Amazon (NASDAQ:AMZN) has strategically invested in its fulfillment network over the last five years, leasing planes, buying trucks and vans, and contracting pilots and drivers for deliveries. For the most part, Amazon has built its network to operate synergistically with its third-party delivery partners like UPS (NYSE:UPS). But the tech titan's sending a message that that's about to change.
The superhub is coming
Amazon announced plans for an air hub at Cincinnati/Northern Kentucky International Airport (CVG) in 2017. It broke ground in 2019, and it'll start moving packages around the country later this year.
The hub at CVG will operate similar to UPS' hub in nearby Louisville. Amazon will route much of its air traffic through CVG, moving millions of packages in and out of the airport every day.
The air hub will enable Amazon to use its warehouse and shipping capacity more efficiently. If it can move items from a warehouse on one side of the country to a customer's doorstep on the other side of the country in one day, it doesn't have to rebalance inventory across its warehouses to keep items close to customers. That will also help it expand its one-day shipping benefit for Prime customers to more items.
Opening the hub at CVG and ramping up its capacity will dramatically reduce its reliance on third-party shipping partners like UPS. Amazon already delivers about two-thirds of its packages through its own network of planes, trucks, and vans. Amazon appears capable of handling nearly 100% in the long run.
More planes and owning them outright
Amazon leases all of the planes it uses for its Amazon Air operations through various companies. But the retail giant made a shift in strategy this year, announcing the acquisition of 11 aircraft: four from WestJet Airlines and seven from Delta Air Lines. These aircraft need to undergo conversion from passenger to cargo planes, and they'll be put into operation in 2021 and 2022.
"Having a mix of both leased and owned aircraft in our growing fleet allows us to better manage our operations, which in turn helps us to keep pace in meeting our customer promises," Sarah Rhoads, Vice President of Amazon Global Air said in a press release. Amazon will have greater control over its future operating expenses by owning the planes outright, which will translate into operating leverage long-term.
As Amazon's cargo capacity continues to climb, especially with the opening of the CVG hub, it could move to acquire more planes instead of leasing.
More spending on transportation is coming
Amazon's just getting started in building out its logistics network. The CVG hub will have capacity for 200 takeoffs and landings per day, and it'll require about 100 planes servicing the airport to meet that capacity. After the 11 aircraft it just acquired, it has just 91 planes under contract, with far fewer actually operating today.
"We do see continued expansion and capex, specifically in our transportation area. So that will be the start of probably a multiyear period where we're higher on capex for that," CFO Brian Olsavsky said during Amazon's third-quarter earnings call.
Investors should expect Amazon's spending to continue increasing over the next few years, as Olsavsky noted. And as it ramps up to fill the capacity of its CVG hub and builds hubs at other airports (including Leipzig/Halle Airport in Germany), the company could see pressure on its operating margin. But as it fills out its fleet of planes and reaches full capacity at its hubs, it should see greater long-term operating margin as a result.
The good news is Amazon has already shown hints of its ability to produce very strong operating margin when it's running at or near capacity. Its second- and third-quarter operating profits showed the possibility of a 10% operating margin if you removed the impact of its COVID-19-related spending. Taking greater control over its own logistics can raise that margin potential even higher.