Amazon Earnings May Not Impress, But Here's Why the Stock Could Still Be a Buy

Amazon's (AMZN - Get Report)  quarterly earnings report Oct. 24 may not be its best ever, but take that with a grain of salt.

Barclays analysts have identified several areas that may disappoint investors when Amazon's earnings come out. Morgan Stanley analysts agree on one of those areas. Meanwhile, the stock is up only 15% year-to-date, trailing the S&P 500's 19% gain, as Amazon, like the rest of the FAANG group, has fallen out of favor somewhat with investors of late.

Near-Term Downside

"We see another mixed bag from Amazon in the third quarter," Sandler wrote in a Friday note. While he is positive on Amazon's retail sales for the quarter, "We think the street's $9.2B AWS [Amazon Web Services] estimate may prove a tad too aggressive."

Sandler's AWS revenue estimate for the third quarter, at 9.05 billion, may be slightly disappointing should it turn out to be correct, but there's another point that has been more in focus of late.

Amazon's retail operating margin is likely to fall in the near-term as the tech behemoth builds out its one-day and same-day e-commerce delivery capabilities. That's because it has to make initial investments for that business that won't bear fruit immediately. "Amazon is likely to see inefficiencies and stress around its retail operations as it scales up the zip codes and SKU [stock-keeping unit] count available for 1-day delivery," Sandler said. He said the retail operating margin will be pressured as Amazon makes initial investments to kickstart the segment's logistics, shipping and headcount costs.

This will certainly weigh on the company's consolidated operating margin, which Wall Street expects to be 5.2%, a tick down from 2018's 5.3%.

Morgan Stanley analyst Brian Nowak wrote in a late September note that higher costs through 2020 will weigh on Amazon's profits as he lowered his 2020 gross margin forecast by nine basis points. He lowered his EBIT (earnings-before-interest-and-tax) dollar count expectation by 2%.

Amazon's one-day and same-day delivery aspirations are aimed at gaining market share in e-commerce as competitors like Walmart (WMT - Get Report) have gained momentum. Amazon certainly has superior scale and capacity to service these needs, but Walmart is no slouch.

Long-Term Upside?

Amazon's e-commerce business may be much lower growth than in past years, but its AWS cloud business is a huge bright spot for a stock that trades at a far lower multiple than it did before.

"AMZN remains a compelling long term idea," Sandler wrote, adding that the valuation makes the present "a good entry point for long-term investors." And the average sell-side price target on the stock is $2,265 a share, representing 30% upside from here.

While Sandler may be bearish on the third quarter AWS revenue result, most optimism on the stock has stemmed from the high expectations for AWS. That business is expected to see sales growth of roughly 30% for the next several years. Plus, its a far higher margin business than e-commerce, and AWS is expected to contribute over half of Amazon's profits in 2020 for the first time.

Meanwhile, Amazon is trading at 52 times the next twelve month's earnings, low historically. Some of that may be justified, as Sandler and other analysts have pointed out. At the same time, Amazon's forward multiple has hit 100 in recent years.

One factor to watch out for: Microsoft (MSFT - Get Report) . Analysts have recently cited Microsoft's potential to gain cloud market share against AWS. 

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