Last week wasn’t great for Amazon shareholders. First, it released results that included a dramatic decline in earnings and a softer than expected outlook for the forth quarter. This resulted in the stock price falling 5% on Friday. Then, the US Pentagon awarded its $10 billion cloud migration contract to Microsoft. Amazon was widely viewed as the favorite to win the contract.

When second-quarter results disappointed investors in July, we said sentiment would get even worse later, providing a better entry point. Amazon is a stock to buy when the outlook looks bleak. The question now is whether or not sentiment can deteriorate even further.

Shipping costs rise 46%

Revenue growth remains robust, with total revenue growing 23.7% to $69.98 billion during the third quarter. GAAP EPS were $4.23, down 26%  for the year. The loss was primarily a result of global shipping costs rising 46%.

North American sales rose 24% to $42 billion, but operating income for the segment declined 37% as a result of the rise in shipping costs. The international segment grew sales 18% to $18 billion but lost $386 million after costs were accounted for. The operating loss was flat compared to a year earlier.

Amazon’s cloud business, AWS, increased revenue by 35% to $9 billion. The segment still only contributes 12% to total revenue but turned a larger profit than other segments.

Other revenue, which includes the advertising business grew revenue 45%, up from 37% last quarter. At $3.5 billion this segment is becoming a meaningful contributor to the bottom line.

Revenue guidance for the fourth quarter was 5% lower than consensus estimates with a midpoint of $83 billion. Operating income is expected to be between $1.2 billion and $2.9 billion, or 24 to 70% down on last year. It is notable that the company has given itself such a wide margin on costs.

Pentagon contract goes to Microsoft

Amazon was the favorite to win the Pentagon JEDI contract over Microsoft, IBM, and other bidders. The contract is worth $10 billion over ten years, which at AWS’s current run rate would add 2.5% to its revenue.

Amazon is expected to challenge the decision in court, but the chance of success is doubtful. The stock traded 1% lower in late trade on Friday after the announcement was made.

Is this the buying opportunity investors have been waiting for?

Three months ago, further downside was clearly probable. It’s a more difficult call this time around. While there are still reasons to be bearish the odds of upside are improving.

The reason for lower earnings was increased spending to reduce delivery times. This has always been part of the plan, so no one should be surprised. Long term investors should see this spending as a catalyst for growth in the future. And, the resulting price weakness will eventually create the optimal buying opportunity.

The cloud computing side could create some volatility in the future. Many Analysts say migration to the cloud is only just beginning for many companies. However recent results from several cloud companies point to a potential slowdown. Even if cloud migration is just beginning, it may slow in the near term.

Another reason for the uncertainty is that costs may continue to rise. The fact that Amazon has given itself such a wide margin on fourth-quarter expenses indicates this is a real possibility.

Further downside is entirely likely – unless large buyers decide this is the best opportunity they will get. So, the price action will be the best guide over the next few months. If support at $1700 holds, long term investors may want to begin to scale in. If it doesn’t, the next level to watch is $1,600. That would be 22% off the all-time high and would likely attract some serious buying.

 

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.