After-hours drop by nearly 7%! Profits temporarily give way to AI spending, Amazon's Q3 profit guidance lower than expected

According to Zhitong Finance, Amazon (AMZN.US) announced its financial performance for the second quarter. In the quarter ending June 30, total revenue increased by 10% year-on-year to $148 billion, slightly below analysts' average expectation of $148.8 billion. Operating profit was $14.7 billion, nearly doubling year-on-year, with analysts' average expectation around $13.6 billion, raising the operating profit margin from 5.7% in the same period of 2023 to 9.9%. Earnings per share were $1.26, higher than the $0.65 in the same period last year and also exceeded expectations. Despite this, risking Wall Street's dissatisfaction, Amazon informed investors that profits will temporarily give way to substantial spending in artificial intelligence. The company's profit guidance for the third quarter is also below Wall Street's expectations.

Q2 operating expenses for Amazon increased by 5.2% to $133.3 billion, lower than Wall Street's expectations. The company's workforce increased by 5% to over 1.53 million.

The cloud business, which saw historically low growth in sales last year, continued to recover in the second quarter. AWS revenue increased by 19% to $26.3 billion, exceeding expectations, and achieved sequential growth for the second consecutive quarter.

Despite profits and cloud computing sales in the second quarter exceeding analysts' expectations, the stock price still fell after hours. As of Thursday's close, Amazon's stock price has risen by over 20% this year, but investors were disappointed with the company's forecast of current quarter sales below Wall Street's expectations. After the earnings announcement, Amazon fell by about 7% in after-hours trading. The stock has risen by 21% this year.

Looking ahead, the company expects operating profit for the quarter ending in September to reach $11.5 billion to $15 billion, with analysts' average expectation at $15.7 billion. Amazon also provided conservative revenue guidance for the third quarter. The company stated that sales will grow by 8% to 11%, reaching $158.5 billion, with analysts' average estimate at $158.4 billion.

Substantial capital expenditures will continue to grow, with significant investments in the AWS cloud division

After focusing on cost reduction over the past two years, Amazon CEO Andy Jassy is heavily betting on the flourishing development of generative artificial intelligence. Generative AI can create text, video, and images based on simple user prompts. Amazon stated that this opportunity represents "operational business with billions of dollars in revenue."

Since Jeff Bezos founded Amazon 30 years ago, the decision to invest in short-term investments for long-term growth opportunities has always been ingrained in Amazon's DNA. However, investors usually do not favor this behavior. DA Davidson analyst Gil Luria said, "Amazon has been making significant investments at the expense of sacrificing short-term profit margins, and they seem to be planning to make significant investments in the remaining time this year." Luria said that the good news is that most of the funds are flowing into Amazon Web Services (AWS). The department's sales growth in the second quarter exceeded analysts' expectations.

At a press conference after Amazon's second-quarter earnings announcement on Thursday, Chief Financial Officer Brian Olsavsky said that the company's capital expenditures for the first half of the year were $30.5 billion, implying second-quarter spending of about $16.5 billion, including funds for the data centers needed to power AWS. He then promised to invest more in the second half of the year, with most of the spending going towards supporting the growth of AWS infrastructure. Olsavsky stated, "We see strong demand for both machine learning and non-machine learning workloads."

Wall Street grows impatient with massive AI spending

Like other major tech companies, Amazon is increasing capital expenditures, investing in AI infrastructure and development. However, in recent weeks, investors have become increasingly impatient with tech companies' efforts to profit from their large-scale investments in AI.

Microsoft (MSFT.US) announced on Tuesday that its Azure cloud computing business growth was slowing and that it expects to continue to invest heavily in data centers, with capital expenditures for the fourth quarter jumping from $14 billion in the previous quarter to $19 billion, including server leasing; subsequently, the stock price fell. The next day, Meta (META.US) reported optimistic earnings, expecting this to buy time for its AI investments to pay off, leading to a significant increase in stock price. Last week, Alphabet (GOOGL.US) reported a significant increase in costs, causing the stock price to fall, surprising Wall Street and overshadowing better-than-expected quarterly sales.

Alphabet and Microsoft had previously warned investors that costs for developing expensive AI software and services for the full year would remain high; investors interpreted this as the return on this popular technology possibly taking longer than initially expected.

Daniel Morgan, Senior Portfolio Manager at Synovus Trust, said, "Wall Street doesn't have much patience. They see you spending billions of dollars, and they want to see a significant increase in revenue. If these companies' performance doesn't exceed expectations, and far better than expected, they will be eliminated."

Retail business under pressure

When discussing revenue prospects, Olsavsky stated that the company "sees cautious consumers looking for deals." He added that major news events, including the Olympics, seemed to disrupt normal purchasing patterns in the current quarter, making sales forecasts more challenging In terms of retail business, Jassy and Olsavsky pointed out that in the second quarter, consumers continued to lean towards lower prices, and they expect this trend to continue into the third quarter as consumers remain cautious and vigilant in seeking bargain goods. Physical store sales increased by 4% to $5.2 billion. Online sales grew by 5% year-on-year to $55.4 billion.

Olsavsky stated that the reason for the lower-than-expected revenue is that consumers are choosing to purchase cheaper products, leading to a decrease in average selling price (ASP). Olsavsky said, "What we're seeing is the ASP of products customers are choosing and a lower ASP. They continue to be cautious in spending and are opting for lower ASP products."

Strong cloud computing performance was offset by weakness in Amazon's core e-commerce business. Amazon's seller services and advertising revenue were both below expectations. Amazon's online retail business faces fierce competition from low-cost retailers like Temu and Shein. To counter the impact of soft consumer demand and competition, Olsavsky stated that Amazon's two-day discount sales event in July was "the largest ever," but did not provide specific details.

Analyst Sky Canaves from EMarketer stated that there was "soft consumer spending" in the online business this quarter, with a decline between major sales in March and July. She said, "Amazon will have to position its products and promotions to capitalize on these trends, such as reportedly planning to launch a discount department similar to Temu's before the holidays this year."

Canaves mentioned that as more consumers seek value for money, the company has had to offer more entry-level prices, expand the range of Oscar Mayer products in dollar stores, and introduce Capri Sun multi-pack beverages.

An analyst noted that the slowdown in retail sales growth is driving after-hours selling of Amazon. M Science analyst Charles Rogers stated, "In terms of re-acceleration, they have shown continued momentum in cloud computing, so I think investors will definitely be more optimistic, but retail is definitely a factor currently dragging down the stock."

Advertising Business Below Expectations

Amazon's advertising revenue also fell short of expectations, which is a closely watched metric as competition with rivals Meta, OpenNewTab, and Google intensifies. According to LSEG data, advertising revenue for the quarter was $12.8 billion, a 20% year-on-year increase, while the average expectation was $13 billion. Earlier this year, the company began placing ads in its Prime Video service for the first time. However, Olsavsky stated that he is satisfied with the advertising performance.

Amazon's advertising arm has become one of its largest profit sources, with most ad sales still coming from sponsored product listings on its online store. The company has introduced new products and expanded its market share in the digital advertising space, competing with Meta and Alphabet. Among online advertising companies, Meta saw the strongest quarterly revenue growth at 22%. Google's ad business only grew by 11% this quarter. Snap reported a 16% increase in revenue compared to the same period last year.