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As cloud business shines, Amazon facing 'many fires' elsewhere

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As cloud business shines, Amazon facing 'many fires' elsewhere

Wall Street analysts expect to see downward macroeconomic trends reflected in e-commerce giant Amazon.com Inc.'s July 28 earnings report.

An expected decline in discretionary consumer spending has already driven Amazon's earnings estimates and target share price down, as thin margins make the company vulnerable to short-term disruptions. Long term, however, analysts see reasons for optimism, saying market share growth for the company's Amazon Web Services cloud offering and enhancements to its Prime membership should support overall performance into next year.

"Amazon's stock valuation is dependent on that cloud business doing really well, and AWS is not a recession-proof business," said Arun Sundaram, senior equity research analyst at CFRA Research. "But if we do enter a recession, Amazon will come out of this stronger, with more market share."

Amazon shares were down 31.1% year-to-date as of market close July 26. By comparison, the tech-heavy Nasdaq was down 26% over the same period.

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Cloud growth

Demand for cloud infrastructure remains robust amid an increase in cyberattacks and the ongoing digitization of enterprise workflows, said Jonathan Woo, research analyst at Phillip Securities Research.

Amazon's cloud unit generated $18.44 billion in net sales in the first quarter, representing 16% of total net sales within the company. AWS held about 33% of the cloud infrastructure market during the period, compared to Microsoft Corp.'s 22% and Google Cloud's 10%, according to estimates by Synergy Research Group.

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In the event of a downturn, AWS could see some pullback if some of its clients need to conserve cash. Startups or smaller tech companies in particular may need to hold back, said AB Bernstein senior analyst Mark Shmulik.

According to a 451 Research report titled "SME IT spending in Q3 to drop amid economic uncertainty," about 26% of small to medium-sized enterprises are expecting their information technology spending budgets for the second half of 2022 to decrease. That compares to 15% three months ago, "indicating an increase in overall sluggishness in the IT spending outlook for the remainder of 2022," according to the report.

Margin pressure

While the cloud business is poised for long-term growth, Amazon today still earns the majority of its revenues from its online stores.

Walmart Inc., one of Amazon's foremost e-commerce rivals, recently said it expects its earnings per share for the second quarter to decline between 8% and 9%, and between 11% and 13% for the full year.

"For Amazon, we would expect progress with supply chain and logistics overbuild headwinds in [the third quarter] but some additional gross margin pressure driven by consumers trading down to less discretionary items, and possibly some [first-party] inventory clearing," wrote Bank of America Global Research analysts Justin Post and Michael McGovern in a research note.

Amazon is expected to generate $119.16 billion in second-quarter revenue, according to S&P Capital IQ consensus estimates, up from $116.44 billion in the first quarter. The company is expected to generate second-quarter net income of $1.08 billion, compared to a loss of $3.84 billion in the first period. Notably, the first-period results included Amazon's first quarterly loss in seven years.

"With the big internet names, and Amazon in particular, there's a lot of questions," Shmulik said. "It's not just about solving one issue; it certainly feels like all of these companies are grappling with many fires on many fronts."

Prime growth

One factor that could help fuel online sales is Amazon's efforts to expand the scope of its commercial ecosystem and enhance the value of a Prime membership, said CFRA's Sundaram.

The company has been ramping up investment into the Prime Video streaming offering, which could help bring more advertising dollars if Amazon is able to take ad market share from its competitors, Sundaram said.

"Three to five years ago, [Amazon] wasn't really invested in that space," Sundaram said. "That wasn't a major value proposition for their customers. But now it's starting to really get there."

The company is also investing in next-day shipping services, which is likely to spur online buying but may impact margins.

In February, Amazon raised the annual fee for a Prime membership to $139 from $119, or $14.99 on a monthly basis.

"One of the reasons they're becoming a little bit aggressive this year and adding these new value offerings is because they're trying to justify their price increase," Sundaram said.

451 Research is part of S&P Global Market Intelligence.