Amazon.com, Inc. (NASDAQ:AMZN) continues its rapid movement into a bunch of new industries in 2017. After shocking the grocery world with the Whole Foods purchase just a couple months ago, Amazon appears set to make another big move. This time the target is drugstores. And that makes things interesting for AMZN stock.
Now, to be clear, nothing is finalized yet. Reports last week suggest that Amazon will make a final decision as to whether it joins the pharmacy space or not by Thanksgiving. So, it’s still possible that it could choose to pass up this possibility. However, it’s unlikely that the company invested so much time and energy in preparing to enter pharmacy if it didn’t have serious plans to do so. The analysts at Leerink, in fact, suggest that it’s now a matter of when Amazon starts competing in pharmacy, not if.
Will Pharmacy Work for Amazon?
Amazon has done a lot of things that seemed particularly bold or risky in the past. Some of these things, such as the Fire Phone, performed badly. But on the whole, Bezos has a great aptitude for picking his spots when Amazon enters new markets.
On the upside, pharmacy offers a huge addressable market for Amazon. One of the issues with the long-term bull case for AMZN stock is that you have to assume double-digit revenue and EBITDA growth for many years to come. Without it, the math doesn’t pencil out in a way that supports the current AMZN stock price. Given this, Amazon can’t just tack on incremental markets anymore, it needs big stuff.
Given the United States’ aging demographics, it’s virtually certain that the pharmaceutical drug market will keep expanding rapidly. Yes, there are risks — in particular from regulation — that could force down drug prices. But on the whole, the rise of diabetes, cancer and the general aging of the population, make this a huge market for Amazon.
There’s a great deal of overhead in the traditional brick & mortar retail model. Even if Amazon can’t replace physical stores for time-sensitive prescriptions, it should, in theory, be able to grab a sizable chunk of the less acute part of the market. There’s already a well-established tradition of mail-order pharmacies; Amazon doesn’t have to reinvent the wheel.
Can Amazon Do It Alone?
One uncertainty revolves around whether Amazon will build its own pharmacy system from scratch or acquire a competitor. Much of the bull case on Rite Aid Corporation (NYSE:RAD) revolves around someone buying the business out. And Amazon could be a decent fit. In Rite Aid, they’d get a decent store base, along with a pharmacy benefit manager (PBM) — killing two birds with one stone.
Unlike Whole Foods, however, Rite Aid doesn’t have particularly high-end stores or an especially desirable consumer base. Amazon and Whole Foods had more natural synergy in terms of their corporate attitude and marketing to consumers.
If Amazon wants to make a bigger splash, it could try to buy one of the big two chains — CVS Health Corp (NYSE:CVS) or Walgreens Boot Alliance Inc (NASDAQ:WBA) — or, perhaps, one of the independent PBMs. Both CVS and Walgreens are in the $75 billion market cap range. That’d be a bigger deal than Whole Foods by far, but it’s not out of Amazon’s financial capacity to pull off. That said, there’s a good chance the FTC would strike down any such mega-merger attempt.
On the other hand, Amazon can build out pharmacy by itself. There is a ton of regulatory paperwork to deal with, but Amazon is playing the long game here. It can deal with the political headaches if it’s worth the hassle. Whole Foods, in particular, came with a great deal of synergies to Amazon. In pharmacy, there’s no such obviously attractive partner. That doesn’t mean Amazon will avoid the sector, though.
What Would a Pharmacy Business Do for Amazon Earnings?
AMZN stock got hit on second quarter results. In fact, it’s traded no higher since then and is still 7% off its all-time high and under the $1,000/share mark. This during a time when large-cap tech stocks have generally performed well.
Amazon also guided for a fairly soft third quarter. With Prime Day showing booming sales results, but the rest of the quarter’s sales momentum looking slow, it hints that we’ll be seeing falling margins in Q3. We’ll also likely see some one-off charges and numerical swings due to digesting the Whole Foods purchase.
Assuming Amazon goes ahead with pharmacy, it adds another drag on near-term earnings. The company would have to fund the start-up costs, including licensing, employee training, infrastructure build-out, and heavy promotional pricing at the beginning to get the pharmacy operation up and running. In other words, Amazon is doing so much that hits margins in the short run that you shouldn’t be surprised if Amazon shows weak earnings into 2018.
Verdict on AMZN Stock
Investors in Amazon probably shouldn’t worry too much about the pharmacy business. In fact, while this comes with some regulatory risk, it makes more sense to me than the grocery deal.
However, pharmacy increases near-term risk to AMZN earnings. If you are speculating on AMZN stock in the short run, realize that this is another headwind. Amazon isn’t built to optimize quarterly earnings. And 2017 is shaping up to be a fairly challenging year even compared to Amazon’s usual low reported profitability.
Don’t expect the market to start rewarding Bezo’s latest bold moves until 2018. If you’re wondering whether to buy or sell Amazon stock today, the pharmacy venture tips the scale toward sell — or, at least, avoid.
At the time of this writing, the Ian Bezek owned WBA stock. He had no position in AMZN stock or any other of the aforementioned securities. You can reach him on Twitter at @irbezek.