Will Amazon's Cloud Have a Silver Lining?

E-commerce giant Amazon.com AMZN is expected to have closed out 2022 with another round of disappointing results.

The main culprits behind the current struggles: the continued slowing of Amazon Web Services’ growth and declining e-commerce sales. Central to the outlook for the stock is the company’s strategy to improve operating efficiency as it reckons with rising expenses and a difficult economic backdrop.

When Amazon reports earnings after the close of trading on Feb. 2, analysts expect revenue of $145.7 billion and earnings per share of $0.17 according to data from FactSet. Expectations for the company’s fourth quarter have been damped by its third-quarter results, led by a slowdown in AWS, as well as much weaker guidance for the fourth quarter.

Dan Romanoff, senior equity analyst at Morningstar, sees the near-term outlook for Amazon as cloudy thanks in large part to economic headwinds such as inflation, a stronger dollar, and a deceleration in AWS’ growth. “We can look through these issues, but we believe they are likely to persist throughout 2023, which decreases our confidence over the medium term as well,” says Romanoff.

Q4 2022 Amazon Earnings Expectations

• Revenue estimate of $145.7 billion versus guidance of $140 billion to $148 billion;

• Earnings per share estimate of $0.17;

• Signs of further deceleration in AWS growth and declining e-commerce sales.

Wall Street is bracing for a soft quarter, in part in the wake Amazon’s weak revenue guidance when it reported third-quarter earnings.

At the time, Amazon’s management set fourth-quarter revenue guidance between $140 billion and $148 billion, compared with former FactSet mean estimates of $155.1 billion. The lower guidance was a result of a weaker outlook for e-commerce sales along with the deceleration in AWS growth.

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Those disappointing third-quarter results and outlook led Romanoff in October to cut his fair value estimate for Amazon stock to $150 from $192. Heading into the fourth-quarter earnings report, the stock is undervalued by roughly 32%, based on his fair value estimate.

Every Cloud…?

AWS drives most of Amazon’s revenue growth, says Romanoff, and as such will remain a key business for investors to keep an eye on. During the third quarter, AWS grew 27%, well below the average quarterly growth of 37% during 2021.

Given a tougher economic environment, customers are now more cautious with their spending. In a strategy similar to that of competitor Microsoft MSFT, whose Azure cloud business is also coming under pressure, Amazon is working to help its customers manage cloud computing costs to help retain business relationships.

Soft Amazon.com Demand Expected

While much of Amazon’s overall revenue growth is coming from the AWS cloud business, retail sales through the company’s website are still the majority of its revenue. During the third quarter, roughly 84% of Amazon’s revenue came from its North America and International segments (which does not include AWS sales).

“E-commerce demand has not rematerialized in the way many were expecting, and I don’t think it’s going to get much better this quarter,” says Romanoff.

Expenses have also significantly risen in the two segments, reducing the company’s retail sales profitability. In fact, during the first three quarters of 2022, Amazon posted a combined operating loss of about $8.13 billion from its North America and International segments. Most of the losses were in its international segment, though the North America segment still lost about $2.61 billion. In 2021, the first three quarters had an operating profit of $8.18 billion, with both segments reporting profits.

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Amazon is also working through staffing challenges, according to Romanoff, after a hiring binge aimed at meeting the surge in demand during the coronavirus pandemic. That higher level of staffing has led to higher operating expenses, pressuring operating margins, which have dwindled to 1.99% during the third quarter from 4.38% a year earlier.

The company recently announced layoffs of as many as 18,000 employees and, in the UK, staff recently went on strike for the first time in protest at working conditions.

“Details regarding the recent layoffs, where those positions are, how much more efficient operations are in the quarter and can they get in the next several quarters, what the financial impact will be in the near term and how that factors into guidance will be crucial,” says Romanoff.