Amazon (AMZN 1.34%) has earned a spot in Warren Buffett's Berkshire Hathaway portfolio. The e-commerce retailer is buzzing with the news of its recent stock split. While the split takes center stage, it's easy to forget the company's struggles in 2022, which led to the price falling by 25%, split-adjusted.
What has caused Amazon's stock to be down considerably this year, and is it likely to bounce back?
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Amazon's pandemic hangover
Amazon's sales exploded during the initial phases of the pandemic. Folks hesitated to shop in person during that time, and non-essential businesses were temporarily closed. Amazon seemed tailor-made to thrive in that backdrop. And thrive it did with sales and earnings rising by 37% and 82%, respectively, in 2020.
Note that Amazon grew revenue by 37% from a base of $280 billion in 2019. The rate of increase meant sales growth of $105 billion in absolute terms. As you might imagine, expanding a business by over $100 billion in a single year is no easy feat. Management needed to invest in its capability to serve the rapid surge in customer demand.
Amazon CEO Andy Jassy elaborated on the challenge in the company's earnings release on April 28, saying, "Our consumer business has grown 23% annually over the past two years, with extraordinary growth in 2020 of 39% year-over-year that necessitated doubling the size of our fulfillment network that we'd built over Amazon's first 25 years -- and doing so in just 24 months."
AMZN Revenue (Annual) data by YCharts
Unfortunately, online sales have slowed since economic reopening gained momentum in 2021. In combination with the rapid expansion of its capacity, that trend has left Amazon with more than it needs right now. Management forecasts that operating income in the second quarter will fall to $1 billion at the midpoint. That's a dramatic fall from the $7.1 billion it reported in the same quarter last year. Further, it guided for revenue growth of 5% at the midpoint for the second quarter.
The modest growth and relatively static nature of its expenses mean it will take some time for Amazon to reach an optimal balance.
More profitable segments can lift the stock higher
Even though Amazon's online sales segment will take time to adjust, its more profitable segments can carry the load in the near term. Amazon Web Services revenue accelerated revenue growth to 37% in the quarter ended in March, up from 32% in the same time the prior year. The segment generated an operating profit margin of 35.3% in Q2. Compare that to Amazon's overall operating profit margin, which has never exceeded 6% in the last decade.
AMZN Operating Margin (Annual) data by YCharts
Amazon has also developed a robust ad inventory that marketers covet. Businesses can place ads in front of Amazon's over 200 million Prime members, who have access to fast and free shipping. While the company does not break out the profitability of this segment, it can be inferred (by looking at profit margins of other digital advertising businesses) to have a higher profit margin than e-commerce sales. In the quarter ended in March, Amazon's ad revenue jumped by 25%.
So, yes, Amazon's stock can bounce back. It will likely require the more profitable segments to sustain robust revenue growth while demonstrating sequential progress in bringing costs down to meet the moderating demand in the online sales channel.
