It turns out Amazon (AMZN 3.43%) is mortal.
After years of breakneck growth, shares of the e-commerce stock plunged Friday after the company called for fourth-quarter revenue to grow just 2% to 8%, slower than the pace of inflation. Currency-exchange headwinds accounted for 460 basis points of the expected slowdown, but the forecast still shows the company struggling to grow in a difficult economic environment. It also shows that Amazon's historical growth rate of 20% or more could be a thing of the past.
While it's understandable why the stock fell 6.8% on Friday even as the Nasdaq soared nearly 3%, one number from Amazon's report that was largely ignored shows why the stock still looks attractive.
Image source: Amazon.
The ad biz is still booming
Companies that rely on digital advertising like Alphabet, Meta Platforms, and Snap flopped in the third quarter. All of them cited macroeconomic headwinds, saying that advertisers were lowering their budgets in anticipation of a possible recession and lower consumer demand.
However, Amazon, which is now the country's third-largest digital ad platform behind Google and Facebook, posted much stronger results in its ad business. Its advertising segment jumped 25% in the quarter, or 30% in constant currency, to $9.54 billion, approaching an annual run rate of $40 billion.
Amazon doesn't report operating income for advertising, but it's fair to assume it generates high margins for the business. Amazon dominates e-commerce with roughly 40% market share in the U.S., and third-party marketplace sellers make up most of those sales. For them, Amazon's page listings are highly valuable digital real estate at the so-called bottom of the marketing funnel. According to one marketing report, successful Amazon ad campaigns cost at least $50 to $100 per day, and Amazon has millions of stock-keeping units (unique items) for sale on its website, creating a plethora of monetizable ad space.
The company essentially has an advertising monopoly with its third-party sellers. There's no other place for them to go that's going to generate the same direct return on investment, and there's no e-commerce marketplace that's nearly as big.
Peers like Google and Facebook have historically generated operating margins around 30%. If you assume the same for Amazon, the ad business would have brought in nearly $11 billion in operating profit in the last four quarters. That profit stream may not stand out in a company as large as Amazon, but overlooking it would be a mistake.
A vast network of competitive advantages
Amazon is facing a variety of headwinds both external and of its own making. The company overexpanded its warehouse footprint and also hired too aggressively in its retail division. As a result, the company closed or canceled plans for dozens of warehouses and has frozen hiring for some business segments like retail.
Additionally, macroeconomic headwinds are forming in both its e-commerce and cloud-computing divisions, the main reasons for the weak fourth-quarter revenue growth. Inventory levels remain elevated like they are for many of its retail peers too.
Those challenges are distracting from Amazon's long-term competitive advantages, and it has many of them in addition to advertising, including its Prime membership program, its third-party marketplace, Amazon Web Services, and its logistics network.
Amazon still isn't as profitable as many investors would like it to be, but that's largely because the company is still investing for growth. Capital expenditures were $66 billion in the last year as the tech giant added new warehouses and data centers for AWS, but the company expects those expenses to come down. CFO Brian Olsavsky indicated as much on the earnings call, saying, "As far as new normal, we're working very hard to make sure that current profitability is not the new normal, and we'll see how quickly we can make improvements."
There's no doubt the fourth-quarter guidance is disappointing for investors, but it's a mistake to think the current challenges will last forever. With macro headwinds likely to be temporary and profit centers like advertising still growing rapidly, the company should be significantly more profitable a year from now.
