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Amazon Q3 Earnings Preview: AWS, Ad Growth Anticipated; Retail Faces Short-term Challenges

Amazon is set to report its third-quarter earnings after markets close on Thursday. Analysts project revenue at $157.25 billion, marking a 9.9% rise year-over-year, and earnings per share of $1.14, up 21.27%.

Year-to-date, $Amazon.com(AMZN)$   shares have gained 23.6%. In July, the stock reached a record $210.20. However, shares dropped nearly 13% following disappointing Q2 results and a market downturn on Black Monday. The stock has experienced a volatile recovery, currently trading at $187.80, below its recent high.

The forthcoming Q3 earnings report will spotlight AWS growth and margins, capital expenditures, advertising business performance, and retail profit margins.

How Are AWS's Growth and Profitability?

AWS growth rate is closely monitored by investors as it's Amazon's largest profit generator and most profitable unit. In Q2 2024, AWS posted an operating margin of 35.5%, significantly outperforming the company's overall margin of 9.9%.

Amazon remains the leading provider of enterprise cloud services with a market share of approximately 32%. However, it faces fierce competition from Microsoft and Google, both ramping up their AI offerings.

Amazon Web Services is actively working to reduce energy costs by investing in microreactors to power its vast data centers. This month, the company announced a $500 million investment in the nuclear power sector, signing three agreements.

Analysts expect the division's sales to rise 19.1% to $27.5 billion, according to Bloomberg data. The operating profit margin is projected to fall by 2.1 percentage points to 33.4%.

Can the Ad Business Maintain Its Rapid Growth?

Amazon's advertising revenue hit $12.77 billion in the second quarter, accounting for nearly 9% of total sales. The ad segment expanded by 19.5%, down from a 24% increase in the previous quarter, yet it remains the company's fastest-growing division.

Amazon introduced Prime Video in the first quarter of 2024, featuring 180 million users in the U.S., potentially elevating its status as a major ad-supported streaming service. According to Nielsen, Prime Video currently captures 3.1% of total U.S. TV viewership.

During the latest earnings call, Amazon's management noted that the video advertising segment is still nascent, hinting that its vast user data and closed-loop system could secure a larger slice of the ad market in the future.

Bloomberg analysts forecast that the ad business will grow by 18.2% in the third quarter, reaching $14.2 billion.

Retail Performance: Signs of Recovery?

Amazon's retail division remains its main revenue engine, accounting for roughly 65% of income in the second quarter. Yet, the segment is grappling with several challenges amid rising macroeconomic uncertainties. The Q2 earnings report, released in early August, showed retail sales climbed 4.58%, missing estimates.

In September, Amazon announced a $1.50 hourly wage raise for approximately 800,000 U.S. employees, pushing the average hourly wage to $22. Increasing labor costs are pressuring operating profit.

Furthermore, Amazon's average sales price dropped in Q2. Management highlighted on a conference call that sluggish consumer spending is becoming apparent in key markets, with demand potentially continuing to decelerate in the third quarter.

Bloomberg analysts project a 4.15% year-over-year growth in the retail business for Q3, reaching $59.6 billion.

Analyst Views

Jefferies analysts have set a price target of $210 for Amazon, maintaining a "Buy" rating. While expressing concerns over short-term retail margins and guidance, they are optimistic about the medium-term outlook. In their report, they noted, "AWS growth and its margin opportunity are key reasons to own Amazon," adding, "We also see the potential for retail margin reacceleration in the second half of 2025 if the shift to consumables normalizes."

$Morgan Stanley(MS)$   analyst Brian Nowak maintains an "Overweight" rating on Amazon with a price target of $210. He notes that Amazon's emphasis on low-cost, low-margin essentials is weighing on overall margins and constraining profit growth in its North American retail sector. However, the firm remains optimistic about Amazon's long-term growth potential, anticipating a rebound in profitability after 2024. "We view these profit challenges as temporary and not structural," the bank states, adding that they remain "buyers on weakness" as they anticipate multiple profit drivers into 2025.

Earlier this month, $Wells Fargo(WFC)$   analyst Ken Gawrelski downgraded Amazon from "Overweight" to "Equal Weight," cutting the price target from $225 to $183. The firm cites increased competition from $Wal-Mart(WMT)$  , slowing ad revenue contributions, and high costs associated with its satellite broadband project. In his report, Gawrelski stated, "Keeping these headwinds in context, Amazon remains a margin expansion story, just likely a more moderate margin expansion pace than the market expects."

Overall, analysts remain bullish on Amazon, with an average price target of $225, implying about 20% upside from Friday's closing price of $187.83.

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