Amazon (AMZN 0.50%) and PepsiCo (PEP -0.02%) are fortunate to benefit from sales growth during the coronavirus pandemic. That is not to say they are not facing challenges. Amazon is investing billions of dollars to meet the increasing demand. And PepsiCo is leaning on its snacks segment as people staying home consume fewer beverages.
Things will be changing again, now that there is some very positive news on a coronavirus vaccine. Let's take a closer look to determine if Amazon's better growth prospects outweigh PepsiCo's higher profit margins.
Amazon has better growth prospects
Amazon started the year with 150 million Prime members and has likely added millions more. Revenue from subscription services, which includes fees paid by Prime members, increased to $6.6 billion in the most recent quarter. That's more than 25% higher than the end of 2019 when the company first reported having 150 million Prime members.
Prime members shop more often and spend more than non-members. Access to a massive base of shoppers attracts third-party sellers to Amazon, and Amazon collects a percentage fee on all third-party sales on its site.
Prime members also pay a subscription fee either annually or monthly, a stable source of recurring cash flow. True, Amazon continuously needs to invest billions of dollars into its fulfillment capabilities to get items to customers. But as it is scaling up, its profits are expanding (see chart). If more people in an apartment building are Amazon customers, delivery trucks can drop off several orders in one location. And the incremental cost of servicing each additional customer is likely to continue decreasing.
Then there is its lucrative Amazon Web Services segment, which is growing at nearly 30% and sustaining a 30% operating profit margin. Admittedly, competition is heating up from other cloud service providers Microsoft and Alphabet. Still, Amazon is the clear leader in a segment that's growing rapidly and profitably.
Pepsi is more profitable
PepsiCo is home to some of the most globally recognized snacks and beverages, including those from Lays, Gatorade, Quaker, and Pepsi. Its portfolio of products helped it weather the storm during the pandemic. While sales of its beverages faced pressure as people stayed home, its snacks segment benefited from consumer pantry loading as people prepared to hunker down.
Still, the company is facing a longer-run headwind from people actively looking to reduce sugary drinks and unhealthy snacks. While the company is aware of this trend and is attempting to diversify into healthier options, it might take many years for the bulk of its revenue to come from healthy products. Moreover, increased health consciousness may be one of the aftereffects when the coronavirus pandemic has run its course.
And while PepsiCo has consistently maintained higher profitability when measured by the earnings before interest, taxes, depreciation, and amortization (EBITDA) margin, Amazon is closing the gap quickly. If Amazon continues growing revenue faster than PepsiCo, it might only be a matter of time before Amazon is more profitable.
While it is true that PepsiCo is the more profitable business, Amazon has the edge when it comes to revenue growth. Over the last 10 years, Amazon has grown revenue at a compound annual growth rate (CAGR) of 27.6%, while PepsiCo has managed a CAGR of 4.5%. That wide gap in growth, if continued, will allow Amazon to overtake PepsiCo in profitability in the not-too-distant future. Further, the recurring nature of Prime membership fees and those that businesses pay for cloud services gives the company steady cash flow to invest in fulfillment, content, and technology to continue improving its services.
In determining which consumer discretionary stock is a better buy, Amazon's larger and more sustainable growth prospects give it the edge over PepsiCo.