Amazon (AMZN) stock recently received its first downgrade from Wall Street following its earnings results, ending its streak of unanimous bullish analyst consensus. While I maintain a “Buy” stance on AMZN for the long term, I believe there are important factors to consider regarding the stock’s short-term behavior. Amazon’s Q2 results fell short of market expectations, missing revenue estimates and providing weak Q3 guidance.
Consequently, shares dropped nearly 12% immediately after the announcement but gradually recovered as the market digested the results, which did not intensify the underlying bearish momentum.
In this article, I will highlight the concerns raised by the recent downgrade. While I agree with many of these points, I will also explain why I remain bullish on Amazon shares in the long term.
Amazon Stock Experienced a Rare Downgrade
As one of the key players in the AI gold rush, Amazon’s bullish thesis has been strongly supported by Wall Street, which was evident in the consistently positive analyst consensus. Before the Q2 earnings report, every analyst covering AMZN stock had an outperform rating.
This unanimous optimism reflected Amazon’s impressive performance over the past 18 months, during which the share price nearly doubled from its lows in 2022. This strong performance was driven by Amazon’s strategic shift towards higher-margin services, such as cloud computing and advertising, rather than relying on first-party retail sales. As a result, profitability in its e-commerce operations rebounded significantly, with EBIT rising from 1.8% in Q4 2022 to 9.9% in the most recent quarter.
However, following a mixed Q2 earnings report, Amazon’s previously unanimous bullish consensus received its first downgrade. Itaú BBA analyst Thiago Kapulskis was the first to adjust his stance, citing signals in the Q2 results that suggested a shift from focusing on margin recovery to concerns about top-line growth. As a result, he became the sole analyst on Wall Street to issue a “market performance” rating on AMZN.
Kapulskis’ rationale for the downgrade centers on the potential impact of weaker economic activity on Amazon. He observed a notable slowdown in the third-party and advertising businesses, particularly in North America. It was also concerning that these issues were not addressed during the earnings call.
Additionally, Kapulskis noted comments about Amazon preparing for more challenging logistics in electronics and higher-end categories, further suggesting that reduced economic activity in the U.S. might be affecting the company.
Is Amazon’s AWS Enough to Overcome Current Challenges?
This is where the article gets interesting. My bullish sentiment relies on one of AMZN’s most profitable segments—Amazon Web Services (AWS), which boasts an impressive operating profit margin of 35.5%. However, I also find myself in dispute with Mr. Kapulskis’ analysis on this matter, as he’s not confident this segment is enough to cover less profitable segments in Amazon’s operations. To clarify my position, I must highlight my opposing take on this issue.
My View on AWS
As stated above, AWS has posted an impressive 35.5% profit margin year-over-year. Although this margin has slightly decreased from 37.6% in the previous quarter, it remains significantly higher than the International segment, which is more than 35 times less profitable and about six to seven times more profitable than the North American segment.
In Q2, AWS reported net sales growth accelerating from 12% to 19% over the past four quarters. In my view, this remains the primary driver of Amazon’s growth story, which is likely still in its early stages. Amazon, the undisputed leader in the cloud market, is expected to see an increased share of its business from the cloud segment as artificial intelligence takes on a larger economic role both in the U.S. and globally.
The Analyst’s View on AWS
However, according to the Itaú BBA analyst, AWS’s strength may not fully counter Amazon’s challenges. Kapulskis suggests that, despite AWS’s continued growth and strong margins, AI investments could eventually pressure margins due to increased depreciation and amortization. Consequently, Amazon’s guidance indicates that the EBIT margin might plateau, even with AWS’s robust performance and near 20% growth.
These concerns prompted Kapulskis to lower his price target for Amazon stock from $210 to $186.
AWS Conclusion
I believe the analyst’s concerns about Amazon facing headwinds from weak spending trends are valid. However, challenges like customers opting for lower Average Selling Price (ASP) products are typical during a challenging macro environment rather than indicative of weakening fundamentals. In fact, Amazon’s retail operations continue to outperform competitors and maintain its leadership position in the market.
Moreover, beyond the growth opportunity with AWS, Amazon also has significant potential to leverage sales through upcoming integrations with social media platforms like TikTok and Pinterest (PINS). These integrations should bolster other key areas of its business, such as advertising.
Is AMZN a Buy, According to Wall Street Analysts?
The Itau BBA analyst may have been the only one to downgrade Amazon after its earnings report, but he wasn’t the only one who reduced the stock’s price target. Several other analysts also lowered their price targets for AMZN, which now has an average price target of $223.00. Based on the latest share price, this suggests a sizable upside potential of 25.92%.
Among those who trimmed their targets is Brian Nowak from Morgan Stanley (MS), who lowered his price target from $240 to $210. While maintaining his bullish stance on the stock, he removed AMZN as his “top pick,” calling the company’s June quarter “disappointing and multi-faceted.”
Despite these revisions, the consensus remains largely bullish, with 41 out of 42 analysts rating the stock as a “Buy.”
Key Takeaways
Even with Wall Street’s recent downgrade and other analysts’ price target cuts, I’m maintaining a “Buy” rating on Amazon. AWS’s impressive growth and Amazon’s strong retail position continue to bolster its long-term potential. While short-term volatility is likely due to tougher market conditions, the company’s strategic moves across multiple segments and solid fundamentals should help sustain its bullish outlook.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.