Amazon Research Notes

Topics: Amazon, supply chain, consumer spending

Price

$180 -> $90. That’s good for a -50% return. Yikers. Outside of META, this is the worst-performing stock on the (M)MAGA list. I guess consumers don't like the idea of taking on more credit card debt to buy Christmas presents that will probably get returned anyways. Maybe next year??

Technicals

Of our group of mega-cap misfit toys looking for a loving investment portfolio to call home, AMZN is the *most* oversold (based on MACD - RSI looks fine). Technicals suggest that AMZN is slightly oversold at the moment, making it a potential buying opportunity for all you chart-loving investment gurus.

Financials

Amazon’s business model is (basically) entirely built on its retail platform, most of which is generated from online store sales, warehouse / shipping & handling fees (“Third-Party Seller Services”), and physical store sales. A note of differentiation: online and physical store sales are products sold from Amazon’s inventory (chiefly private label products), while sales from "Third-Party Seller Services" are items published by third-party providers and are recorded as the net amount of revenue generated. In English, online and physical store sales represent Amazon-branded/owned products, while third-party seller service revenue represents all the other thingys you buy on Amazon; this means that the actual amount of products purchased on Amazon is much larger.

Amazon Web Services is revenue generated from computational, storage, database, and other services for start-ups, corporations, government agencies, and academic institutions.

Advertising relates to selling advertising services to sellers, vendors, publishers, authors, and other people interested in selling you more stuff.

Subscription services include Amazon Prime memberships, as well as subscriptions to Amazon Prime Video, Amazon Book Box, Amazon Music, and other subscription services.

For a more comprehensive breakdown of how Amazon makes money, check this out.

AMZN doesn’t break out its profitability by segment, but they’re typically good for a 10%+ margin on EBITDA and often have ROA of 5%+. During 9/30/2022 TTM, EBITDA margins and ROA were 10.3% and 2.0%, respectively; this is down from 13.2% and 5.3% during 9/30/2021 TTM, respectively. Because of its use of leverage, ROE decreased from 25.8% to 8.8% over that period (refer to DuPont analysis if that sentence doesn't make sense - or just tell me to write about it if you want more "color" on this).

As Amazon eloquently states in its most recent 10-Q, “We believe that operating income is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services.” Great, yes, I’d agree! But if they’re so important, why are they so bad? And if gross margins aren’t as important, then why are they the only margins to improve (41.3% -> 43.0% from 9/30/2021 TTM to 9/31/2022 TTM)? BTW, these are rhetorical questions - I'll answer them in a sec. Thx.

Also, (not) fun fact for you: AWS was the only operating segment (out of North America, International, and AWS) to be profitable. Bit of a yikkers for our boys over at Amazon.

Why are operating margins compressing?

Growing supply chain costs related to shipping and fulfillment costs, increasing wages and incentives, and “fulfillment network inefficiencies” are the culprits behind lower margins.

On the downside, AMZN's margins are suffering because of “limited fulfillment and technology infrastructure”, tight labor markets, and supply chains being a hot mess.

On the double downside, because Amazon has grown so much so fast, its fulfillment network and data centers have suffered due to increasing complexity and challenges regarding predicting customer demand, optimizing operations, and managing capacity.

On the triple downside, because fulfillment networks are primarily managed by employees, the labor shortage has hit Amazon’s fulfillment network and data center capabilities big time. Yes, this hurts margins.

On the quadruple downside, Amazon is seeking to “reduce our variable costs per unit and… leverage our fixed costs” through investments in its fulfillment network. Scale is good, scale is great, but when growth is likely to fall and margins are in rough shape, operating leverage can hurt you even more if margins go negative. I do like that they are committed to investing in future growth despite current headwinds.

Amazon is a great company, but its susceptibility to changes in consumer spending make them extremely vulnerable, especially given its (proven) inability to absorb adverse costs related to labor market inflation and supply chain shocks.

Products and Innovation

Amazon is dedicated to innovation and expects spending on technology to continue increasing as they add staff to build out new products and technologies. They are specifically focused on improving the speed and cost of processing power, data storage and analytics, wireless connectivity, and, you guessed it, artificial intelligence and machine learning.

Amazon has continued growing its R&D costs, to $68B as of TTM 9/30/2022; this is relative to R&D spending of $51B as of TTM 9/30/2021. I’m cool with this, but R&D as a percent of sales has increased (from 11.1% to 13.2% from 9//30/2021 TTM to 9/30/2022 TTM); this is directly impacting its margins at a time when margins are already compressing. Amazon has launched a cost-cutting review that is likely to decrease R&D spending in the future, as in the fad. This is on top of firing ~18,000 employees.

Also, Amazon owns ~17% of Rivian. They’ve invested ~1.3B in the company, but have experienced a loss of $10.4B YTD as of 9/30/2022. Yikers. All good, because Amazon will undoubtedly use its equity ownership stake to get a sick deal on some new wheels (EV delivery trucks). For my car fans out there, here are more details on Rivian's delivery trucks.

Valuation

AMZN’s valuation multiples have decreased more than most of its peers, but a large portion has to do with its financials and compressing margins. Its valuation multiples are currently sitting at or below its pre-pandemic levels, though that is largely justified by lower growth prospects and decreased margins. Investors have justified the lower valuations because of AMZN’s inability to maintain margins in the midst of higher costs and supply chain issues.

Leverage: Hmm

Amazon is one of the few companies on this list that can’t repay all of its debt with its current cash balances. Amazon has $165B of debt relative to $58.7B of cash.

Here’s a summary of its leverage ratios.

Short-term and long-term liabilities have increased over the prior periods, with its ability to repay debt (EBIT / interest exp.) falling as well. Though leverage is higher than its peers, Amazon should not face any material solvency or liquidity issues. Leverage, of course, will amplify its margins (for better or for worse).

Other Notable Attributes

Think I’ve said enough for now… haha

Recommendation: She’s amazing, but isn’t she out of my league?

Amazon has a great business model and is (obviously) everywhere. Amazon has been dealing with the most issues of the stocks on this list and its stock price has suffered as a result. Will tight labor markets, supply chain issues, and falling consumer demand continue impacting Amazon’s margins and future growth? For the long-term, probably not. However, if we do enter a recession, Amazon will suffer more than the rest of the stocks on this list due to its leverage (both operational and financial) and susceptibility to changes in consumer spending.

Stepping back and looking at the big picture, I have a very hard time believing that I'd ever be convinced to switch from Amazon to Walmart (or some other company) for online orders. Though I'm cutting back on spending, Amazon is still the gold standard for e-commerce platforms. I smell blood in the water here and, despite there being projected short-term fluctuations in Amazon's financial performance, I like this stonk and may dip my toes in the (blood-filled) water here pretty soon because (say it with me) we're long-term investors (and because I think everyone is refusing to swim through the blood-filled waters to get to the treasure chest on the bottom of the ocean floor).