What a difference between Facebook and Amazon June quarter results make
Key points:
- As we sail into the seasonally stronger second half of the year, I am boosting our price target on Amazon (AMZN) shares to $2,250 from $1,900, which keeps the shares on the Tematica Investing Select List.
- After a disappointing outlook for the back half of 2018 due to slower revenue growth and mounting spending costs, we will remain on the sidelines with Facebook (FB) shares for now.
Over the last few days, we’ve had quarterly results from two companies that are riding tailwinds associated with our Digital Lifestyle investment theme – Facebook (FB) and Amazon (AMZN). The report from each company, however, and their reception from investors couldn’t have been more different.
Amazon’s earnings report reflected continuing strength as consumers across the globe embrace digital commerce and the company’s Amazon Prime service, while Amazon Web Services saw its business and profits surge as cloud adoption continues. Facebook on the other hand … is a very different story. A story that included rising costs and slowing revenue growth, which led the social media giant to not only miss revenue expectations but signal slower growth and earnings ahead.
No surprise then that Facebook shares were pummeled, while Amazon traded higher. Now let’s break both of those reports down, focusing on what matters with each.
Amazon – Operating Income Crushes Expectations
Last night, Amazon reported blowout June quarter earnings, which more than overshadowed a modest top-line miss as its operating income not only crushed expectations but shattered the company’s own guidance. On almost every front for each of its three business segments — North America, International and Amazon Web Services (AWS) — the company continued to make solid progress, delivering its third straight quarter with profits over $1 billion and continuing the string of a dozen profitable quarters. I doubt we’ll be hearing much from those “no profit at Amazon” naysayers anymore.
As I’ve said previously, one of the “secret weapons” that Amazon has under its hood is it’s the high margin and cash flow rich Amazon Web Services (AWS) division, and the June quarter clearly confirmed that. Revenue at AWS rose 49% year over year. That’s a figure that clearly shows Amazon is fending off the likes of Alphabet (GOOGL) and Microsoft in the cloud computing space. To me, the more important figure was the operating profit that AWS generated, $1.6 billion, which is up an impressive 80% year over year, and roughly 47% of the company’s overall operating profit. On the earnings call, management shared that machine learning, artificial intelligence and analytics have been key drivers of AWS’s revenue gains, which to me cements Amazon’s position in our Disruptive Innovators investing theme.
The balance of Amazon’s operating profit was generated by the company’s North American business as International continued to generate operating losses, albeit less than a year ago, as Amazon target future growth in those markets.
That profit generation and prospects for more led Wall Street to overlook the modest top-line miss for the quarter, but then again, it’s hard to complain at the 39% year over year revenue growth Amazon did deliver. Amazon also served up a September quarter revenue forecast in the range of $54-$57.5 billion, which was also below analysts’ consensus estimates. Here again, those same analysts will have to adjust their profit forecasts higher following AWS’s performance in the June quarter. My take is the combination of the recent Prime membership price increase ( a 20% increase to $119 per year) and Prime Day paired with what will likely be an aggressive attack on Back to School shopping could make for conservative 3Q 2018 revenue guidance.
One other potential upside driver for Amazon in the coming quarters is its digital-advertising business. In the segment breakdown, this is found in the often overlooked “Other” category, which generated $2.1 billion in revenue for the June quarter (wish I had an “other” revenue source like that!). While it accounted for less than 4% of overall quarterly revenue, these Other items grew nearly 130% year over year. Amazon does not disclose Other’s profitability metrics, given that the digital advertising business is one of the larger ones in the category with billions in revenue and hundreds of thousands of customers, but odds are it has the potential to be wildly profitable if it isn’t already.
For those unfamiliar with Amazon’s digital advertising business, it is attracting spending that would have traditionally taken place in brick-and-mortar stores to ensure good “shelf placement” and other brand initiatives across Amazon.com. Small today, compared to advertising efforts at Google and Facebook, but Amazon is able to tell its advertising customers when a consumer actually bought a product, directly showing an ad’s effectiveness — something Google and Facebook can only accomplish through tracking cookies and other data mining techniques, which are not 100% accurate and are also coming under the scrutiny of privacy advocates more and more these days. Of course, all of this also allows Amazon to amass a sea of data that it can use to formulate its next move with its own private label products — forcing retailers into a dance with the devil of sorts.
If there was anything disappointing on Amazon’s earnings call it was the lack of comment on the company’s announced acquisition of online pharmacy PillPack. Not surprising given the company’s usual tight-lipped nature, but still disappointing.
- As we sail into the seasonally stronger second half of the year, I am boosting our price target on Amazon (AMZN) shares to $2,250 from $1,900, which keeps the shares on the Tematica Investing Select List.
Facebook – the bloom is off the rose
Ouch! There is no other way to say it given the 19% drop in Facebook (FB) shares following what can only be described as unexpected results inside its June-quarter earnings report. While the market might have been caught flat-footed, it was the privacy and user data issues at Facebook that led us to remove the shares from the Tematica Select List back in March as we saw the risk-reward trade-off to be had as limited.
Despite those slipups, expectations have been running high for Facebook as advertisers look to reach increasingly connected consumers across Facebook, Instagram and the company’s other social media platforms. Indeed, those expectations and the potential impact to Facebook’s revenue and bottom line were what catapulted the stock from $160 in late April to Wednesday’s closing price of over $217.50. That’s a surge in excess of 35% in 14 weeks, compared to a 6.7% rise in the S&P 500 over the same time frame.
But that was before the June quarter earnings report and conference call…
While Facebook reported a bottom line beat and rising revenue per customer in the U.S. for the June quarter this week, the rest of the earnings press release and conference call took the bloom off the rose at the social media juggernaut. Revenue for the quarter missed expectations and management guided for declines in revenue growth in the back half of 2018 as spending on safety and content continue leading to a one-two punch to its operating margins. For those tracking monthly and daily active users, there was saw a sequential dip with the U.S. users flat but a 3 million drop in Europe due in part to General Data Protection Regulation (GDPR) that went into effect in late May.
You may recall that earlier this year management telegraphed a shift toward a focus on building community, which would likely hit revenue growth, but as management shared on the earnings call, it expects “revenue growth rates to decline by high-single-digit percentages from prior quarters sequentially in both Q3 and Q4.” Not exactly the vector or velocity that investors had been expecting at all.
Adding to the shock and awe of it all was the simple fact that this was the first time Facebook has missed expectations since the March 2015 quarter. However, continued investment and revenue pressure is expected to take its toll and we are seeing operating margin expectations reverse course — going to mid-30% vs. the mid-40% that was previously forecasted by Wall Street for 2018 and 2019.
The net result has Facebook shares crashing as analysts put pencil to paper to re-forecast top and bottom line expectations. While that happens, we’ve already seen several investment banks slash their price targets to the $180-$185 level and a number of them also cut their “Buy” ratings to “Hold.”
Of course, the main question is that since March we’ve been on the sidelines with Facebook shares as of late, we have to ask is now the time to jump in? The removal of Facebook from the Tematica Investing Select List stemmed from the potential fallout from Cambridge Analytica as well as implications from the phase in of GDPR. There was also the hefty amount of insider selling on behalf of CEO Mark Zuckerberg as well as COO Sheryl Sandberg. When management is selling that much stock that fast, it’s usually not a good sign. At a minimum, and no matter the actual reason for the sale, it raises a flag.
Getting back to the question raised, above, we believe it hinges on the value in the shares relative to revised EPS expectations and management gaining back some credibility.
Do I expect advertisers will continue to utilize all of Facebook’s platforms to reach consumers? Yes, but even Facebook has stated that corporate advertising using Instagram’s Stories is ramping slower than expected.
For me, Facebook shares will sit in “stocks to keep tabs on” group until we see user engagement metrics rebound and the share price reflects not only revised growth prospects but a favorable value to be had. I don’t expect that to happen in just a few days. That said, I’ll be watching how those revised EPS and revenue expectations shake out. Thus far, 2018 EPS expectations have dropped to $7.31 from $7.74, while those for 2019 have fallen to the $8.50 level from nearly $9.30. Hefty cuts, but odds are we won’t see the full impact on consensus revisions for at least a few more days.
