49% is no holiday discount! It is instead the fall in net income of the world’s largest online retailer, Amazon.com Inc. Burdened by approximately $2 billion in additional operating costs during the third quarter, Amazon’s net income for the third quarter decreased to $3.2 B, versus $6.3 B in the corresponding quarter last year. The numbers, released on October 28, 2021 are far from analyst estimates and triggered selling in the company’s stock amidst fears of macro economic factors spilling over to the fourth quarter – the holiday months – keeping the earnings suppressed.
1. Steepest fall in 4 years:
Amazon Chief Financial Officer, Brian Olsavsky estimates “the cost of labor, labor-related productivity losses, and cost inflation to have added approximately $2 billion in operating costs in Q3, particularly in August and September.” The demand for labor during the seasonal months coincided with the shortage of available workers that put a burden on the company. Additionally, the global supply chain disruptions followed by inflationery trends in commodities like steel and logistics such as trucking, fueled the fire. Total operating expenses jumped 18% Y-o-Y to $106 B for the quarter under review, versus $90 B in the same period last year. This against the total net sales of $111 B for the quarter against $96 B in the year ago period. The diluted earnings per share fell to $6.12 from $12.37 a year ago, down 50% – steepest since Q2 of 2017.
2. Cost escalations eat into margins:
Heavy dependence on labor and logistics for its key operations, make current times a nightmare for Amazon. The shortage of labor across industry and uncertain logistics costs due to global supply-chain disruptions is bleeding the company’s balance-sheet. Container costs, freight rates and flight charges are on the rise. Company estimated a $1 billion cost burden in Q3 primarily due to wage increases and incentives. Anticipating holiday demand in Q4, it is recruiting over 150,000 workers in the U.S. alone. Out of Amazon’s total $111 B net sales for the quarter, 58% ($65.5 B) come from North America and 26% ($29 B) from International sales. But expenses jumped in both these territories by 14% and 20%, respectively. Moreover, the international segment slipped into losses at (-) $0.9 B against $407 million profits last year. Amazon Web Services (AWS) gave some solace, despite a 37% surge in expenses, its operating income grew 39%. This growth is attributed to customers turning to cloud-based technologies during the pandemic.
3. What to expect?
Costs to further go up. Company’s Q4 guidance puts costs nearing $4 billion. Q4 net sales are expected to be between $130 B and $140 B, or to grow between 4% and 12% versus the same period last year. Operating income is expected to be between $0 and $3 B, compared with $6.9 B in fourth quarter 2020. Besides the labor cost, inflationary pressures in raw materials and logistics services remain high. Additionally, it has a nearly $1 billion year-over-year increase in Q4 for spend to support digital media content efforts, including video, music, and games. Good part is that Amazon observes consumer spending returning to pre-pandemic patterns. “We’re seeing strong adoption across Amazon vendors, sellers, and authors, as well as brands that don’t sell in our store, particularly as we’ve built out our streaming TV offerings,” said the CFO expressing ther company’s commitment to make the necessary investments in both – people and capacity – to bring more items in-stock and make quick deliveries.
4. Balancing act on revenues and profitability:
“We’ve always said that when confronted with the choice between optimizing for short-term profits versus what’s best for customers over the long term, we will choose the latter—and you can see that during every phase of this pandemic,” Andy Jassy, Amazon CEO was quoted as saying in the results press release. This clearly indicates that in the given circumstances, the company struggles to strike a right balance between the lower margins and higher volumes. As macro economic factors continue to influence the industry at large and the company in particular, Amazon is expected to push for sustained sales even if it has to make little compromise on margins. This strategy is seen keeping it competitive in the holiday months when most retailers witness a large part of the annual sales happening. But a shrinkage in profitability isn’t very pleasing for the investors and shareholders.
5. Stock, shareholders and the Street:
The Q3 earnings announcement came as a disappointment for the investors. The stock lost over 4 per cent since the announcement of results last week. While a dip in the earnings was anticipated and factored-in, the sentiment remained subdued over uncertainty on macroeconomic factors and a guidance on weak earnings to continue for the fourth quarter as well. Amazon had given a weak forecast in the Q2 earnings call, but even a weaker forecast for the Q4 even as there was an expected recovery in demand and greater adoption of digital spaces by small businesses and corporations, a reduced earnings estimate has impacted investor confidence. The company is under a test of resilience against the macroeconomic factors and logistics issues.
A 15% increase in net sales for Q3 against 37% growth reported in the corresponding quarter last year accompanied by a steep fall in income point to the issues broader than what the balance-sheet shows. As the devastating impact of the pandemic recedes, consumers are seen turning back to physical stores. Industry-wide labor shortage, coupled with supply disruptions due to global factors is spoiling the holiday sentiment for the business. Amazon sails through these challenges, it foresees bigger challenges waiting ahead during the holiday peak. Assuring that the company is making its efforts to minimize the impact on customers and selling partners during holidays, CEO Andy Jassy carefully puts it, “In the fourth quarter, we expect to incur several billion dollars of additional costs in our Consumer business… It’ll be expensive for us in the short term, but it’s the right prioritization for our customers and partners.”