Is Amazon a Bargain Heading Into 2023?
Amazon.com Inc. (NASDAQ:AMZN) has already warned of slow holiday growth. With the Federal Reserve continuing to raise interest rates, analysts predict the economy will enter a shallow recession in the first quarter of 2023, affecting the profitability of e-commerce companies. A major decline in consumer spending is one of the biggest concerns of investors and analysts alike, but recent data shows consumers continue to spend.
Although the Seattle-based retail giant reported it will face a challenging environment in the coming quarters with the slowest holiday season growth in its history, there are signs that Amazon will have a better Christmas than expected.
According to a recent Bloomberg report, regardless of rising interest rates, U.S. consumers are seeing prices moderate with retail sales growth hitting an eight-month high in October. Despite a deteriorating economic outlook, the fourth quarter has started on the right track with robust consumer demand.
Exhibit 1: Change in retail sales
Source: Bloomberg
According to Insider Intelligence, online sales are predicted to increase 12% year over year in November and December, exceeding the 10.4% growth that was seen in 2017. The Cyber Five period, which is the five days between Thanksgiving and Cyber Monday, typically outperforms the holiday season growth. During this period last year, Amazon experienced record sales, which did not come as a surprise after almost two years of lockdowns. This year, Cyber Five sales are anticipated to generate $34.8 billion, or 16.3% of the season's revenue, which is in line with the growth of overall holiday sales. Cyber Monday is expected to clock in the biggest year-over-year growth of 5.1% this year.
Additionally, Deloitte's holiday retail survey found 49% of consumers intended to shop during the Thanksgiving week, with consumers planning to keep spending at a similar level to last year and the majority shopping at online-only retailers. Given these holiday shopping trends, Bloomberg data shows that analysts anticipate Amazon's revenue will increase 6.7% to $146.6 billion in the fourth quarter, slightly higher than what the company has guided for.
Challenges and opportunities
Despite reporting year-over-year revenue growth, Amazon fell short of investors' expectations in the third quarter due to the impact higher inflation had on consumer demand and operating income. The company will continue to feel this pressure for a little longer given macroeconomic challenges are expected to continue in the near term.
The company saw revenue grow by 15% in the third quarter, but international revenue growth slowed due to unstable exchange rates, the deteriorating business environment in Europe and the energy crisis. Regardless, the e-commerce business continues to grow rapidly in the North American region.
Amazon's cloud business also fell short of analyst expectations, which is cause for concern given that AWS is the only segment that has contributed to the company's growing operating income in 2022. The slowdown, however, is only temporary and enterprise spending on cloud infrastructure services remains strong. According to Synergy Research Group, spending on cloud infrastructure services exceeded $57 billion in the third quarter, up 24% year over year. Additionally, there are numerous opportunities for cloud infrastructure providers to expand, particularly in the small business segment, as only a small percentage of businesses have migrated to the cloud to date. With its expansion into new regions, Amazon will maintain its position as the market leader and record positive growth in the coming years.
To capture the massive growth opportunities for cloud products in India as the country undergoes a digital transformation, AWS launched a new infrastructure region in Hyderabad, India on Nov. 22 with three availability zones, making it the country's second region for data center clusters. With this launch, AWS has grown to 96 availability zones spread across 30 geographic regions. Amazon has also been recognized as a leader for the 12th consecutive year in the Gartner Magic Quadrant for Cloud Infrastructure & Platform Services.
Exhibit 2: Gartner Magic Quadrant for CIPS
Source: Gartner
One major challenge for Amazon has always been managing supply chain disruptions and fulfillment network productivity. However, the company has made strides in cost management, which it acknowledged in its earnings report. The company expects new initiatives will help it build a stronger cost structure in the future. In a recent report titled "The Fulfillment Network: Built Through 2024," Morgan Stanley (NYSE:MS) noted Amazon has sufficient warehouse capacity to handle its volumes through the fourth quarter of 2024. The company has opened new fulfillment centers in the United States, Mexico, Canada, Ireland and Turkey to serve more customers even faster.
The company plans to cut its capital expenditure budget by a third this year and has already announced job cuts that will last through early next year, which is a common strategy used by companies to reduce costs. Amazon aggressively increased its headcount during the pandemic, more than doubling it since the end of 2019 to 1.5 million. The retailer admitted it exceeded its target and now needs to reduce staff and close non-essential businesses. These initiatives are expected to significantly reduce Amazon's capital expenses and fulfillment costs in 2023.
Exhibit 3: Quarterly fulfillment expenses
Source: Third-quarter earnings report
All this said, it will take time for the companys efforts to result in strong earnings growth. Amazon's advertisement segment, on the other hand, remains strong, while its competitors struggle with slower ad spend. In the U.S., Amazon is by far the most popular e-commerce platform. With over 200 million Prime members, it is also appealing to advertisers and sellers. This year's Prime Day sales remained strong, with 300 million items purchased globally. Amazon is also expanding advertising opportunities on its streaming platform, Amazon Prime, to assist marketers in taking advantage of video ads.
Exhibit 4: Number of items purchased by Amazon Prime members worldwide during Prime day sales (in millions)
Source: Statista
Another challenge to consider is the increasing competition in India, one of the largest and least explored markets for e-commerce. While the region has been Amazons largest overseas and fastest-growing market, it has a limited presence in tier 2 and tier 3 cities and is losing market share to new competitors like Meesho. The size of the companys logistics network is also restricting the products available for same-day delivery, which may impact membership growth.
One survey also found that Amazon is falling short in terms of download share and engagement metrics. In terms of seller presence and product mix, it remains the largest platform in the country. Further, Amazon has a stake in local stores as well as five well-known private labels in India.
Exhibit 5: Festival market share in India
Source: TechCrunch
The company also entered the digital payment market in India with the launch of Amazon Pay, but it is reporting losses due to regulatory challenges. With over 15,000 e-commerce companies currently in operation, the Indian e-commerce industry is rapidly expanding. The competition will only heat up as the number of internet users in India grows dramatically and the government increases its support for local startups. Considering the intense competition and Amazon's performance in India since the start of the pandemic, it is only reasonable to assume the company will face many challenges in this region in the coming quarters.
Takeaway
Given the likelihood of improved consumer spending during the holiday season, planned productivity initiatives for the first quarter of 2023 and a significant decrease in capital expenditures, Amazon seems well-positioned to generate higher-than-expected operating income. Investors, however, will have to tread lightly as the general pessimism surrounding risk assets might result in lower share prices for growth stocks in the coming months before recovering meaningfully. Amazon still has a long runway for growth in the next decade, which makes the stock an attractive bet for long-term growth investors.
This article first appeared on GuruFocus.
