iStock.com/georgeclerk
October 8, 2024
Is Amazon Facing More Margin Headwinds Than Tailwinds?
Amazon saw a rare analyst downgrade as Wells Fargo’s Ken Gawrelski believes strength in its cloud computing business won’t be enough to stave off other hurdles to its profit margins.
“AMZN has been a consistent positive revision story, but we believe factors pressure revisions in the near term,” Gawrelski wrote in a note Monday attained by RetailWire. Wells Fargo’s rating on Amazon was reduced from “Overweight” to “Equal Weight,” the equivalent of going from “Buy” to “Hold.”
Among the threats to Amazon’s margins:
- FBA fee pressure from Walmart: Gawrelski sees rising competition from Walmart’s burgeoning fulfillment services business putting pressure on the fees Amazon can charge merchants for storing, packing, and shipping their products. The analyst wrote, “WMT recently expanded fulfillment offerings to off-platform sales and is pricing its 3p merchant logistics offering 15%+ cheaper than FBA. Believe current WMT impact more likely on AMZN merchant services vs. consumer wallet share.”
- Amazon’s advertising growth moderation: Gawrelski estimates that merchant advertising to gross merchandise value (GMV) increased from 3.7% in 2020 to 6.0% in 2024 but will expand “at a much more modest pace” between 2025 and 2027 “as reinvestment rate plateaus.” Advertising margins will also face pressures as ad revenue becomes increasingly “associated with costly content rights,” particularly its recent contract to air NBA games on Prime Video starting with the 2025/2026 season.
- Amazon’s Project Kuiper costs: Gawrelski estimates that Project Kuiper, Amazon’s initiative to become a satellite broadband internet service provider and rival to SpaceX’s Starlink, will shave $3 billion off its operating income in 2025 and 2026.
Gawrelski argued that while Amazon Web Services (AWS), its cloud business, remains a tailwind supporting operating income, “AWS strength alone is not enough.”
The analyst said that the market is more prepared for pressure on Q4 operating income but warned that margin expansion could also be capped in the first half of 2025.
“Amazon is likely still a solid margin expansion story over the long term,” said Gawrelski. “We remain convinced that NA Retail Margins will eventually reach double digits. But as Amazon management has said multiple times, margin expansion won’t be linear. We, and market consensus, likely became a bit exuberant in our extrapolation of margin expansion trends in 2023 and early ’24 to ’25 and beyond forecasts.”
Wells Fargo’s price target on Amazon was slashed to $183 from $225.
Shares of Amazon on Monday fell $5.71, or 3.1%, to $182.24. Wells Fargo is one of the few Wall Street firms not to have a “buy” rating on Amazon. Wall Street analysts see Amazon stock rising over 20% to about $220 in 2025, according to Bloomberg consensus estimates.
Though Amazon stock closed 3% lower on Monday after Gawrelski downgraded shares, it is up 42% overall from last year, benefiting from sitting among the so-called Magnificent Seven tech stocks that have benefited from investor hype over generative AI. Amazon’s AWS segment has launched a host of AI tools for developers and consumers over the past year.
Amazon’s second-quarter results released in early August fell short of Wall Street’s forecasts as a better-than-expected performance at AWS couldn’t offset weaker-than-expected growth in retail sales. AWS sales grew 19% year-over-year. Meanwhile, Amazon’s Online sales rose 4.6%, down from growth of 7% a year ago, with a similar slowdown seen in physical stores. Advertising segment revenues surged 20%, just short of expectations.
Among analysts more bullish on Amazon, Truist’s Youssef Squali on Sept. 30 reiterated his “buy” rating and raised his price target to $265 from $230 as he expects sustained growth in advertising revenue, accelerated AWS expansion, and improved year-over-year operating margins to offset significant investments artificial intelligence, AWS, logistics, and Project Kuiper.
This past Monday, Mizuho Securities analyst James Lee reiterated his “Outperform” rating on Amazon at a price target of $240 after a recent quarterly survey of AWS customers conducted with a prominent channel partner found regional banks increasing their workload migration investments and enterprise customers strongly committing to generative AI investments.
Discussion Questions
Do you think Amazon could face increased margin pressures in the coming quarters due to growing fulfillment competition from Walmart, slowing ad growth, and other factors mentioned in the article?
Will AWS likely continue as Amazon’s largest growth and profit driver in the years ahead?
Poll
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Neil Saunders
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The current danger for Amazon mainly comes from its lucrative advertising segment, which has traditionally delivered very strong growth. Corporate budget tightening from Amazon’s B2B clients and more competition in the segment could slow growth, which would be unhelpful for the overall margin position. However, this will partly be offset by efficiency gains from Amazon’s greater focus on generating a return from its various initiatives. So, all in all, this isn’t about margins collapsing. It’s about being less exuberant about margin growth prospects in the near term – and don’t forget this comes off the back of a period of very strong margin and profit expansion.
And on fulfillment fees. I take a slightly different view: there is more competitive pressure from rival marketplaces. However, Amazon’s reach and its power to deliver sales remains unrivaled. The higher fees Amazon charges reflect a superior service which many sellers are prepared to absorb – even if they grumble about it. The further offset here is that Amazon is expanding its fulfillment services so sellers can focus more on selling and developing products and less on all aspects of fulfillment. It will generate more fee income from this. The marginal headwind comes from sellers working on more platforms and spreading their spend more thinly across each – but this is currently only happening at the margins.
The point about Amazon’s advertising segment has credence; however, I believe the bigger headwind is its loss of cloud market share. AWS drives the organization’s profit position, effectively subsidizing money-losing ventures like LEO satellites, Alexa, Just Walk Out etc.. That said, if competitors outcomes are a barometer, recent actions to introduce ads across its digital properties (i.e. Alexa, Prime) represent additional levers to broaden the margin base.
In a sane world, Amazon would have been broken up into retail, electronics, entertainment, AWS, and, I guess, logistics. That would expose just how bad the retsil margins are
Why would that be sane though? One of Amazon’s core principles is the flywheel effect that comes from having different divisions all contributing to drive the business.
I’m sorry, but I see no synergies between aws and retail. And each division should stand on its own feet. I mean, no one whined when Carl Icahn forced eBay to divest PayPal. Amazon gets an unfair advantage from the other divisions.
As you probably suspect, I disagree! I think Amazon is entitled to structure its business as it wishes. Consumers will vote with their wallets to determine its success, or failure. It doesn’t need the FTC – which is absolutely clueless about how markets work – stepping in to regulate. And by this logic, all retailers should divest their media units, Walmart should divest its third-party logistics business, Ocado its technology division, and so on. And eBay/PayPal was forced by a private investor – in other words by market forces – not by government action. So I do see that as very different.
The logistics & delivery division would be a formidable and savvy competitor to FedEx and UPS and better optimized for merchants, but its potential is actively hampered by having to carry the company’s retail side, and I’m sure Antitrust would have a word or two if they took over a retail competitor’s back-end operations. Set them free!
I believe the second paragraph of this story makes it the first on Retailwire to be written in code (or whatver you call the garbled sytnax of share pushers). This story – if we even want to call it a story – tells us nothing (beyond speculation) about Amazon as a retailer, and not much more – as in next-to-nothing – about them as a company; I’m with Paula: until they want to expand their financial reporting beyond two lines (revenue and expenses) this is all just so much prattle….useful for Amazon prattle ‘cuz it keeps their name in the headlines, but prattle nonethless.
The English language is wonderfully rich. It is a shame so many on Wall Street don’t have full command of it!
Awesome response
Walmart might (or might not) become a more formidable competitor to Amazon’s core business model, but Amazon is the 8-million-pound gorilla, actually a monster, but its not going to be a slow-moving dinosaur anytime soon.
Most people forget that Amazon is more of a “mall” than an individual retailer. Third party sales are 61% of Amazon’s business, so when we talk about higher or lower margins, much of that is out of Amazon’s direct control.
Amazon is a much broader company than its core type of business and continues to grow and expand in many different positive directions.
To David’s point, the majority of Amazon’s sales are third party, and this is where they are far more profitable than by selling their own merchandise at tiny margins. As such, if there is a corporate initiative to further drive profitability (both at the margin and bottom line level), we may see Amazon deprioritize selling directly, with more focus on the marketplace. This would also free up inventory dollars, allowing them to invest elsewhere.
Every company faces margin pressures. The BOD, investors, and analysts push publicly held companies to operate with profit in mind, sometimes to the company’s detriment. AWS has been a strong part of the brand. In the end, Amazon is a technology company. Even though the public knows Amazon for its retail/ecommerce operation, its future lies in expanding its technologies in both B2C and B2B.
Okay, so there are some margin pressures here…so what? This sounds like an analyst (or two or three) just trying to create a “wall of worry” over Amazon shares. It is still a great business overall, and leadership has the spine to continue to automate when it is realistic (the ultimately failed Amazon Store is a case in point) so I do not see that there is much to worry about here.
If I were and analyst I would be recommending buying and holding for the long term.