Amazon: Not In Its Prime

High contributions to the company’s bottom line made by its AWS (its cloud computing division) over the past several years meant Amazon has always had significant dry powder to maintain its humongous lead in e-commerce via promotions, delivery time ramp-ups, promotional campaigns, subsidising exclusive brand offerings, etc.

Shortly before its Q3 update, Credit Suisse cut AMZN’s target price by more than 10%. A quick analysis of the company’s segment information over the YTD vis-à-vis the consolidated annual reports reveals a fascinating trend in its financials, particularly its Expense Ratio (i.e. net expenses versus net sales):

• For “North America” and “International” segments, the Expense Ratio hovers in the 95-102 range while for AWS, it hovers around 68-72 in both a 3-month horizon in Q1 across 2020 and 2021 as well as in a 6-month horizon as of Q2.
• The latest annual report (2020) indicates that each segment’s ratio has been within the aforementioned range for the past 3 years, i.e. from 2018 till 2020.
• The U.S.’ contribution to consolidated Net Sales has been 68-69% for the past 3 years.
• The company had $32 billion in debt as of 2020.

In this particular quarter, there were some indications that the company’s priorities were out of order – despite being in inflationary times, which Treasury principals say will last (at least) till mid-2022: an additional hiring of 125,000 workers at enhanced wages was announced before the update, along with another 150,000 seasonal workers in Q4. Intensifying competition by Microsoft, Google and Oracle against its stalwart AWS business seemed to receive neither specific attention nor remedy during the update.

The Q3 update held no surprises with respect to the aforementioned trend in financials:

• The Expense Ratios have tightened into the 99-103 range in the 3-month range and into the 96-99 range in the Year to Date (YTD). The “North America” segment is to the left of this range and the “International” segment.
• AWS, predictably, remained an investment manager’s dream with its ratio remaining in the 69-70 range in both 3-month and YTD horizons.

Despite owning a studio subsidiary set up (Amazon Studios), a free streaming service (IMDb TV) and allegedly signing 10-figure deals to make theatrical movies, the company continues to subsidise these activities within its existing business setup, thus confounding the already-fraught margins of the e-commerce division and writing up multibillion-dollar loans on the backs of the AWS division.

The company, also predictably, made no reference to the fact that India’s antitrust body has found damning evidence that Amazon copied products and rigged search results to promote its own brands in the country. The “India story” was supposed to be the company’s growth driver, just like China was supposed to be before the company had to close shop after 15 years of trying.

Given, there could be several arguments for shorting Amazon but the most prominent ones would be:

1. Inflationary concerns will likely impact e-commerce shopping. This will depress the stock price in the future.
2. The competition is heating up in e-commerce and Shopify has been making steady gains with better ratios. Shorting Amazon to buy twice the exposure in Shopify is likely not a bad idea.
3. The company needs to sort out its bottom lines and revenues better. Under its current muddled state, profits don’t translate to revenues efficiently.