One-Day Shipping Poses Problems for Amazon Stock

Shipping change is pressuring Amazon's margins — and perhaps testing investor patience

For years now, investors have given Amazon (NASDAQ:AMZN) stock the benefit of the doubt. Amazon stock has been assigned rich price-to-earnings multiples. Whatever investments the company chooses to make, the market usually has been forgiving.

One-Day Shipping Poses Problems for Amazon Stock
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That patience makes sense — and has paid off. AMZN stock has gained 450% over the past five years, and 1,800% over the past 10. Stock returns aside, Amazon has become the dominant e-commerce retailer, and a cloud computing giant as well.

Those investments have driven those gains — though not all have been winners. One of Amazon’s seemingly minor efforts turned into the hugely valuable Amazon Web Services. More than a few, however, have failed.

But those steady efforts — whether outsourcing cloud computing power or trying to outcompete the likes of Etsy (NASDAQ:ETSY) or Shutterfly (NASDAQ:SFLY) — have contributed to AMZN’s seemingly enormous headline valuations.

Earnings growth looking forward is all that matters, after all. And, in theory, that growth should benefit from those investments, no matter the outcome. If they succeed, future earnings grow thanks to those returns. If they fail, Amazon can cut bait and decrease spending. Amazon simply has never focused on near-term profitability, and Amazon stock has been rewarded as a result.

At the moment, however, that investor trust is being tested. The company’s one-day shipping for Prime customers, launched this year, is having a significantly negative impact on earnings. And with AMZN stock now down 7% over the past year, it’s fair to wonder whether that effort might be the one that leads investors to question the company for the first time in a very long time.

1-Day Shipping Hits Amazon Stock

Amazon announced its plan to offer 1-day shipping to Prime customers back in April. Investors initially liked the move: Amazon stock closed up 2.5% the following day. And the market saw the move as a clear competitive advantage. Shares of Walmart (NYSE:WMT) fell 2%, and Target (NYSE:TGT) nearly 6%.

But since those initial gains, AMZN stock has underperformed. It’s now down more than 6% from where it traded before the launch. The Invesco QQQ Trust (NASDAQ:QQQ) is roughly flat over the same period.

And 1-day shipping has raised its head over that stretch. Most notably, the stock slid after second-quarter earnings in July. Operating profit increased barely 3% year-over-year, missing estimates in the process. An estimated $800 million impact from the shipping change was a key driver. Meanwhile, Q3 guidance looked even weaker, with the company projecting earnings before interest and taxes between $2.1 billion and $3.1 billion against $3.7 billion the year before.

This week, Morgan Stanley cut its price target on AMZN stock — citing margin pressure from the 1-day shipping effort. The firm still sees 23% upside in AMZN shares, and the Street on average projects the market cap will return to above $1 trillion. But there’s some evidence, in both the AMZN stock price and in analyst commentary, that margin concerns are starting to rise.

The Fear for AMZN Stock

To be sure, 1-day shipping doesn’t break the case for AMZN stock. Indeed, I argued after earnings that investors should stay the course. The cost of the faster shipping will be lapped at some point. It can drive more market share for Amazon. And, again, management has earned the benefit of the doubt at this point.

That said, the new policy does create both near-term and longer-term risks for Amazon. The near-term risk is that investors simply won’t allow Amazon to ignore profitability forever. We’ve already seen high-multiple stocks — Roku (NASDAQ:ROKU), Shopify (NYSE:SHOP), Zoom Video Communications (NASDAQ:ZM) and others — pull back in recent weeks. Cannabis stocks, too, have seen an increasing focus on profitability.

The days of investors paying almost any price for revenue growth may be coming to an end, if only for a while. And Amazon is giving up margin to drive revenue growth at the same time that shift is taking place.

The longer-term risk is that the effort simply doesn’t work. Morgan Stanley’s Brian Nowak noted that his firm’s research suggested that average order value was falling sharply — while costs were increasing. Prime members were more willing to buy consumables with the 1-day policy, but those consumables look less profitable. In fact, they may not be profitable at all.

And if this effort doesn’t work, Amazon can’t really go backwards. It can’t tell Prime members “never mind” and go back to two-day shipping. If management got this one wrong, it could take years before the company grows out of its mistake.

Patience Is Required

I’m not ready to reverse my long-bullish stance toward Amazon stock. But it does seem like potential risks are rising. Investors clearly are more nervous about valuation. Amazon probably has a few quarters before it works through the profitability impact of 1-day shipping. And with that effort, there is zero room for error on the top line. Investors may stay patient when it comes to operating spend — but that spend needs to drive continued market share gains.

After all, this still is a stock that trades at 54x forward earnings. I still believe that’s a valuation worth paying for. But I’ll grant that other investors may not feel the same — and may not be convinced for some time to come.

As of this writing, Vince Martin has no positions in any securities mentioned.


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/one-day-shipping-problem-amzn-stock/.

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