sell-off was justified, given AMZN stock growth premium.
Moreover, its NTM FCF yield of 2.5% remains on the lower end among its mega-tech peers. In addition, it's still below its 5Y mean of 2.89%.
Is AMZN Stock A Buy, Sell, Or Hold?
We are still long-term holders in AMZN stock and remain so. We believe that the company's secular growth story in AWS remains robust. Nonetheless, investors should note that we cannot expect AWS' performance to compensate for retail's weaknesses in the near term. Based on a sum-of-the-parts (SOTP) analysis, AWS accounted for just about 44% of its valuation.
In addition, we also noticed a critical support level was breached significantly. From a medium-term perspective, we think the breach is constructive for AMZN stock valuation to re-rate moving forward. However, we would still like to observe the consolidation level first before adding exposure. The subtle bull trap in early 2021 has proved to be a sign of quiet distribution.
So, we encourage investors to wait patiently for momentum to return to AMZN stock and wait for the accumulation phase before adding exposure.
As such, we revise our rating on AMZN stock from Buy to Hold.
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This article was written by
JR Research is a seasoned investor with a background in economics. He focuses on identifying 3 main things - leading growth companies, emerging market trends, and secular growth opportunities. His approach combines price action with fundamentals investing.
He runs the investing group Ultimate Growth Investing which specializes in identifying high-potential opportunities across various sectors. The group is designed for investors seeking to capitalize on emerging, high-growth opportunities, and investors looking for sustainable growth opportunities at a reasonable price.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN 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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