Investors have been really impressed by Amazon’s fourth quarter earnings report.
And there were some impressive numbers in the report for the quarter. Amazon’s cloud services unit, AWS, saw revenue growth accelerate again to a 40% growth rate. Revenue growth from advertising did decelerate to a 32% growth rate but that’s still really impressive given what other companies have been saying about a weak ad market in the quarter.
Frankly, if Amazon were just the cloud and digital advertising businesses I’d be shouting buy even if the stock is trading at a trailing 12-month price-to-earnings ratio of 49.81.
But Amazon is also an e-commerce company and the numbers there didn’t look all that great. Growth in revenue from the company’s online e-commerce stores fell by 1% year over year. Revenue from third-party sellers (companies that sell there goods through Amazon) grew by just 11% year over year.
You could argue that these e-commerce numbers are a result of tough year-over-year comparisons with the fourth quarter of 2020 when everybody wanted to shop online because of the Pandemic. This anemic figures from the e-commerce business are just a one-time thing, you’d argue.
I have to say that I disagree. I think there’s more going on than just tough year over year comparisons. More on that below.
And therefore I’m saying Thank you to the market for the 16.25% gain in the shares from February 4 (the day after the company’s earnings announcement) to the close on February 8. And I will sell these shares out of my long-term 50 Stocks Portfolio on Wednesday,February 9. I added those shares to that portfolio on April 19, 2016. I’ve got a gain of 420.27% in that position as of the close on February 8. I would be more than happy to rebuy the stock–maybe in a different portfolio–at a lower price but given what I see as the problems in the e-commerce business and some questionable (to my mind) capital allocation decisions recently, I don’t want to own the shares at this price.
I assume that many of you will disagree with my decision to sell. So let me explain so you can run your thinking up against mine.
Wall Street cheered when Amazon announced that it would raise the price of its U.S. Prime membership, which offers faster and frequently free delivery and streaming video, to $139 a year from $119 or a 17% jump. That’s the price increase for customers who pay for Prime in one annual lump sum. Prime customers who pay monthly will see a slightly bigger price increase. Monthly bills will go up by $2 to $12.99 or $14.99 a month. That’s an annual cost of $156 to $180 for Prime.
There’s a lot of like about that price increase. With 200 million Prime customers, the price increase generates huge cash flow. A recent price increase by Netflix (NFLX) gives Amazon (and more directly Disney (DIS)) some cover. And the last time that Amazon raised the price of Prime (in 2018) to $119 from $99 it didn’t generate a wave of cancellations and Prime just kept on growing.
But 2022 isn’t 2018. Amazon’s competitors like Target (TGT) and Wal-Mart (WMT) have gotten their digital acts together in impressive fashion. And there’s increased digital shopping competition from unsurprising (Alphabet (GOOG)) and surprising sources. For example, the day after the price increase I got an email from one of my banks, CapitalOne (COF), touting its own online digital bargain hunting/coupon searching shopping service. Look, the bank’s offer said, sometimes Amazon’s free and/or faster shipping is really a significant benefit, but on some purchases you really don’t care if the goods arrive the next day or two days or five days from now. And in those circumstances you just want to find the lowest price, CapitalOne noted. And our digital shopping service can do exactly that for you. And it’s free. Not a bad selling proposition when Amazon has just raised the price of Prime.
The decision to raise the cost of Prime now is–to a degree–a reversal of earlier thinking at Amazon that looked to monthly instead of annual payments as a way to growth Prime membership with households at lower income levels. All the data suggests that the monthly program has done just that. Does this price increase to a top of $180 a year–which is a lot of cash–now undo some of the increase in the addressable market? I don’t know (but I’m not all that anxious to pay 50 times earnings while I wait for the data to arrive.)
But to me the price increase for Prime is just a reminder of how expensive Amazon’s logistics have become.
Statista has pulled together historical data from Amazon to show the rise in Amazon’s logistics costs both absolutely and, more importantly, for investors as a percentage of net sales. Back in 2009, logistics costs come to 23.3% of net sales. By 2015 that was up to 23.3% of net sales. 2018 continued the increase to 26.5%. In 2021 the percentage climbed to 32.3% or a huge $151.86 billion. (See their work at https://www.statista.com/chart/17207/amazon-shipping-and-fulfillment-costs/)
Now there’s a good side to all this spending. It will be hard for any competitor to dislodge Amazon from the e-commerce leadership slot without putting billions upon billions into matching Amazon’s logistics prowess.
But there are also three downsides to Amazon’s logistics spending.
First, all this spending means that an investor buying Amazon at a price-to-earnings ratio of 50 is getting a company that generates comparatively low returns on its invested capital. Return on invested capital for Amazon in 2019 was 11.72%. Return on assets was 5.9%. Operating margin was 5.18%. Compare this to Alphabet (GOOG), which isn’t building warehouses to hiring workers to ship boxes. Return on invested capital in 2019 for Alphabet was 16.5%. Return on assets was 13.5%. Operating margin was 22.2%. All that means is that it requires Amazon to invest a lot more dollars to generate return for shareholders than it does for Alphabet.
Second, Statista has broken down Amazon’s logistics costs into two categories, shipping and fulfillment. Fulfillment is a category that includes operating and staffing fulfillment centers (the warehouses that ship out stuff), customer service centers, and physical stores. What’s striking is that fulfillment has in recent years grown even faster than shipping. In 2020 Amazon’s shipping costs, which include sortation and delivery centers and transportation costs, amounted to $76.7 billion. Fulfillment costs added another $75.1 billion making up roughly half of the company’s logistics bill. What the figures argue is that Amazon has become a very labor intensive company and a lot of the growth in the size of the company’s workforce has come in the last year or two. In 2020 the company created 500,000 new jobs and added another 170,0000 in the first nine months of 2021. Amazon now has 1.5 million employees across the world and is second in the size of its workforce only to Wal-mart, which employs 2.2 million worldwide. Which makes Amazon very, very sensitive to rising labor costs. But the company’s labor cost structure may be even more subject to disruption than these raw numbers suggest. Amazon chews through workers at an amazing pace. The average Amazon warehouse worker leaves within just eight months. That’s a reaction to the high stress, breakneck speed, constant monitoring, and stingy breaks that are standard at Amazon’s warehouses. It makes me wonder if Amazon’s business model is actually sustainable.
Third, I’ve got to wonder about Amazon’s infatuation with physical stores. Buying Whole Foods Market looks to me–as a once faithful and now infrequent Whole Foods shopper–to be a failure. (And, of course, there is the question of why a company that itself should be looking to raise margins would invest in the notoriously low margin grocery business.) And why the roll out of Amazon standalone stores–even if they have really neat automated technology at point of sale? Why the talk about a partnership with Kohl’s (KSS)? As a way to handle returns? One of the big doubts about Amazon over the years has been about the company’s investing discipline. (Why build hardware for TV or to read e-books, for example?) The problem doesn’t seem to have disappeared. It may be in the company’s DNA. And as an investor I don’t like companies that seem focused on buying into businesses with low margins.
If you’re an Amazon bull, then you think the upside justifies any of the risks that I’ve mentioned (if you think any of them are real, that is.) Morningstar, which I’d call an Amazon bull, has a price target of $4,100 for the stock.That’s about 27% higher than the February 8 close. Morningstar also ranks that target as “uncertain.”
I’ll sit this one out for a while. And maybe use the sale of this stock as a source of cash for buying other stocks with less uncertainty and more upside.
