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Amazon Stocks Should Grow on Its Automation Efforts

Amazon's automation efforts provide the next driver for improvement in margins

Amazon (NASDAQ:AMZN) is increasing the pace of automation investments in its fulfillment centers. The company will invest millions of dollars in custom machines to box customer orders in 55 fulfillment centers. This will reduce the labor requirement by 1,300 positions.

AMZN Stock: Amazon Stocks Should Grow on Its Automation Efforts
Source: Shutterstock

Amazon hopes to recoup the cost of these machines within two years. And Amazon stock should give better returns as the management increases the focus on adding automation, cutting labor costs and improve margins.

Automation also improves the delivery service, which has helped the company improve its subscription revenues.

Amazon has a big opportunity due to the automation trend. Smaller retailers would not have the ability to make heavy capital investments. This will lead to an “automation effect” which would be similar to “network effect” on big internet platforms. Amazon’s ability to improve operational efficiency increases the long term moat for the company and increasing the bullish trend for Amazon stock.

Besides the growth of AWS and advertising segment, investors should also look at the future trajectory of shipping and fulfillment costs.

Increase in Fulfillment Centers and Labor Costs

Amazon has been increasing its fulfillment centers at a rapid pace in the last few years.

Source: Reuters, MWPVL International

Amazon had 58 fulfillment centers in 2014. This increased to 168 in 2019. The massive growth has also increased the labor cost for the company.

Since 2014, the revenue increased by 160% while the employee headcount has increased by 320%. At the same time, Amazon has introduced a minimum wage of $15 per hour. This ends up having an adverse impact on the margins. For the past few years, we have seen a rapid increase in fulfillment and shipping expense which exceeded the sales growth. Hence, automating the fulfillment centers is an ideal goal for the company. A large chunk of future margin growth and better sentiment towards Amazon stock would depend on the automation ability of the company.

AMZN Stock Automating the Tough Jobs

The job of boxing up customer orders has until now been very difficult to automate. This job requires robots to handle the most delicate objects in a precise manner. At the same time, the sheer variety of objects is immense, which makes it difficult to create automation programs. But with the latest machines, Amazon hopes to reduce the manpower required in this job.

The investments have not been minor. At $1 million per machine, the total investment would reach over $50 million for all the fulfillment centers in the U.S.

The ability to make such a massive upfront investments gives Amazon a big lead over other retailers. Almost every other retailer aside from Walmart (NYSE:WMT) would find it difficult to replicate such investments. The long-term result of this is that Amazon’s operational efficiency would be much higher than other peers. This will improve the moat for the company and increase the valuation multiple of Amazon stock.

This machine works five times faster than a human. This should help Amazon in reducing fulfillment time. The company has already announced the move to one-day shipping for all Prime members.

To be fair, Walmart has also announced next-day shipping. But this will only be available for 200,000 items. Amazon would be providing one-day shipping for millions of items.

A PR Problem and Margin Improvement

Automation and loss of jobs is a big issue within the entire economy. Amazon’s move to increase the pace of automation can bring a further backlash against the company. The management has already tried to downplay this initiative. It has also announced that all the workers would be provided alternative employment in other services within the company.

Although the issue is very sensitive, it is likely that we haven’t seen the end of investment in automation of fulfillment and shipping. The recent improvement in Amazon’s margins was largely due to AWS and advertising segment. But lower fulfillment and shipping costs can also help in improving margins.

Source: Amazon Filings

In the past few quarters, the growth in shipping costs has exceeded the worldwide paid units. For example, in the latest quarter, the shipping costs increased by 21% while worldwide paid units increased by only 10%. By making these massive investments in different stages of its logistics operation, Amazon hopes to reverse this trend. The shipping cost is also massive. In the latest quarter, it was $7.32 billion. This is close to AWS revenue which was $7.5 billion and higher than advertising revenue which came at $2.7 billion.

Hence, a big chunk of future profits will depend on the ability of the company to rein in the shipping and fulfillment expenses. By making rapid investments in automation, the management can reduce its shipping costs and create a bigger moat by offering faster services. This is one of the main reasons to be bullish over the long term returns for Amazon stock.

Investor Takeaway

Amazon is making a big bet on automation to reduce future operating expenses. The labor cost for the company has exceeded the revenue growth in the last five years as new fulfillment centers were opened. By automating major tasks in the fulfillment jobs, Amazon should be able to reduce its expenses and expand margins.

The big investments in automation will also reduce the shipping time. This gives Amazon a lead over other retailers. Few retailers have the resources to make this level of investment. This should cause further consolidation in the retail space, reducing the pricing pressure on Amazon.

The PR backlash can be minimal if Amazon continues to move redundant workers to jobs in other services. Investors should closely watch the growth of shipping and fulfillment expenses in the next few quarters. Reduction in these expenses should help the company in reporting better-operating profits and boosting the returns for Amazon stock.

As of this writing, Rohit Chhatwal did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/06/amazon-stock-can-deliver-better-returns-due-to-higher-automation-investments/.

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