We're disappointed by Amazon's terrible results, stock plunge; but sticking with it for now

Published Thu, Oct 27 20228:20 PM EDTUpdated Thu, Oct 27 20228:33 PM EDT

Club holding Amazon (AMZN) reported weaker-than-anticipated results for the third quarter after the closing bell Thursday and guidance that was even worse. Considering all the cross currents and a terrible initial stock reaction, we're going to sit tight on the stock for now. Net sales increased 15% year over year to $127.1 billion, nearly in line with estimates of about $127.46 billion, according to Refinitiv. Foreign exchange (FX) fluctuations had a 460 basis point impact on sales in the quarter. That's 70 basis points or $900 million more than initially guided. Operating income of $2.5 billion fell from $4.9 billion last year and missed estimates of about $3.1 billion. The result was higher than the midpoint of management's breakeven and $3.5 billion guide. Net Income was $2.9 billion, or 28 cents per share, but this includes a pre-tax valuation gain of $1.1 billion related to the company's investment in Rivian Automotive (RIVN). So EPS does not exactly compare to estimates of 22 cents. Bottom line Sales were in line despite some beats and misses here and there. Still, it was a disappointing operating income result as Amazon did not generate the cost improvement and efficiency gains that had been anticipated. At the same time, inflation and broader economic uncertainty weighed on the business as the quarter progressed, leading to a fourth quarter outlook that was far below expected. The selloff in the stock after-hours — roughly a 13% decline — is a tough pill to swallow because Amazon understands the importance of tightening its belt and controlling expenses during this tough time. For a few quarters now management has talked about addressing its bloated cost structure, which is partly a result of all the e-commerce demand it enjoyed during the Covid pandemic. While the fruits of those efficiency driven labors have yet to fully show up in the results, we remain optimistic about the efforts. Once Amazon cleans up its margins, its free cash flow should significantly improve, leading to a higher stock price. It's going to take some time. But with shares disappointingly lower after the release, the dilemma we face with yet another mega-cap tech name is: what is too low to sell and what do we need to exit? While Amazon has an expensive valuation, its business model can be tuned up, leading to higher profits in the future. The company knows it over-extended and over-expanded itself last year. But it's taking longer than previously anticipated to clean up those costs, and now the business is feeling the effects of inflation and the broader economic slowdown. We are sticking with Amazon for now, but cutting our price target to $140 per share from $160 to factor in headwinds on valuation due to higher interest rates and lower earnings estimates. Guidance Management's outlook for the fourth quarter (the current quarter) was a massive disappointment. It expects sales to be between $140 billion to $148 billion, representing year-over-year growth of 2% to 8%. At the $144 billion midpoint, this guide is well below the $155 billion estimate the Street was looking for. Guidance anticipates an unfavorable impact of approximately 460 basis points for foreign exchange rates. Operating income is expected to be in a range of breakeven to $4 billion. Management is typically prudent when it comes to providing operating guidance and often under-promises, over-delivers, but it's hard to get excited about this view when at its midpoint of $2 billion the guide is about $3.5 billion below what the consensus expected. Why the slowdown? Management pointed out that it began to see a slowdown across many of its businesses and an increased headwind from FX as the third quarter progressed. These headwinds are expected to persist through the fourth quarter, partially explaining the weak guide. At least in this macro slowdown, management understands the importance of not spending like crazy. "As we've done at similar times in our history, we're also taking actions to tighten our belt, including pausing hiring in certain businesses and winding down products and services where we believe our resources are better spent elsewhere. We aim to strike the right balance between investing for our customers for the long term, while driving operational efficiency improvements and accomplishing more with less.," CFO Brian Olsavsky said on the earnings call. For the full year, Amazon expects about $60 billion in capital investments, which is about $5 billion higher than 2021 levels and in line with estimates. This figure includes an estimated $10 billion year over year reduction in fulfillment and transportation capital investments offset by a $10 billion year over year increase in tech infrastructure, primarily to support its Amazon Web Services (AWS) cloud arm. Geographic Q3 sales In North America, sales increased 20% year-over-year to $78.84 billion, beating estimates of $77.24 billion. The operating loss in the region was $412 million, which is tough to see off that much revenue. But it's a small consolation as expectations were for an even greater loss of $485 million. International sales increased 12% year-over-year, excluding foreign exchange (FX), at $27.72 billion, missing estimates of $29 billion. The operating loss was worse than anticipated at $2.47 billion compared to estimates of $2.26 billion loss. Segment Q3 sales Online Stores: $53.49 billion, up 13% year over year excluding-FX, missed the $54.27 billion expected. Amazon said it had a great reaction to its second Prime Day of 2022, but growth slowed down as the quarter progressed as inflation, and higher fuel and energy hurt the budgets of consumers. The slowdown was most evident in the international part of the business. Physical Stores, mostly Whole Foods: $4.69 billion, up 10% from last year ex-FX, in line with the $4.71 billion expected. Third-Party Seller Services, commissions and any related fulfillment and shipping fees, and other third-party seller services: $28.67 billion, up 23% year over year excluding-FX and a beat versus the $27.93 billion expected. Subscription Services, mostly annual and monthly fees associated with Amazon Prime membership: $8.9 billion, up 14% from last year ex-FX, a small miss versus $9.09 billion expected. AWS: $20.54 billion, up 28% year over year excluding-FX, and a miss versus the $21.2 billion expected. The segment reported operating margins of 26.3%, well below estimates of 30%. Hurting sales was the ongoing macro uncertainty, which is causing customers to focus on controlling costs and monitoring how much they are spending on the cloud computing platform. It doesn't sound like we should expect an uptick in the fourth quarter as management noted that in the back end of the quarter, AWS' growth rate was trending more in the mid-20% range. Despite the recent slowdown, the AWS backlog still remains healthy up 57% year over year at $104.3 billion, indicating that the long term demand is still there. Advertising Services: $9.55 billion, up 30% year over year excluding-FX, and a slight beat versus the $9.481 billion expected. Other, sales related to various other service offerings: $1.26 billion, a surge of 168% from last year ex-FX, a beat versus the $843 million expected. (Jim Cramer's Charitable Trust is long AMZN. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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An Amazon Prime truck is pictured as it crosses the George Washington Bridge in New York.

Mike Segar | Reuters