Analysis: AMZN

Amazon (AMZN) reported a strong beat with its second-quarter 2020 earnings results. Even against lofty expectations net sales of $88.9 billion (+40% year over year) exceeded estimates of about $81.6 billion. Operating income increased to $5.9 billion, crushing estimates of $1.2 billion, leading to an earnings per share number of $10.30 (+97% YoY) that obliterated the $1.48 expectation.

Speaking to the results in the press release here, Amazon founder and CEO Jeff Bezos said: "This was another highly unusual quarter, and I couldn't be more proud of and grateful to our employees around the globe.

"As expected, we spent over $4 billion on incremental Covid-19-related costs in the quarter to help keep employees safe and deliver products to customers in this time of high demand-purchasing personal protective equipment, increasing cleaning of our facilities, following new safety process paths, adding new backup family care benefits, and paying a special thank you bonus of over $500 million to front-line employees and delivery partners.

"We've created over 175,000 new jobs since March and are in the process of bringing 125,000 of these employees into regular, full-time positions. And third-party sales again grew faster this quarter than Amazon's first-party sales. Lastly, even in this unpredictable time, we injected significant money into the economy this quarter, investing over $9 billion in capital projects, including fulfillment, transportation, and AWS," Bezos concluded.

Before we get deeper into the results, let's take a look at third-quarter 2020 financial guidance.

Net sales are expected to be between $87 billion and $93 billion, representing growth between 24% and 33% year over year. This guidance includes an unfavorable impact of approximately 20 basis points from foreign exchange. At a midpoint of $90 billion, management's guidance comes in much better than the consensus forecast of $86.4 billion. For operating income, management expects this to be in the range of $2 billion to $5 billion, and this figure already includes more than $2 billion of costs related to Covid-19. That $2 billion is a step down from the more than $4 billion incurred in the second quarter. With consensus at about $3.1 billion, this $3.5 billion at the midpoint guidance looks very favorable.

In response to the much better-than-expected quarter and an outlook that is all around better than consensus, AMZN is pushing higher in after-hours trading to about $3,200, overcoming an extremely difficult bar into the print.

By geography, total North America sales were $55.436 billion (+43% YoY), exceeding expectations of $50.4 billion. Operating income was $2.1 billion (+37% YoY), a result that was far better than expectations for a $758 million loss.

Similar story in International sales, which in the quarter were $22.668 billion (+38% YoY), higher than the estimates for $19.665 billion. Furthermore, operating income swung from a loss last quarter to a $345 million gain against expectations for a $1.3 billion loss.

Additionally, unit growth increased 53% YoY, jumping from the previous quarter's 32% rate. Units, according to Amazon, mean "physical and digital units sold" on net of returns and cancellations by the company and sellers in its stores, as well as Amazon-owned items sold in other stores.

Here's the complete breakdown of the quarter by segment:

The second quarter is seasonably the lowest in terms of volumes at Online Stores, the heart of Amazon's e-commerce business, but not this quarter as revenues in the quarter were $45.896 billion billion (+48% YoY, +49% ex-FX), topping estimates of $39.888 billion. The growth rate nearly doubled sequentially as Amazon was without question one of the largest beneficiaries of the shelter-in-place orders, an event that has already reshaped the entire retail landscape and accelerated the ongoing shift from bricks-and-mortar to e-commerce. But with increased sales come elevated shipping costs, which rose 68% YoY to $13.65 billion.

At Physical Stores (essentially Whole Foods) revenue was $3.774 billion (-13 %YoY) in the quarter, well short of the $4.5 billion consensus. Sales were likely impacted by stay-at-home orders forcing customers to order their groceries online and getting them delivered to their homes.

At Amazon Web Services, revenue of $10.808 billion (+29% YoY, +29% ex-FX) surprisingly came in again a touch below consensus estimates for $11 billion. The growth rate slightly decelerated for what is the sixth quarter in row -- likely a product of the law of large numbers as this business is now on a $43 billion run rate and we are seeing similar trends at Microsoft's Azure. On the conference call, CFO Brian Olsavsky provided really meaningful insight on the rate of adoption the cloud industry is seeing.

"But we're also seeing a lot of companies that are really wishing that they had made more progress on the cloud because they're seeing how companies that are on the cloud can turn into a variable cost and either scale up or scale down depending on their particular situation. They realize their on-premise infrastructure is not really flexible to go up or down. And especially in the time of sinking demand, it's a big fixed cost for them. So we expect -- we're seeing migration plans accelerate. They're certainly not going to happen overnight, but we see companies moving more in that direction. We think that will be a good long-term trend," Olsavsky said.

Even though growth has slowed, we still see so many positives about the long-term trend of this business.

AWS Operating Income came in at $3.357 billion (+58% YoY), a nice beat against estimates for $3 billion. At 31%, the operating margin here expanded for the third quarter in a row sequentially, up from 30.1% in the first quarter and 26.1% in the fourth quarter of 2019 and has now trended back to its historical high levels.

In Subscription Services, which include annual and monthly fees associated with Prime, audiobook, e-book, digital video, digital music, and more, revenues of $6.018 billion (+29% YoY, +30% ex-FX) were right in line with estimates for $6 billion. The results here continue to show that Amazon's Prime delivery and video/music content offerings are excelling at driving membership. Of note, management said on the call that Prime renewal rates improved in the quarter while membership growth accelerated. Speaking further on the Prime environment, Olsavsky said, "Our demand is still super high. What we're seeing on -- it's driven by Prime members, and Prime member engagement. They're shopping more often. They have larger basket sizes. There's still a heavy component of grocery -- online grocery sales tripled year over year in the quarter as we added capacity there." And internationally, management spoke on the call of opportunities still available to increase Prime membership value proposition.

Third-Party Seller services includes commissions and any related fulfillment and shipping fees, and other third-party seller services. Sales were $18.195 billion (+52% YoY, +53% YoY ex-FX) slightly ahead of estimates for $15.5 billion. It's no surprise to see this business track higher alongside Online Stores as both benefit from increased e-commerce adoption, and this segment is a focus area as well because it runs at a higher margin than Online Stores.

Other sales, which predominantly comes from Advertising, came in at $4.221 billion (+41% YoY, +41% YoY ex-FX) and outpaced the $4.09 billion consensus. Even though the entire Advertising industry was an uncertain one in the quarter, the growth rate here was relatively steady quarter to quarter. It is also good to remember that Amazon's ad business isn't levered to challenged industries such as travel and auto.

Well, what is there to say besides Amazon pulled it off. Even with expectations as elevated as you'll ever see because AMZN headed into the print up 65% year to date and more than 82% off its March bottom, the company posted staggering revenue growth and massive profitability despite more than $4 billion earmarked to Covid-19 related costs.

Guidance was also stronger than expected, a solid result to see considering management is typically conservative with their initial forecasts. Whether it be greater adoption of e-commerce or the necessity of the cloud, Amazon is one of the largest beneficiaries of the accelerated trends brought on by the pandemic. And in a time when lockdown orders disrupted everyday life as we knew it, management's relentless focus on their customers paid off in spades.

We'll update our price target with the Weekly Roundup on Friday.