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Amazon 4Q Earnings Preview: "Prime" Time?

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Amazon (AMZN - Free Report) will report fourth quarter results on Jan 28 after the bell.

The shares carry a Zacks Rank #2 (Buy) and earnings expected surprise prediction (Earnings ESP) of -2.48%, which make it difficult to predict a positive surprise. Valuation also appears rich: Amazon has a PEG of 3.31 compared to 1.11 for the industry.

Our model says there’s a good chance of a positive surprise when a Zacks Rank of #1, #2 or #3 is paired with a positive ESP. In this case, the rank is supportive while the ESP is not. We generally don’t recommend Sell-rated stocks (Zacks Rank #4 or #5) going into an earnings announcement.

That said, Amazon has blown past estimates in each of the last four quarters with the four-quarter average surprise at a whopping 147.97%.

The Zacks Consensus Estimate for 2015 is up 7.5% while that for 2016 is up 17.8% in the last 90 days. For the fourth quarter it is up 3.9%.

Factors in Play

Most of the triple-digit share price appreciation in 2015 was on account of Amazon’s cloud infrastructure business AWS. But while this remains a big deal (especially since it generates most of the profit), the fourth quarter will likely be more about retail because of the holiday season and the fact that retail still accounts for more than 90% of Amazon’s business.

All publicly available numbers for the big shopping days indicate that Amazon has had a super quarter. Adobe’s Digital Index showed a 17% increase in online sales in the 5-day period from Thanksgiving to Cyber Monday with mobile sales hitting a new record. Channel Advisor estimated that sales over the five-day period grew 18% with Amazon growing faster than the market at 24.1%. This kind of growth rate is particularly creditable because it indicates that Amazon is not just the largest but also the fastest-growing e-tailer out there.   

The Prime subscription service has proved itself to be the best weapon to deal with competition. The service, which cost $79 a year a couple of years ago, now costs $99. Not only that – a new report from Consumer Intelligence Research Partners (CIRP) estimates that there are currently 54 million Prime members in the U.S. with 47% of Amazon shoppers having subscribed to the service.

Members’ average spending is $1100 a year compared to $600 for non-members. So Amazon has been focusing on converting shoppers to Prime members and then spoiling them so they never leave. The strategy appears to be working like a charm because believe it or not, memberships are still growing double-digits (up 35% in December according to CIRP).

One of the reasons the Prime membership remains so popular is Amazon’s strategy of piling on the benefits. Today, members get not just the broadest product range and free shipping, but also, increasingly, great choice on content, both books and video. This focus on media, while expensive in the short run ensures that people get whatever they want on Amazon. 

Amazon has scale and a rock-solid strategy. Generally, companies in a dominant position start raising prices, which gets customers looking for competing platforms and arouse regulatory scrutiny. But Amazon does everything it can to get the cheapest product out to customers along with good customer service. Any profits come from scale and its ability to innovate on expense control such as shipping/logistics. As a result, users are happy and competitors can’t find a weak point to get in.

Encouraging Numbers from 3Q

North America Prime subscriptions grew 50% and global Prime subscribers grew 53%. AWS operating profit margin expanded 1,660 bps from the year-ago quarter, operating profit dollars increased 431.6% (511% ex-FX). Accounting for just 8% of revenue, AWS comprised over 52% of profit.TTM cash flow jumped 72.2%. FCF as reduced by lease principal repayments was also up substantially (29.6% sequentially).

Other Stock Picks

Here are some companies you may want to consider as our model shows that these have the right combination of elements to post an earnings beat this quarter:

First Data Corp , earnings ESP of +5.26% and a Zacks Rank #1.

Microstrategy (MSTR - Free Report) , earnings ESP of +2.75% and a Zacks Rank #1.

SolarWinds (SWI - Free Report) , earnings ESP of +2.27% and a Zacks Rank #1

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