$AMZN Q2 Earnings Preview

by Enis July 23, 2014 11:36 am • Commentary

Event:  AMZN reports its Q2 earnings tomorrow after the close.  The options market is implying about a 6.5% one day move, which is below both the 4 qtr avg of about 8.25% and the 8 qtr avg of about 7.5%.

Sentiment:  Wall Street analysts are bullish on the stock, with 34 Buys, 13 Holds and 1 Sell, and a 12 month price target of $411, despite AMZN’s 10% year-to-date decline, a major underperformer relative to the broader market.  Short interest is only around 2% of the float, though the stock is one of the more highly contested in the investment community.

Options Open Interest:  Calls slightly outnumber puts in terms of total open interest, by a ratio of around 1.05 to 1.  The volumes over the past month have also favored calls, by a ratio of 1.25 to 1.  AMZN has been on a roller coaster in 2014, so the relevant options strikes have changed over time.  At the moment, the weekly 340 puts have the most open interest among short-term maturities, with over 2500 of open interest.  Farther out, the Oct 400 calls have over 10k of open interest.  The Jan15 400 calls and the Jan15 375 puts both have around 7k in open interest.

Price Action / Technicals:  AMZN has had quite a range so far in 2014.  After rising nearly 60% in 2013, AMZN stalled once the calendar turned to 2014.  After a minor new all-time high of $408 on Jan 22, 2014, AMZN moved 11% lower on its January earnings report, and the stock has been negative year-to-date ever since:

AMZN daily chart, Courtesy of Bloomberg
AMZN daily chart, Courtesy of Bloomberg


In the near term, there are two key levels to watch.  First is $380 resistance, which was support in January, and then resistance in March.  On the downside, $340 is important support, as shown by the times it acted as resistance or support in the past year.

Aside from simply this quarter’s earnings move, two other levels to watch are the unchanged mark on the year of $398.79, and the low of 2014, which is $284.38 from early May.

Fundamentals:  We have laid out on numerous occasions the difficulty of analyzing the fundamentals of a company like AMZN.  Dan discussed the issue in a NTT post last month:

Since the stock bottomed in November 2008, to its all time high made in January of this year, it rose more than 1000%. While annual sales have grown from $19 billion in 2008 to this year’s expected $90 billion, operating profits are expected to be just a tad higher than the $842 million back in 2008.

So you get it, as long as sales keep growing to the sky, coupled with new product and service categories, investors have had little worries about mundane things like valuation in their investment thesis.  To be clear, AMZN is a great company with a visionary founder firmly in charge. But even as a happy customer and a fan of Bezos, I am not inclined to be long the stock as management has demonstrated time and time again that they are solely focused on growth and innovation as opposed to profits, which is a strategy that helps a stock go higher until it doesn’t.  So I will avoid the valuation argument altogether and just focus on the set up after the stock’s recent bounce.

Many smart investors remain quite bullish on AMZN, as they are confident the future profitability levers are stronger than ever.  We prefer situations where visibility of cash flows into the investor’s pocket is more clear.

In any case, here is an excerpt from Goldman’s upgrade of AMZN to the Conviction Buy list in early June to illustrate the bull case:

We are adding Amazon to the Conviction List as we believe it represents one of the best risk/reward propositions in the sector following the recent sector rotation. While concerns over AWS pricing, slowing Media growth, and ongoing margin pressures are likely to continue, we believe – given Amazon’s track record of delivering consistently high returns on invested capital –, the ongoing investment in fulfillment and infrastructure will widen Amazon’s competitive lead through initiatives such as Fresh, AWS, and faster fulfillment and product availability, driving incremental growth and, ultimately, profitability.

That ultimate profitability – that’s the crux of the bull/bear argument in AMZN.

Volatility:  On a relative basis, AMZN implied volatility has been better bid over the past 6 months, and has remained well above its 2 year lows, in contrast to most of the broader market:  

AMZN 30 day implied volatility, Courtesy of Bloomberg
AMZN 30 day implied volatility, Courtesy of Bloomberg

AMZN realized volatility has also picked up, even without an earnings report over the past few months.  Much of that volatility has been attributable to the numerous headlines regarding new products, initiatives, and partnerships announced by AMZN management.  That might be fuel for further volatility in the next few months.

My View:  AMZN is on our banned trading list for a reason.  Assigning an appropriate value to this company is extremely difficult given that they have not historically made any profits, and management seems content to continue that strategy as long as investors remain willing to finance the new projects and low margins.

We don’t plan on any new trade in AMZN ahead of earnings tomorrow.  The bar is relatively low (analysts have actually modeled in a year-over-year decline in earnings on a 23% increase in sales), but traders’ reaction to AMZN’s earnings release is notoriously difficult to predict.  We like to joke that we wouldn’t know if the stock would go up or down even if we saw the full press released beforehand.

Technically, the stock looks like it’s range-bound, and implied volatility is relatively elevated, but we’ll stay away, thank you very much.