Seeking Alpha
Long/short equity, medium-term horizon, airlines, carmakers
Profile| Send Message|
( followers)  

Summary

  • Amazon's unique customer approach creates loyalty, but forbids increasing prices.
  • The company's frequent investment in an expanding business does not generate huge profits.
  • European unions may cause additional expenses.

When I think of Amazon (NASDAQ:AMZN), I think of a unique company with a direct approach to customers. Being an editor of a scientific publication, I had some issues with my former publisher last year since Amazon did not list the publication as "in stock." I called them and they offered to get my work published through one of their subsidiaries (createspace). I was amazed to hear that they entered the publishing industry.

As of now, it is not just possible for customers to publish their own book, to get it printed and distributed by Amazon; they can also publish it directly to the Kindle platform. Moreover, they can create and sell their audio book. Also, independent filmmakers are able to publish and sell their own movies. In my opinion, Amazon pays fair when compared to many other independent publishers. This is indeed an innovative and fresh approach. Basically, Amazon is supporting its customers and their creativity and thus helping itself by expanding its item list. Think of an airline offering an economy passenger who sells insurance for a living help in selling his insurance in its duty-free magazine -- this is almost what Amazon does.

Such an involvement creates loyalty and appreciation, and to an extent that is by far larger than that of a loyalty card. Customers now want to work with Amazon -- to be a part of it -- and Amazon is expanding its catalog, which contains over 20 million items so far. And this customer-approaching tendency can be seen on the fulfillment site, as well when Tom Szkutak, the company's CFO, stated, "we continue to work to be, as we have over the years, to become closer and closer to customers."

Another way of doing that is certainly the Amazon Prime service, which I will not focus in this article since so many others have done that already. But, briefly put, the Amazon Prime service is essentially a "club." It is something a customer can be a part of, the business class of online shopping -- thus creating loyalty as well. What we are seeing here is an increase in trust and therefore an increase in business. In my personal view, this unique customer approach or the Amazon way of customer service played a significant part in the 23% of revenue growth in Q1 this year -- in a good and bad way.

Amazon as a company is highly valued, yet not overvalued (at least not anymore). Analyzing the stock chart with respect to the Q1 data provided during the earnings call, I interpret the stock's fall from $400 in late December 2013 to $300 as a correction, but not as a bearish trend. Investors have experienced minor corrections at the very start of 2010 and twice in 2011. Despite this new correction, the stock did well on a 12-month basis, soaring roughly 11% from $270 in mid-June 2013 to $300. The Q1 data that interests me consists of the high cash flow ($5.35 billion), the steady adding of new customers (there are now more than 244 million active customers), the strong revenue growth (26% on the domestic market, 18% internationally), and the growing Prime members. Reading this data, I realize the still existent great potential of the company. Yet, there are some points why I think that Amazon's stock is not likely to exceed a growth rate of 10% this year.

1. Regarding the history of the company, Amazon seems to always invest a huge part in business expansions of what was earned before.

This is not necessarily bad. Amazon may have been the first big online retailer, but it is certainly not the last. Recently, China started Alibaba, which has great potential to grow quickly. Therefore, it is a wise decision of Amazon to try and stay at the top of the game. On the other hand, business expansions are usually costly and not so fast to be realized. Despite new business in Italy and Spain, the revenue growth rate was far higher in North America than in Europe.

2. Amazon is eager to keep prices low.

Low prices are great for customers since they offer them a great deal. However, some analysts have suggested that the company should raise prices slightly in order to widen profitable margins. When Amazon increases the prices for Prime membership, the prices on products stay merely as they are. My perspective is that the good deals customers can get on Amazon play a significant role in their choice of buying at the online giant. I have no doubt that slightly increasing prices would make some investors happy for a quarter or two, until customers realize that they could get things cheaper at the mall. With an item list of almost 20 million, even a slight price increase would generate a reasonable additional profit, yet is risky at the same time.

3. Work conditions may cost Amazon a lot.

Work conditions are another factor the company can do something about. Of course, every company can make sure the work conditions are favorable for all of its workers -- and not just for the working elite. In a recently written article by Simon Head, he mentions that "Amazon equals Wal-Mart in the use of monitoring technologies to track the minute-by-minute movements and performance of employees and in settings that go beyond the assembly line." This might be necessary in such gigantic storage facilities, but at least Amazon can do something about complaints on the site -- maybe by easing pressure a little or in allowing more time. One the other hand, this would slow down performance and is not what Amazon wants for its customers.

In Germany, however, the company has an additional problem: The unions. Unions are very powerful in there, almost too powerful for some. (Just ask Lufthansa.) The problem that Amazon has to face here is that the vast majority of its employees working at the storage facility get paid what is approved in the logistics sector (€8.57/$11.72). That makes perfectly sense to investors and surely to Amazon. Yet, their union is arguing that since Amazon is a "store" operating online, it should pay its employees what is approved in the retail sector. This would be significantly more (€11.59/$15.85). In 2013, they even went on strike close to the Christmas sale. Here is my point: If Amazon has to implement significantly higher wages in Germany that will likely be the case in Italy, Spain and other European countries next.

Conclusion

From my point of view, Amazon's stock still has a lot of potential -- especially due to the good data we got from the Q1 reporting (see above). The total revenue growth of 23% and the expectations for a similar growth in Q2 are especially good signals. But there are two major factors holding the stock back: On the one hand, the willingness to keep prices modest and to constantly expand and invest in new directions does not generate juicy profits, although this willingness just may be what will keep the company strong in the future. On the other hand, European unions might cause Amazon unwanted internal expenses due to higher wages. Investors who expect an intermediate performance of the company's stock might find a good investment opportunity in Amazon. However, I don't expect a strong performance this year, for the reasons I have pointed out.

Source: What's Holding Amazon Back: Customer Involvement Vs. Work Conditions