Amazon expected to show earnings drop

By Dan Gallagher, MarketWatch

SAN FRANCISCO (MarketWatch) — Amazon.com is expected to report strong sales growth but a decline in earnings for the second quarter as the company continues to invest in its distribution network as well the development of new products — including, according to analysts, a widely expected tablet device.
Amazon AMZN -0.72% is slated to issue its second-quarter report after Tuesday’s closing bell.

Wall Street currently expects strong top-line growth, with sales surging more than 42% to $9.37 billion, according to consensus estimates from FactSet Research.

Earnings are expected to fall to 35 cents a share from 45 cents a share in the same period last year. Operating income is expected to slide to about $196 million from $270 million last year.
Earnings are likely to be “constrained by continued investments” in order-fulfillment centers, technology and content, as well as a “step-up in marketing spend,” wrote Dan Geiman of McAdams Wright Ragen in a note to clients Monday.

Amazon’s operating margins are a closely watched metric. The company guided to a wide range during its last earnings report in April, predicting a margin range of 1% to 2.5% for the period. Wall Street is predicting a strong improvement for the third quarter, with consensus estimates baking in an operating margin of about 4%.

The margin forecast could be a catalyst for the stock, which is up more than 18% from the first of the year, though Amazon’s valuation remains pricey at more than 75 times estimated earnings for the next four quarters.

While Amazon rarely delves into upcoming products and services during its earnings announcements, Ben Schachter of MacQuarie said he expects analysts to inquire about the company’s much-rumored tablet device, which is expected to launch within the next couple of months.

“Tablets will clearly be a focus area for the call, and we expect a lot of questions and few answers from the company,” Schachter wrote in a note to clients.

A tablet would add to the company’s Kindle line of e-readers as a branded device designed to showcase the company’s growing library of digital content.

Along with e-books, Amazon has been building out its online music, movie and videogame stores, along with its “Cloud Drive,” which is a cloud-based digital locker service that can store media files and allow users to play them from any Internet-connected PC.

One risk to the tablet strategy is the low prices the company will likely have to carry in order to effectively compete with the popular iPad from Apple Inc. AAPL +1.20% . Collin Gillis of BGC Partners said such a move is likely to weigh even heavier on Amazon margins.

“It is also very reasonable that the company produces a tablet product to complement its recent music-locker service and movie-streaming service — and we expect that the company maintains aggressive pricing that could result in the hardware being sold for no profit,” Gillis wrote Monday.

Anthony DiClemente of Barclays countered that an Amazon tablet could drive adoption of the company’s digital content, writing that “a tablet should help offset future declines in the physical media business as media shifts from physical to digital.”

Media, he noted, represented 40% of Amazon’s sales in the first quarter of this year.

Dan Gallagher is MarketWatch's technology editor, based in San Francisco.