Amazon (AMZN) has made its intentions clear that it wants a big chunk of the shipping industry. FedEx (FDX) has recently announced that it would not be renewing the express shipping contract with Amazon. This should lead to greater investments by Amazon in its logistics network.
In the latest earnings report, the company announced one-day shipping for Prime members. This will require Amazon to make higher investments in logistics and control a greater share of the delivery network. The company has ample resources to build a strong logistics network in the US and other important international regions.
In the past few weeks, Amazon made a big investment in Deliveroo, a UK-based food delivery startup. It has also promised an investment of $1.5 billion in airport development outside Cincinnati. The shipping costs in the recent quarter was $7.32 billion, which was equal to 12.3% of the net sales. While this cost will increase in the near term, Amazon can also use this logistic network to monetize other profitable services.
Importance of Shipping
The importance of a strong logistics network for Amazon’s business cannot be overstated. The company is shifting all its Prime members to one-day shipping. This would require greater reliability from its delivery network and more in-house logistics ability. The company has already started automating important functions. A recent Reuters report mentioned that the company is investing heavily to automate boxing up of customer orders. This report mentions that the machine will be able to box orders five times faster than a human.
Amazon would need to automate other functions within its fulfillment centers to deliver its promise of one-day shipping. While Walmart (WMT) has also announced a similar feature, it should be noted that Walmart is offering quicker delivery on only 200,000 items. On the other hand, Amazon will be offering this service on millions of items. Many of these items might not be available in the nearest fulfillment network. This would require building of better shipping capability.
Amazon has recently broken ground for a $1.5 billion airport development outside Cincinnati. It will also make more than $100 million investment for air cargo complex in Lakeland, Florida. These are big numbers and we should see a similar scale of investments in the next few months as the company improves its delivery network.
Fig 1: Shipping costs of Amazon. Source: Amazon Filings
Shipping is one of the biggest cost items for the company. In the recent quarter, Amazon spent $7.32 billion on shipping which was a growth of 21% over the year-ago period. In the above image, we can see that the growth in shipping costs has exceeded paid units shipped for all the past six quarters. The main reason behind the higher growth in shipping costs is the more rapid delivery options offered by Amazon. Amazon has been expanding its free same-day shipping options in several metro areas.
The rapid growth in shipping and fulfillment cost has put additional burden on Amazon. Massive investment in this segment has vastly improved the delivery network of Amazon. In the next few years, we should see an increase in the ability of the company to provide shipping-as-a-service platform.
Source: Statista, Company Filings
The entire logistic sector plays a central role in many industries. Freight operators are already wary about Amazon’s entry into this segment. The company is offering an online freight brokerage platform to connect available trucks and shippers in five Eastern states in the US. We should see this service rolled out in other areas by the end of this year. Amazon is also getting more work done in-house.
Investment in Deliveroo and airports
Amazon has invested $575 million in Deliveroo. It is a food delivery startup from UK that is competing with Uber Eats. Deliveroo has over 60,000 delivery people within its platform. A big investment in this startup shows that Amazon is looking towards other options to solve the problem of last-mile delivery. It might be possible to integrate this business with Amazon’s Prime membership. There are many other synergies which Amazon can get from Deliveroo. Interestingly, the company was forced to shut down Amazon Restaurants in 2018, which offered takeout delivery in UK due to competition from Uber Eats and Deliveroo.
Amazon has also promised investment of $1.5 billion in airport development outside Cincinnati. Another $100 million has been promised for air cargo complex in Lakeland, Florida. The scale and speed of these investments show that the management wants to a better control over its delivery network.
The recent report about non-renewal of express shipping contract by FedEx is not a surprise when we look at the initiatives taken by Amazon. In the next few quarters, Amazon would try to bring more shipping services in-house. This should help the company in providing better service to customers and also reduce the long-term shipping expense.
Impact on margins and bottom line
Most of the analysts and investors are focused on AWS and advertising segment to forecast Amazon’s future profits. However, Amazon can also improve margins and profits by bringing down its shipping and fulfillment costs. The company has a number of levers to reduce these costs. One of the most important is to reduce the growth of shipments from its own online store. As long as higher prices on Amazon do not hurt Prime membership, we should see lower discounts from the company in the next few quarters.
This will reduce the unit shipments and also bring down the shipping costs. This trend can already be seen in the past few quarters. According to Fig 1, the shipping cost growth in the recent quarter was 21% while paid units growth was 10%. In the year-ago quarter, the shipping cost growth was 38% while paid unit growth was 22%. Both the shipping cost and paid units growth have been trending downwards in the past few quarters.
Together, the shipping and fulfillment costs made up close to 26% of the net sales of Amazon. Hence even a few percentage point reduction in these costs will have a big impact on the bottom line of the company.
Amazon’s EPS forecast for 2 fiscal years ahead has been moving higher. In the past year, this number has increased from less than $20 to over $50. According to this metric, the stock is trading at 36 times the EPS projection of 2 fiscal years ahead.
Amazon has the ability to spend heavily in order to build a strong logistics network. Few companies can match Amazon's investment ability. At the same time, the company has the option of monetizing its logistics network by adding new services to its Prime membership. These two factors should allow the company to deliver improvement in margins within its shipping cost. This will have a major positive impact on the EPS in the next few quarters.
Amazon has been able to reduce the growth in shipping costs in the past few quarters. It is also investing heavily to improve its own logistics capabilities. This should allow the company to offer better shipping than other e-commerce competitors. We should also see a rollout of shipping-as-a-service platform in which Amazon offers its delivery network to other businesses. This will convert the shipping segment to a revenue source from a cost source.
There are few players (if any) that can match Amazon’s ability to invest in the logistics network. This should allow the company to increase its market share and pricing power in this huge industry. There is a lot of scope of revenue and margin growth in the next few years as Amazon’s shipping network improves in scale. This is one of the key reasons that makes Amazon stock a good buy-and-hold bet at the current levels.
Disclosure: I am/we are long AMZN, SAVE. 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.