For most investors, watching a stock they own increase in value by more than 30% in one year would be reason to celebrate. However, Amazon (NASDAQ: AMZN) isn’t just any company, and investors haven’t been used to a prolonged decline in the stock. Since late September, Amazon’s shares have struggled to get back to their old highs. Whether this is a short-term issue, or a longer-term consolidation remains to be seen. It’s exciting when Amazon gets into new markets, but investors should be equally happy that the company is addressing its profit margins in a meaningful way. Fulfillment costs consumed just under 15% of revenue last quarter, and Amazon is making moves to cut this expense. The first step was to order thousands of delivery vans. The most recent step is developing its own fleet of airplanes.
Tired of using the “delivery boy”
Amazon has several reasons to develop its own delivery business. One of the most obvious is in response to a bold claim by President Trump. The President said that Amazon is, “costing the United States Post Office massive amounts of money for being their delivery boy.” Given unwanted attention by the President, combined with billions of dollars being spent on delivery each quarter, Amazon is moving to address both issues at once.
The first step in addressing this issue has already been taken with Amazon ordering thousands of delivery vans. The company’s delivery service (Amazon Flex) allows individuals to make money delivering packages as independent contractors. Amazon originally had about 5,000 delivery vans, but ordered an additional 20,000 to expand this capability.
The current move is for Amazon to take delivery of as many as 40 planes by the end of this year. There is further speculation, that the company could expand this fleet to as many as 100 planes. FedEx Corporation (NYSE: FDX) and United Parcel Service (NYSE: UPS) don’t appear to have anything to worry about presently. However, Amazon’s move to take control of some of its deliveries should give investors in all three companies a lot to think about.
Amazon’s routes will overlap, “with over two-thirds of the volume flown by UPS and FedEx combined.” According to Morgan Stanley, Amazon will save between $2 and $4 per package through these changes. In theory, the initial rollout would save the company between $1 billion and $2 billion annually. To make things simple, savings billions is a huge reason to make these changes even if the President never made a comment at all.
Is Amazon delivery going to take on FedEx and UPS directly?
At this point, the short answer is Amazon is not going after FedEx and UPS for delivery of other company packages. There are several reasons Amazon quite honestly cannot take on the, “big two” delivery companies at the present time.
First, the size of the UPS and FedEx fleets makes going head-to-head an impossible task at present. In total, UPS has roughly 120,000 vehicles, while FedEx Express has 85,000 vehicles and FedEx Ground reports 60,000 for a total of about 145,000. As mentioned before, Amazon’s vehicle count stands at about 25,000. When your competitors have tens of thousands of vehicles more than you, the battle has been lost before it even started.
Second, the size of the FedEx and UPS airline fleets is far larger than Amazon at present. FedEx currently has just under 700 airliners, whereas UPS has just under 600 including what is on order. Even if Amazon builds it fleet to 100 airliners, again the size difference is far too great to imagine any real competition for the “big two.”
To be blunt, the comparison favors FedEx and UPS at this point, but that doesn’t mean the situation will stay that way forever. If Amazon can successfully cut costs by handling some of its own delivery, it’s certainly possible the company could go after the logistics market and the billions in potential revenue this would mean to the company. However, any move to take on FedEx or UPS directly is likely at least years away.
What’s the bottom line?
If Amazon isn’t going directly after FedEx and UPS, what is the benefit to the company? The short answer is Amazon is looking to save money on its fulfillment expenses. As mentioned earlier, the company’s fulfillment expenses have been growing faster than revenue for quite a while. Just to put some numbers to this claim, consider that in a single quarter in 2015, fulfillment costs were $2.9 billion or 12.4% of revenue. As of Amazon’s last quarter, this same line item had grown to $8.3 billion or 14.6% of revenue.
The description on Amazon Air’s own web site makes the purpose of this venture very clear. The goal is to, “create technological solutions to help us exceed the expectations of our Prime customers through the use of our air cargo planes.” Amazon’s job description of the Amazon Air Procurement Manager position seems to echo this thesis: “game changing air transportation solutions for Amazon’s middle-mile transportation network, with the aim of ultimately improving our customer’s experience.”
Last quarter, Amazon generated $56.6 billion in revenue and produced an overall operating margin of 6.6%. However, the company’s operating margin in U.S. sales was 5.9% and international sales was a negative 2.5%. This is precisely why Amazon wants to attack one of its biggest expenses.
By point of comparison, FedEx generated over $3 billion in U.S. revenue and nearly $3 billion in international revenue. The company’s overall operating income margin was 6.3%. UPS generated even better numbers last quarter. The company produced over $10 billion in U.S. revenue and over $3 billion in international revenue. UPS seems to have the leg up on its peer, with an operating margin last quarter of just under 10%.
If FedEx can generate a margin of 6.3% and UPS can post a margin of almost 10%, it stands to reason that Amazon’s thinner margins would be improved by handling more of its own deliveries. I mentioned earlier that estimates suggest that Amazon might save as much as $1 to $2 billion per year by cutting fulfillment costs. How realistic is this estimate?
In the current quarter, Amazon’s sales, outside of AWS and Advertising, totaled just under $50 billion. If Amazon running its own deliveries cut expenses in these units by just 1%, the company would have saved roughly $500 million in the last quarter alone. Using this estimated savings on an annual basis, would equate to savings of $2 billion per year.
Some might worry that Amazon is trying to do too many things at once. However, if building a fleet to develop its own delivery services means saving $2 billion a year in expenses, this sounds like a solid investment to me. Beyond the initial phase, Amazon could theoretically continue to build its delivery system for further efficiency gains.
The bottom line is Amazon is showing investors that it knows future growth in earnings can come not only from greater sales, but better control of its expenses as well. There are always risks involved in buying planes and vans, hiring new staff, and developing a transportation network from the ground up. That being said, with Amazon shares down in the short-term, and a seemingly clear path to better earnings in the future, taking a gamble on Amazon stock seems like a solid bet.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.