Amazon: why the tech giant is not over and out
It’s not every day that you see Amazon, the online retail giant that has made its founder one of the world’s richest men, drop 7% in one trading session, but that is exactly what happened at the end of last week. Amazon’s share price sunk after reporting Q2 earnings that missed analyst expectations. Online sales growth, its core business, grew a “mere” 15% last quarter, the slowest rate of growth since 2019. It appears that Amazon is a victim of its own success, the end of pandemic-era lockdowns around the world meant that consumers, particularly in the US and Europe, were too busy doing other things rather than perusing Amazon’s millions of products and buying things that they don’t need to help a billionaire fly into space.
2020: a year like no other for Amazon
All joking aside, the record jump in online shopping in 2020 was always going to stall at some stage, and even with these “disappointing” numbers, it is worth noting that Amazon still managed to pull in $113bn, with profits rising some 50% compared with last year to $7.8bn. So, even if Amazon is not meeting sales and revenue targets, it is getting more profitable as the costs of meeting demand when online shopping surged to its highest ever level last year are starting to reap rewards. There was more bad news to come from last week’s earnings, the CFO gave a downbeat assessment of future earnings growth, saying that operating income from July – September could be between $2.5 - $6bn, a fairly large range, but if earnings come in at the lower end of that range for Q3, it could be one of the worst results for a number of years.
Reasons to be cheerful
The pessimism from Amazon’s top brass was baked into the share price last week, which is why the stock dropped so precipitously. However, we think that the recent sharp decline in Amazon’s share price is appealing for a few reasons:
We believe that the digital habits that we all picked up during the pandemic are here to stay, even in a vaccinated world. Thus, we expect that Amazon’s own income forecasts could be on the low side. We do not believe that the executive teams of Amazon or Apple, who also offered downbeat forward guidance, are trying to mislead investors, rather that they are highlighting that the fact that record-breaking growth, and 50% boosts to profits, do not happen consistently. They are prepping the market in a realistic way, even if we think that they are being too conservative.
Amazon has a proven track record and is operating across markets with strong growth. The diversified nature of Amazon’s business was reflected in Amazon’s Q2 results, for example, the company’s “other business”, which includes its advertising efforts saw revenue surge 88% compared with the same period last year, rising to $7.9bn, a significant chunk of change. Amazon’s cloud computing business, AWS, also continued to perform strongly, with the segment posting $14.8bn in Q2, compared to $10.8bn in the same quarter last year. This was the second consecutive quarter of 30%+ growth. The fact that the chief exec of AWS is succeeding Jeff Bezos as CEO of the whole company, suggests that Amazon’s focus will continue to be on this fast-growing service division. If, as we expect, Amazon will continue to focus its efforts on cloud computing then it should benefit from the trend for more global corporations to move to the cloud in the wake of the pandemic.
As we mentioned above, the new CEO of Amazon, Andy Jassy, may not have had the first quarterly earnings release of his corporate dreams, but one thing we do not think investors need to worry about is the departure of Jeff Bezos. In the past, the departure of the CEO/ founder has spelt disaster for a company as it can erode the culture. However, we would point out that Jassy has been at the forefront of the diversification of Amazon’s business, which is vital for its future success. Also, other tech giants have managed to successfully move to a new CEO without hurting profits and keeping the company on the same growth path, for example Apple and Tim Cook, after the death of Steve Jobs. Thus, we do not think that any selling of Amazon stock on the back of a loss of faith of the new Amazon leadership is justified and this could be reversed.
From a fundamental standpoint, last week’s sell off was partly because expectations for a behemoth of a company like Amazon are usually extremely high, so concerns about the future will trigger a knee jerk reaction lower in the stock price. Regulatory concerns are also worrying some investors, however, unlike the blunt treatment received by Chinese tech giants from the Chinese government in recent months, we do not think that the same will happen to Amazon. Although the US government and the European Union are monitoring big tech closely, we doubt that any hard regulatory blows are likely to land on Amazon any time soon, thus the prospect of tougher regulation is too obscure to try and price in to its share price right now. Also, the global minimum tax rate of 15%, which looks like it will be implemented relatively soon, is barely touching the edges of the profits made by the likes of Amazon et al in the big tech space, so, for now, this is also not a threat to share price stability.
The technical view
From a technical point of view, the sharp sell-off in Amazon’s share price has brought it back to early June levels. After doubling in price throughout the pandemic, the sharp drop in the share price looks healthy and relatively insignificant from a technical standpoint, although the stock now looks less overbought than it has in recent months on a long-term basis. We would need to see a drop to $3000, the 38.2% Fibonacci retracement level of the March 2020- end of June 2021 rally, for us to be concerned that the Amazon share price is in for a steep decline. For the reasons above, we do not think that this is likely, thus, we think that any signs of buying at $3320 in the short term, could trigger a recovery rally in the coming days.