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Amazon's (AMZN) Q3 Earnings to be Hurt by Heavy Investments

Amazon.com AMZN will report third-quarter 2017 earnings on Oct 26 after the bell.

We expect the company’s earnings to be hurt (as usual) by continuous heavy investments in fulfillment centers, TV shows and movies, AWS, acquisitions, India expansion and what not. It’s looking for a second headquarter in North America and plans to invest $5 billion for it. Amazon’s global margins are likely to be under pressure at least for a few years.

However, revenues are expected to improve on strong Prime Day’ 17 sales, the integration of Whole Foods, a solid loyalty system in Prime and the Fulfillment by Amazon (FBA) strategy.

We observe that Amazon shares have gained 29.2% year to date, underperforming the 47.9% rally of the industry it belongs to.

Factors to Consider

AWS: It's a multi-billion-dollar business and the cash cow for Amazon. It has millions of customers and generates much higher margins than retail. It is the key driver of Amazon’s profitability.

We remain optimistic about the functionality; partner ecosystem and the experience AWS offers and believe this will lead to continued customer wins.  If AWS continues to witness the same kind of success, investors can hope for significant growth this time as well.

Prime: Amazon keeps its retail business very hard to beat on price, choice, and convenience with the help of a solid loyalty system in Prime and its FBA strategy. The company continues to push advantages exclusively to Prime members, thus encouraging them to spend more on Amazon. It is focused on building video content, primarily for Prime subscribers because the growth prospects in that market are considerable.

Prime is now widely available and generates increased sales for Amazon. Prime Now, the company’s super-fast delivery service, is expanding rapidly in the United States

IoT: Alexa powered Echo devices are going great guns and help the company sell products and services. Alexa has already been integrated into a host of everyday devices for the digital home and there are agreements for more.

The company is racing to build an ecosystem around Alexa to make sure that it stays way ahead of Alphabet GOOGL subsidiary Google's smart assistant, Apple’s Siri and Microsoft's Cortana.

Grocery Push: Amazon has already gone the brick-and-mortar way with books and is treading the same path with other merchandise as well. Its acquisition of Whole Foods indicates that it is targeting the considerably large customer base that still prefers to shop at physical stores.

Amazon Go, the no-queue-checkout-counter grocery store, is going to be a boon for customers who are too worn out to stand in long lines at physical cash counters or are baffled by complicated self-checking counters. It has the ability to completely shatter the traditional brick-and-mortar convenience store setup.

International Expansion: The company has been expanding Prime internationally to strengthen its foothold in international markets and create a launch pad for its other business. It could complement the company’s current expansion efforts such as investments (in India) and acquisitions (like that of Souq.com).

Guidance: In the third quarter, management expects revenues to include a $125 million or 40 bps negative FX impact and come in around $39.25–41.75 billion. Operating income is expected to come in at approximately ($400) million–$300 million.

What Our Model Says

Amazon has a Zacks Rank #5 (Strong Sell) and an Earnings ESP of -1,219.26%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

According to the Zacks model, a company with a Zacks Rank #1 (Strong Buy), 2 (Buy) or #3 (Hold) has a good chance of beating estimates if it also has a positive Earnings ESP. Zacks Rank #4 (Sell) or #5 are best avoided especially if they have a negative Earnings ESP.

Bottom Line

If we delve deeper into Amazon’s key investment areas, we see a futuristic approach. Amazon’s long history of execution, growing focus on innovation, technological prowess and huge cash balance not only give it the flexibility to pursue growth in any area that exhibits true potential but also to create value for investors.

Amazon has never hesitated to sacrifice margins to pursue its long-term objectives, bringing more customers under its umbrella and giving them reasons to stay.

Stocks to Consider

Here are some stocks that you may want to consider as our model shows these have the right combination of elements to deliver a positive earnings surprise:

Applied Materials, Inc. AMAT, with an Earnings ESP of +0.37% and Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Extreme Networks, Inc., EXTR with an Earnings ESP of +9.75% and a Zacks Rank #3.

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