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Amazon’s Ad & Cloud Segments Could Be the Silver Lining in Q2, Says Analyst

Story Highlights

Although macroeconomic concerns weigh on Amazon, analyst Michael Pachter remains optimistic about this e-commerce giant with a market cap of $1.2 trillion.

Shares of Amazon (NASDAQ: AMZN) have plunged 29% year-to-date as the e-commerce giant battles soaring inflation reflected in higher operating costs. The higher costs have been a concern for Wedbush analyst Michael Pachter as well. However, the analyst remains bullish on the stock and believes the company’s Ad and Cloud segments could very well be the silver lining.

On Monday, July 25, Reuters reported that Amazon will hike its yearly Prime membership fees in Europe by up to 43%, effective September 15. The report stated that the company cited “increased inflation and operating costs” as the reasons for the increase in prices.

Amazon is expected to announce its Q2 results on July 28.

Amazon’s Q2 Outlook

Amazon expects net sales to range between $116 billion and $121 billion in Q2, up by 3% to 7%. This guidance assumes an adverse impact of 200 basis points from currency fluctuations.

Wall Street analysts expect Amazon to generate revenues of $119.1 billion. Pachter has projected revenues of $121 billion in Q2.

Earnings are expected to come in at $0.12 per share by analysts.

Regarding analyst Pachter’s revenue projections, he admitted that these could prove to be “overly optimistic” due to higher inflation.

Inflation Could Be a Major Challenge for Amazon

The analyst added that while rising inflation could benefit Amazon’s retail business through “higher pricing and marketplace fees” ranging from 8% to 15%, the higher inflation could also lead to a fall in discretionary consumer spending.

Pachter cited the University of Michigan’s Consumer Sentiment Index, which “identified inflation as the biggest concern for consumers, with 47% of respondents noting that their living standards have been eroded by the sharp increase in prices.”

As a result, the analyst expects that non-Amazon Web Services (non-AWS) revenues could fall in the range of 2.5% to 5% year-over-year in Q2, while advertising “would equate to roughly 5–10% of online store sales in Q2:21.”

Higher Costs Could Weigh in on Amazon’s Profits

Amazon’s management had stated on its Q1 earnings call that it expected to “incur approximately $4 billion of these incremental costs in Q2.” These incremental costs include fixed costs related to additional capacity in its transportation and fulfillment network and higher operating costs as a result of inflation.

Pachter expects “Labor costs could also weigh on profits due to high attrition rates and unfilled U.S. job vacancies of roughly 11.5 million in Q1.”

The analyst anticipates that in Q3, Amazon could guide to revenue growth in “mid-single digit” and “in-line EBIT [Earnings Before Interest and Taxes].”

Wall Street’s Take

Pachter reduced his price target from $3,500 to $175 on the stock, adjusting for Amazon’s 20-for-1 stock split. The analyst added, “The recent 20-to-1 stock split briefly lifted share prices higher, but it will likely take a material shift in the broader macroeconomic outlook before investment sentiment turns.”

Over the long term, the analyst expects that Amazon could see its margins expand steadily “driven by its cloud and ads businesses.”

Besides Pachter, other Wall Street analysts are also bullish about the stock, with a Strong Buy consensus rating based on 40 Buys and one Hold. The average Amazon price target of $171.84 implies an upside potential of 42.1% at current levels.

Conclusion

While macroeconomic concerns will continue to weigh on Amazon’s retail business, this could be offset by growth in its advertising and cloud services businesses.

Amazon scores a nine out of 10 on the TipRanks Smart Score system, indicating that the stock is highly likely to outperform the market.

The TipRanks Smart Score system is a data-driven, quantitative scoring system that analyses stocks on eight major parameters and comes up with a Smart Score ranging from 1 to 10. The higher the score, the more likely the stock will outperform the market.

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