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Amazon Stock: Overcoming Growth And Margin Woes

Amazon’s problems this year transcend lower growth and tough comps. As supply chain costs rise, e-commerce margins have compressed. When will the company overcome the challenges?

Following Q3 earnings, Amazon stock  (AMZN) - Get Free Report price quickly dropped 5% in just a few days. Investors seemed disappointed in e-commerce: growth was lower than expected and the online retail seems to be the culprit in lagging Q4 guided growth of 4% to 12% — analysts were projecting 13%.

But revenues were not the only problem. Amazon’s P&L also took a hit from lower cost efficiency. Operating margins for the North America segment fell from 3.8% to 1.3% on a yearly basis, while International’s dipped from 1.6% to -3.1%.

For Amazon stock to find long-term momentum, e-commerce must show signs that it can excite investors once again. But when will it?

Figure 1: Amazon's Spheres in Seattle, WA.

Figure 1: Amazon's Spheres in Seattle, WA.

(Read more from the Amazon Maven: How Amazon Stock Can Build Momentum Again)

Amazon: e-commerce king

First, we start with the good news. Amazon has not grown as fast as many once believed that it would in 2021, but this does not mean that the company has been underperforming lately.

The pandemic accelerated Amazon’s e-commerce dominance, especially in the US. A report from e-marketer shows pre-pandemic projections pinning Amazon’s US sales growth at 17%. Instead, the Seattle-based giant delivered 44%, causing its market share to rise from 39.8% in 2020 to 40.4% in 2021.

Stats from Oberlo show that e-commerce in the US could grow at the expense of brick-and-mortar revenues. Projections are that online sales will represent nearly 25% of US retail by 2025 — a seven-plus percentage point increase compared to 2020.

Therefore, despite the revenue deceleration seen in the last quarters, US e-commerce is still looking good for the next years. Amazon is positioned to capture quite a bit of this growth due to economies of scale, ability to invest heavily in infrastructure, and the impact of Prime memberships on customer loyalty – i.e. the “flywheel” model (see below).

Figure 2: Amazon's economic "flywheel" model.

Figure 2: Amazon's economic "flywheel" model.

(Read more from the Amazon Maven: Amazon Stock: Why Wall Street Sees 20% Upside Potential)

Operating costs: different story

Amazon’s operating margins, on the other hand, have been hurting from higher supply chain costs – e.g. wage and Covid-related expenses, which were highlighted by CFO Brian Olsavsky during the last earnings call.

Prices (costs, in this case) are primarily a function of supply and demand, so one could expect them to get back to pre-pandemic levels soon and help to push Amazon’s margins back up. But research suggests that it is not so simple, certainly when it comes to labor costs.

According to Deloitte, job openings in June 2021 were higher than the number of unemployed laborers. Also, wages tend to be “stickier”: once they are increased, workers are reluctant to take pay cuts. Lastly, with benefits (such as health insurance and childcare) becoming a bigger piece of the compensation package, costs associated with labor tend to head higher over time.

The recovery in e-commerce

The e-commerce expansion story has been a big piece of the AMZN investment thesis. But could margin pressures turn the narrative less enticing? For the immediate term, the prospects are bleak. Unemployment has been falling to pre-pandemic levels, and the impact to wages and capacity is likely to be mildly bearish at best.

However, CEO Andy Jassy believes in an eventual transition from short-term pressure for long-term stability. Meanwhile, Amazon continues to put its cash to use, expanding its footprint and entering new markets, always with an eye on long-term growth.

Once the collateral damage from the end of the pandemic eases, we think that the e-commerce leader will see a recovery in margins and profits, and investors will feel more comfortable again.

Twitter speaks

Amazon has been facing problems in e-commerce: tough 2020 comps mean low growth rates this year, and higher supply chain costs reflect in lower margins. How long until Amazon “recovers”?

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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Amazon Maven)