Takeaway: This event is in line with our view that AMZN is stepping on the gas to maintain its dominance, to the detriment of near-term profitability.

This Amazon Q was much like we expected. Solid topline, margin weakness, AWS slowing with lower margins – the weakest gross margin performance AMZN has put up since 2011.  Amazon is clearly in investment mode, don’t underestimate its appetite to invest, especially when it sees potential for weakening competitors.  Would you think a company this big was about to add another hundred thousand employees in 1 quarter at this point of the cycle!?  Well it did. This has been our short call all along, TGT and WMT stepped up their ecom spending over the 2-3 years.  Amazon was not about to let them gain much ground, hence re-entering investment mode, gross profit slowing and margins going down all to set up the next big leg of growth over the long term which has made the trend bearish for AMZN. We don’t want to get too greedy short side on one of the best and most dominant companies in a generation, that is doing the right thing by investing in its business to gain share in the future. We’ll see where the stock trades tomorrow and evaluate our positioning accordingly.


Revenue

  • NA revenue was strong, accelerating 450bps (ex physical stores).  That’s huge growth for the scale of this business at this point in the cycle.  Paid units were up 22%, that’s ramping from up just 10% 2 quarters ago.
  • Physical stores were down 1.3% despite Amazon still opening some doors. Whole Foods evidently underperforming.
  • International accelerated 400bps in C$ capitalizing on the easy compare.  Per guidance, it may have had some help from a shift in the Diwali calendar that is negatively impacting 4Q.
  • AWS slowed again to +34.7%, 260bps below 2Q growth.  The company hinted last Q that this slowing growth rate was potentially becoming the new norm via the law of large numbers.


Margins

  • Gross margins were down 70bps, the first time they have been down in a quarter since 2011.  People shouldn’t really be surprised with this result though.  The Prime 1-Day launch has clearly weakened gross margins on a 1 and 2 year basis, and the company was comparing against the 2nd best gross margin quarter EVER.
  • SG&A continued to accelerate as the company added nearly 100k to the headcount in preparation of fulfillment needs for 1-day shipping heading into holiday. In addition the company acknowledged it's adding people in sales and marketing within AWS to sustain growth and share gains in that business.


Guidance

  • The market may be puzzled by the 4Q revenue guidance and its implied weakness.  However, we have been highlighting for years the “4Q Effect”, as we call it, where the law of large numbers coupled with the rest of retail getting crazy promotional means AMZN’s rate of share gain slows each year, causing ~350bps slowdown in revenue growth every 4Q.  This 4Q will be no different.
  • The company also noted a timing shift of the Diwali holiday from falling entirely in 4Q last year, to partially in 3Q this year.  As well as the Japan consumption tax increase indicating some early purchasing for Amazon.
  • The last thing to consider, which the company did not mention, is that this year there will be 6 fewer selling days in the prime selling season from Thanksgiving to Christmas.  Faster shipping will help offset one or two of those days, but it likely has an impact on total holiday ordering vs last year.
  • The 4Q expense impact of 1-day Prime is expected to be $1.5bn, nearly double what the company was expecting for 2Q. That drives much of the ~50% EBIT guide down vs street, as well as incremental investments in AWS.


Macro

We are now out of Macro Quad 4, heading to quad 2 or 3.  Historically the only time you really want to avoid Amazon is in Quad 4, but a Quad 3 does mean real growth slowing (generally not good for consumer).


Ecosystem

The key read from this event is that speed matters.  Prime 1-day took unit growth, for such large a company with such a dominant market position, from 10% to 22% in 2 quarters.  Amazon added $8.3bn to NA online revenue this Q YY.  That translates to ~$14bn in incremental US online sales at retail for Amazon. That is over half of all the incremental US non-store retail in 3Q19, and about 38% of total retail (ex food service, auto and gas). If you operate in general merchandise and are not investing for speed of delivery online (TGT), you are putting yourself in a very dangerous long term competitive position.

AMZN | Bearish Print In Line With Our Thesis - 10 24 2019 amzn chrt1

AMZN | Bearish Print In Line With Our Thesis - 10 24 2019 amzn chrt2