Here’s Why Amazon Might Remain in the Red for Much Longer

Amazon's spiraling operating costs are likely to grow as long as the company continues to rapidly increase its revenue. What's this mean for Amazon and its investors?

May 22, 2014 at 9:13AM

Amazon (NASDAQ:AMZN) has for a long time now been the most dominant online retailer. Its revenue growth is unparalleled by those of brick-and-mortar retailers such as Target and Wal-Mart (NYSE:WMT).

However, Amazon's top-line growth of late seems to bear an inverse correlation with its bottom line -- one is steadily rising while the other one is falling. However, this does not seem to bother investors too much as they seem enamored of its rip-roaring growth and business model.

Amazon investors got some reprieve when the company started posting positive earnings last year, albeit at the expense of revenue growth, which slowed down a bit. In a strange twist of fate, the company provided guidance for the second quarter of the current year and said that it expects its revenue to grow between 15%-26%, but expects to make an operating loss of $(55) million-$(455) million. Amazon managed to pull in a $79 million profit in last year's second quarter.

Spiraling operating costs
Amazon seems to be facing the bugaboo of many companies which are experiencing high revenue growth -- spiraling operating costs. The online giant added 33,000 new workers to its payroll during the last 12 months, or 36% of its workforce, not counting temporary workers. The company's employee count now stands at 134,600. That growth in its workforce was more than 1.5 times its revenue growth of 23% during the year.

Amazon also saw significant increases in other operating costs. The company's shipping cost as a percentage of sales had shown signs of stabilizing at around 4.6%-4.7% in recent quarters, but it has crept up again to its 2011 level of 5%. Amazon recently introduced the Amazon Prime Pantry service for Amazon Prime shoppers. Shoppers are allowed to fill up a four-cubic-foot box with up to 45 pounds of select items and have them shipped for just $5.99. This is likely to put some more pressure on overall shipping costs.

Amazon's net property and equipment shot up a hefty 60% last year, a clear reflection of the huge investments the company has to make to support its rapidly growing sales.

Amazon Prime hike is a wild card
Amazon hiked the price of Prime by $20 from $79 to $99. The company has yet to release figures to show whether there has been any material attrition in its subscriber base, as many investors had feared. However, if Costco's (NASDAQ:COST) example is any indication, then Amazon Prime's price hike might not lead to a mass exodus of members.

Costco hiked its membership fee by 13% in 2000, 12% in 2006, and 10% in 2011. However, its membership has remained undeterred by the price hikes, growing at around 9% per annum. Costco depends very heavily on its membership fees to boost its bottom line -- the company made a net profit of $2.04 billion on sales of $102.87 billion in fiscal 2013. Its membership fees clocked in at 2.29 billion, which implies that Costco would have posted an operating loss had it not received the huge boost from its membership fees.

Amazon Prime members get free two-day shipping on most purchases as well as free streaming media. It appears as if the program's benefits still outweigh its costs even at the higher price. However, with the assumption that 5%, or 1 million, of Amazon Prime members decide not to renew their subscriptions on account of the higher fees, Amazon would still make about $301 million more from the service this year than it did last year, assuming no new members join the program.

However, Amazon said in its guidance that it might post a loss of up to $455 million, which clearly indicates that the positive effects of the Amazon Prime hike might be cancelled out by its skyrocketing operating costs.

Amazon's case is not unique to retail. Many rapidly growing companies, including tech companies such as Yelp and Salesforce, seem to struggle to make profits. Yelp's top line grew 66% in the first quarter of the current fiscal year, but the company still reported an operating loss. In fact, Yelp has never made a profit in the 10 years that it has been in business. Its close peer in the business, Angie's List, has also never made a profit even though it has been in business for 20-odd years and it has grown its revenue at a fast clip. All of these companies share similar issues -- sales and marketing costs which grow at faster clips than their revenues.

Wal-Mart is not dead money
Wal-Mart has long been the target of many up and coming retailers, including Amazon. This has had a debilitating effect on its revenue growth, and its U.S. stores have suffered same-store revenue declines in three out of the last five years. Wal-Mart's U.S. stores are, however, more lucrative than its international stores, as they enjoy an operating margin of 8% vs. 5% for its international stores.

The giant big-box retailer's stock has enjoyed an excellent run, as its price has risen with considerable aid from stock buybacks.

The company has a long history of considerable and regular dividend hikes, and the shares currently sport a dividend yield of 2.5%, which looks quite attractive.

Foolish bottom line 
It appears as if Amazon is doomed to continue making losses as long as its top line continues to expand at a brisk clip. Shareholders can, however, take some comfort in the fact that Amazon is not alone with high revenue growth but not profits. This trend seems to be the norm for other high growers, and might be the price the company has to pay to continue expanding its top line at a rapid pace.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends, Costco Wholesale,, and Yelp. The Motley Fool owns shares of and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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